Like many, I have watched wide-eyed as Bitcoin values have soared – another of the peculiar outcomes of the COVID-19 pandemic. Naturally, this has attracted many to start seeing so-called ‘cryptocurrencies’ as an investment that will generate outstanding returns in a generally low return environment. Some major financial institutions, never ones to miss out on any fad, have started offering cryptocurrencies as part of investment portfolios.
Yet, before diving in, it might be as well to understand what these offerings are and what they are not.
First of all, ‘cryptocurrencies’ are not currencies in any meaningful sense of the word. They are digital assets that we still don’t really understand. So, let’s call them what they are: cryptic digital assets – or cryptic assets for short.
What would it take to turn them into real currencies? Many things. But maybe the biggest would be if governments started accepting such cryptic assets in payment of taxes. That would create immediate and substantial demand and embed them as meaningful means of exchange. I don’t believe that any serious government will or should do such a stupid thing. Cryptic assets will not become currencies. Their role as a medium of exchange will remain marginal.
The current narrative is that these cryptic assets will come to be seen as safe haven assets in times of stress. Much like gold has been for decades. Again, this idea is problematic.
Gold has many characteristics that cryptic assets lack. First of all, history and culture. It was not so long ago that currencies were tied to the gold standard, thereby giving gold a status and level of trust that cryptic assets have never had and likely never will.
Secondly, gold is a highly liquid asset. It’s easy to buy and sell. There is a reliable market. One is unlikely to be stuck with gold if one needed liquidity. Gold is, ultimately, a physical asset (though often intermediated by proxy financial products). It cannot easily disappear overnight from your digital wallet because it has been stolen or because an exchange has gone out of business or because you’ve forgotten your password, or for a myriad other reasons.
Finally, gold has utility value in and of itself. It is used in all manner of industrial production besides its desirability for jewellery and other luxury products. None of this applies to cryptic assets.
So what drives the price of cryptic assets? There is only one thing: market sentiment.
Most cryptic assets have been structured to have limited supply in an effort to skew the supply and demand equation towards ever-increasing demand, thereby increasing prices over time. But there is no reason for wanting to buy cryptic assets other than wanting to buy cryptic assets. They have no value other than the possibility that the asset may increase in value because more people want to buy than want to sell. In other words, market sentiment.
There is a lot of talk about the distributed ledger technology on which cryptic assets sit. Interesting. But that’s just the mechanics. It has little or no bearing on what might give these assets value.
Of course, as financial markets have become progressively more dissociated from the real economy, many assets and financial products now on the market are themselves driven by market sentiment. Long gone are the days when, for instance, companies’ stock prices were based on the economic fundamentals of the companies concerned. But maybe some kind of tenuous link remains, even if only in our imagination or in the waffle of investment advisers.
But cryptic assets do not have any such link and have never pretended to. The volatility of the price of these assets simply reflects wide swings in market sentiment towards or away from them. And we all know that market sentiment is utterly unpredictable and that any successful timing of the market is based primarily on luck not skill.
Finally, it may not be long before someone, somewhere comes up with yet another idea, yet another form of tradeable asset that might improve, somehow, on the current forms of cryptic assets. If that happens, demand might well disappear − and prices will tank.
So, personally, I have decided that cryptic assets are not for me. I see them as purely speculative investments with an unknown and unknowable risk profile. Nobody knows whether they will still be flavour of the month next month or whether, for some reason, many will suddenly sour on them. Investing in cryptic assets is less reliable than going to a casino and placing your money on the number 22. With the latter, one at least knows for sure what the mathematical odds of winning or losing are. With cryptic assets, one doesn’t.
This article expresses the personal opinions of the author and must not be considered in any way as providing investment advice.
Joe Zammit-Lucia, founder of the RADIX network of think tanks
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