You are Here > My Investments > Cryptocurrencies and their revolutionary architecture

Cryptocurrencies and their revolutionary architecture

Sep 14, 2018

By Stéphane Monier, Chief Investment Officer, Lombard Odier Private Bank

Cryptocurrencies and their revolutionary architecture Investment experts have often sceptically dismissed cryptocurrencies as excessively volatile. Technologists have described them as revolutionary. Who is correct? Will cryptocurrencies become a mainstream asset class?

First of all, investors shouldn’t fall into the trap of confusing cryptocurrencies with the technologies that make them possible. Blockchain, the technological architecture underlying cryptocoins is, for now, far more important than the hundreds of emerging digital currencies.

At the time of writing there are more than 1 700 cryptocurrencies with a total market capitalisation of 215 billion USD1. Bitcoin, the best-known and largest example, accounts for more than 48% of the total market cap. In early August, the US Securities and Exchange Commission delayed a decision on whether to approve a Bitcoin-backed exchange-traded fund (ETF), pushing the digital currency’s decline this year to 46%2. In twelve months, the original cryptocurrency saw 93% of daily price volatility3, and suffered from a drawdown as large as 68%.

Bitcoin: a highly volatile cryptocurrency

With such volatility possible in the best-known virtual currency, the real value may in fact be the underlying architecture or technology – blockchain – that makes it possible to trade cryptocurrencies.

Digital uniqueness

Blockchain is best defined as a digital ledger software that provides a verifiable public record of every transaction. It stores individual transactions in blocks (sets of data) attached to other blocks in an encrypted and chronological order to create a secure chain. Every user can be sure that every other user is seeing exactly the same thing, with no intermediaries.

Blockchain is not a product nor a service; it’s a revolutionary way of organising, recording and distributing information. Immediate applications are in logistics and inventory management as well as compliance and account reconciliation, limiting the scope for human error. Companies large and small are experimenting with this technology as it allows us to simplify much of what was complex or prone to error or fraud through traditional paperchains and digital databases, and this is a key breakthrough.

The irreversible nature of transactions has profound implications for the finance industry, and the most promising uses could be in post-trade reconciliation. But while the hopes for blockchain’s revolutionary impact are high, deployment is taking time and investors seem to be overestimating the speed of adoption.

Since we last wrote on the subject one year ago, institutions such as the Nasdaq and the Australian stock exchange ASX, have communicated about the adoption of blockchain, but scaled down their plans for immediate implementation4. This is due to the complexity of financial processes and the lack of agreed standards. But as operational set-ups progressively adapt, we expect more blockchain innovations and applications in the medium term.

And while blockchain is developing, cryptocurrencies are facing their own set of challenges. One of the constraints at the moment is that investors lack a single source of market intelligence for all currencies. The situation is a little like the fixed income market before the arrival of the Bloomberg terminal when there was little transparency or price data and investors had to call brokers for quotes and prices were set by a small group of dealers.

And if pessimists about the technology are right, governments will sooner or later take an interest in tracking cryptocurrency transactions. That would rule out cryptocurrencies in their current forms ever replacing fiat currencies, which are essentially tender that a government defines as something that you have to use and accept.

That doesn’t prevent cryptocurrencies being used by investors as a hedge against turbulence in fiat currencies and to avoid capital controls. Nor has such thinking prevented governments including the US and Germany setting out guidelines for declaring capital gains for tax purposes. In the US, for example, Bitcoins are taxable as property and the European Union’s Court of Justice has found that virtual currencies are exempt from value added taxes because they are a means of payment.

Debates about whether there is any intrinsic value in cryptocurrencies are, we believe, beside the point for now. There are, after all, debates about whether there is any intrinsic value in gold, for example. Such discussions will become irrelevant as digital currencies mature, and grow in use and acceptance.

Critical mass

The central question in the debate about cryptocurrencies isn’t whether they will become, in time, part of the investment landscape, but rather, whether their use will reach a critical mass and what governments would then be willing, or able, to do to regulate and tax their exchange.

It seems to us that over time, volatility in cryptocurrencies may decline as they mature, becoming more widely used and exchanged. That depends on their supply remaining limited (Bitcoin for example is limited to a total supply of 21 million, compared with 17.1 million in circulation today) and cryptocurrencies continuing to be fully-backed by ‘real’ cryptocoins, unlike fiat currencies held by banks.

Cryptocurrencies are clearly becoming a part of the global financial landscape. But for now, regulators and central banks are resisting efforts to treat cryptocurrencies the same way as their fiat counterparts. The SEC in the US already denied an ETF listing in July and now has until 30 September to allow ‒ or not ‒ the most recent fund listing to go ahead. And that hasn’t prevented Goldman Sachs Group Inc. looking at providing custody for cryptocurrencies, according to Bloomberg5.

In the meantime, it makes more sense to follow the technologies behind blockchain. And for any investor willing to add a cryptocurrency to their portfolio, the traditional principles of diversification and security apply, as well as the first rule of not investing in anything that you don’t fully understand.


1 https://coinmarketcap.com/
2 Source: Bloomberg, from 1 January to 31 July 2018
3 Annualised, from 1 August 2017 to 31 July 2018. Source: Bloomberg, calculations Lombard Odier
4 https://www.bloomberg.com/news/articles/2018-07-31/blockchain-once-seen-as-a-corporate-cure-all-suffers-slowdown
5 https://www.bloomberg.com/news/articles/2018-08-08/bitcoin-tumbles-to-3-week-low-as-sec-postpones-etf-decision

This post was based on a press release issued on behald of Lombard Odier Private Bank.

0 Comments

Submit a Comment

Your email address will not be published. Required fields are marked *

Maya Fisher-French author of Money Questions Answered

Previous Articles

FSCA issues crypto health warning

The FSCA wants to warn the public that if something goes wrong with your crypto investment, you are not likely to get your money back and will have no recourse against anyone. The Financial Sector Conduct Authority (FSCA) has noted with concern the increasing volume...

Listen: How to select the right ETF in this crazy market

In this podcast, @Satrix_SA Chief Investment Officer, Kingsley Williams joins Maya Fisher-French (@mayaonmoney) to provide some guidelines around selecting the right ETF for your needs. He also gives us some perspective on the investment landscape for 2021. How do we...

How to pay less tax using Section 12J

By Zane De Decker, MD Flyt Property Investment. Did you know that an investment made into a Section 12J registered fund qualifies for a 100% tax refund? What that means, in simple terms, is that 100% of what you invest is deducted from your taxable income by SARS via...

What is the tax benefit of an RA?

A reader asked: “I am 38 years old and I am not happy with the returns on my Retirement Annuity (RA). I am considering scaling down my monthly contributions and rather investing the money offshore myself through a stockbroker. What are the tax differences once I reach...

FSCA to regulate crypto-assets

Globally there has been an increase in the number of retail investors wanting to purchase crypto-assets. Unfortunately this has seen an exponential increase in the number “crypto-scams”. This is where unregulated entities and individuals promise unrealistic returns...

Hindsight, foresight and change at the speed of light

By Izak Odendaal and Dave Mohr, Old Mutual Wealth Investment Strategists. Hindsight, they say, is 20/20 vision. This being the year 2020, it turned out to be truer than ever before. For investors, and all of us really, there was so much about this year that was...

Investment lessons from a horrible year

2020 has reset the bar when it comes to how we evaluate a horrible year, but an "annus horribilis" doesn’t have to be an "investment horribilis". In a speech marking the 40th anniversary of her accession, Queen Elizabeth said, “1992 is not a year on which I shall look...

Vaccine news a shot in the arm for recovery stocks

The result of the US election was big news for the world, for the economy and for markets. But as an investor I’ve always considered the pandemic of far greater consequence. Joe Biden’s electoral success was duly eclipsed by the news on Monday that an effective...

Pin It on Pinterest

Share This