Putting cryptocurrencies in context

For some time now, there has been a great deal of public interest in cryptocurrencies and, specifically, in Bitcoin.

In this blog, we provide you with some context about the cryptocurrency phenomenon and its media coverage.

Definitions and descriptions

Let’s start with some elementary definitions and descriptions:

  • A cryptocurrency is the generic term for a form of digital asset based on a network that is distributed across a large number of computers.
  • This structure allows such currencies to exist outside the control of governments and central authorities – which is part of their appeal for many.
  • The word “cryptocurrency” is derived from the encryption techniques which are used to secure the network.
  • Cryptocurrencies claim to make it easier to transfer funds directly between two parties, without the need for a trusted intermediary, such as a bank or credit card company.
  • Bitcoin is the most popular cryptocurrency. It is a virtual currency embedded in a computer file which is stored in a ‘digital wallet’ app on a smartphone or computer.
  • Every single transaction is recorded in a public list called the blockchain.

Media coverage of the cryptocurrency phenomenon

Cryptocurrencies (including Bitcoin) have inspired a passionate debate in investment and financial media circles over the recent past.

In 2021 alone, The New York Times published four articles and opinion pieces about this fascinating financial phenomenon:

This latter piece was authored by Paul Krugman, the Distinguished Professor at the City University of New York Graduate Center. Professor Krugman won the 2008 Nobel Memorial Prize in Economic Sciences for his work on international trade and economic geography. He wrote:

“The dream of instant riches has been around for as long as money. Only the source of the fortune changes. Gold, tulips and mortgage-backed securities have all taken a turn as the sure-fire investment vehicle of choice for investors in a hurry. Now it’s cryptocurrencies.

(…) Many are now worthless, but nearly 80 cryptocurrencies have market capitalizations above $1 billion and they have won the affections of more than just investor bros. So far this year, U.S. venture capitalists have pumped $4.2 billion into at least 280 cryptocurrency deals, data collected by PitchBook shows. In late June, the venture capital firm Andreessen Horowitz raised $2.2 billion for a crypto-focused fund, its third.”

The Economist, in a recent article entitled, Is the Bitcoin dream over? warned:

“Cryptocurrencies such as Bitcoin promised to upend the financial system and replace conventional money with assets outside the control of governments and banks. Yet, a single tweet can cause its value to rise or fall sharply. This volatility makes it a lousy medium of exchange. Instead, Bitcoin has now become an asset class. Its future is far from certain. El Salvador has become the first country to adopt Bitcoin as legal tender, while other countries, such as China, are closing the door on it.”

Sometimes it’s hard to separate the truth from scaremongering when it comes to cryptocurrencies, but in the interests of clarity, we want to make the following observations.

Two cryptocurrency characteristics: anonymity and volatility amplified

Volatility

All cryptocurrencies, because of their fundamentally speculative nature, are subject to fluctuations in value – sometimes extreme ones. Volatility is also the price that Bitcoin investors pay for its limited supply and its lack of a central bank to control that supply – precisely the features proponents say give it value.

Anonymity

The use of cryptocurrency is anonymous since the transactions supporting them are all stored on an open ledger – the blockchain, as mentioned earlier. This means that the data is available to view by anyone at any time, and that’s a major advantage for those

that value their online privacy and are wary of handing over too much of their digital data.

However, it has also led to the inevitable adoption of the technology by the criminal fraternity.

The black market and the dark web are big users of cryptocurrency. Criminals value the ability to send vast sums of money anywhere in the world with a few taps of their phone.

It is so that many advocates of Bitcoin in particular and cryptocurrencies in general, insist on a degree of anonymity that others operating in more traditional areas of finance think questionable. The fact that criminal organizations primarily use them also crashes with some wealth managers’ values (TWM Group within them).

Bitcoin balance sheet

Hesitancy about Bitcoin finds support in, among many other sources, Nasdaq. The world’s first electronic exchange, Nasdaq, was launched as a global electronic marketplace for buying and trading securities.

Most of the world’s technology giants, including Apple and Facebook, are listed on Nasdaq, so we might have expected them to be less guarded in their support of the cryptocurrency phenomenon, specifically Bitcoin. Nasdaq reports:

“Bitcoin represents one of the most significant economic inventions in history. For many people, it signifies hope and has converted believers from astute banking leaders to seasoned CEOs into ardent supporters. However, its perceived volatility and endless geopolitical uncertainty make some people consider it unsuitable as a true store of value.”

Conclusion

The Crypto Nomads: Surfing the World for Risk and Profit article referenced earlier contained an observation from Timothy Massad, a former chairman of the Commodity Futures Trading Commission, which regulates derivatives: “I am not saying this is going to cause the next financial crisis. But could this be something like the butterfly that flaps its wings in Brazil that sets off a tornado in Texas?”

Let’s not forget that derivatives of a different kind played a crucial role in the financial meltdown of 2008, when highly leveraged bets on home mortgages went bad and helped cause the collapse of major financial institutions.

So, while the popularity of cryptocurrencies is growing, and some businesses race to keep up with expanding demand for their use, it may be too early to know just how big of an impact cryptocurrencies will have in the long term.

As part of our commitment to keeping our clients well informed, we have produced an explanatory video on the subject – which we encourage you to view.

You can read more about our Investment Process here, and feel free to Get in touch if you have questions or comments.

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