Everyone has a view on cryptocurrency, and in most cases it’s a tale of extremes. On one side sit the sceptics, who believe that cryptocurrencies are one big Ponzi scheme that will self-implode like the ‘tulip mania’ of the 17th century Dutch Golden Age, which saw the price of tulip bulbs reach incredible highs and then dramatically collapse. On the other side are the ‘true believers’, who believe cryptocurrencies such as Bitcoin are not just a new form of currency but a symbol of decentralisation and freedom from central banks and governments.
I am by no means an expert on cryptocurrency and blockchain technology, however it is worth noting the growing interest by various institutions in cryptocurrency. Probably the highest profile announcement was Tesla’s decision to buy US $1.5 billion in bitcoin and its announcement that it would start accepting bitcoin as a payment method for its products.
The sceptics would say, yeah but it’s Elon Musk, the guy who sends rockets into Mars and wants to insert computer chips into people’s brains. However, we have seen institutions such as Mastercard indicate that it would bring cryptocurrencies onto their network, and recently JPMorgan Chase & Co strategists have been floating the idea of investors using cryptocurrencies such as bitcoin as a way of diversifying portfolios. According to a survey released by specialty insurer Hartford Steam Boiler Inspection and Insurance Company, 36% of small- to mid-sized businesses in the US accept digital currency for payments for goods and services.
From an investment perspective, proponents of cryptocurrencies such as bitcoin have considered the digital currency from two main perspectives. Firstly, bitcoin can be viewed as a store of value akin to gold. This view has been amplified in a world where central banks have been flooding economies with money via their quantitative easing programs since the time of the global financial crisis. The decentralised nature of bitcoin means that the price is not influenced by central banks, which is the case with traditional fiat currencies. Interestingly the uptake of cryptocurrencies has been strongest in some emerging economies where arguably they are more prone to government instability, and in some instances they have experienced the effects of hyperinflation, which has rendered traditional currency worthless.
Secondly, bitcoin offers ‘frictionless’ transacting, whereby the blockchain technology underpinning the digital currency uses a public ledger system to validate transactions, effectively cutting out the ‘middleman’, hence increasing the speed of transactions and reducing costs. The potential applications of blockchain technology beyond cryptocurrencies are far reaching and many institutions are actively exploring its application in areas such as property transfer, execution of contracts and identity management.
However, there are fundamental questions that need to be addressed before cryptocurrencies can become mainstream. From an investment perspective, how do you value crypto assets? What are you valuing and what metrics do you use to value it? These are valid questions and, in my view, we are yet to address them adequately as an industry. Questions around the secure storing of cryptocurrencies and the associated risks with the different methods, ranging from holding assets on an exchange through to storing assets via a digital wallet using web-based or hardware solutions, all have their pros and cons in terms of security, and need to be considered when allocating assets to crypto. For large institutional investors such as super funds, how they hold investments is very important, and having a custodial structure supporting crypto assets will be imperative for the asset class to gain traction in that market.
We have seen BNY Mellon, the world’s largest custodian bank, announce that it will roll out a new digital custody unit later this year to assist clients in dealing with digital assets. Furthermore, we have already seen crypto ETFs launched in Canada and we will no doubt see managed fund and ETF structures reach our shores at some stage, which will alleviate some of the issues associated with storing crypto.
Another area which has come under the spotlight regarding crypto currencies is ESG (environmental, social, and governance) concerns over the energy required to mine cryptocurrencies. According to the Cambridge Center for Alternative Finance, coal accounts for over 38% of energy consumption by miners. Given ESG is a growing part of people’s investment considerations and processes, this will be a relevant aspect of crypto which will need to be explored further.
Finally, we expect the sector to become more regulated as cryptocurrencies gain greater acceptance. While this does create uncertainty, it is also an important step for digital currencies to become accepted more broadly.
Cryptocurrencies and the associated implications of blockchain protocols and their applications are arguably still in their infancy and will dramatically evolve over time. While we don’t expect cryptocurrencies to suddenly appear within your standard diversified portfolio in the near future, to simply dismiss the sector without trying to understand it would be a mistake. At a minimum, clients are increasingly likely to ask questions about cryptocurrencies, particularly as we see product structures such as ETFs and managed funds make the sector more accessible for investors. The more we learn, the more we will be able to provide an informed response to our clients.