A Cryptic Look at New Currencies and Hoary Chestnuts

In the closing weeks of 2017, I found myself frequently reminded of that old chestnut: when your taxi driver is telling you about the best investment ever, you should already have sold. By December, it was hard to avoid a conversation about cryptocurrencies unless you were sitting alone. Even then, you probably heard one going on without any effort. And the hype was being driven largely by the accelerating market capitalisation of Bitcoin, one of the first and foremost.

What are these ‘currencies’?

In simple terms, cryptocurrencies are generated through computer code and regulated through encrypted packages across a distributed system of independent ledgers. If you use Public Key Infrastructure, e.g. Auskey, you’re already using a distributed ledger (blockchain) product.

The complex process of transactions and verifications, creates integrity, giving these cryptocurrencies credibility. Many coins are mined, creating new coins in the system up to a pre-defined limit. Others have limited issues fully available and are only obtained in exchange for traditional currency – hard cash.

What might they be best used for?

As a tool for global trading there is merit in high-speed, secure systems of transaction. If one of these currencies proves itself stable over time, it could become the chosen vehicle for international transactions, creating a tool for neutral hedging.

Are they tools for criminals and tax evasion?

Probably less so than traditional currency, particularly cash. Every transaction is public and traceable – without the need for the complex warrants required by law agencies when trying to track offshore money movements. Of course, traders may be operating on false or untraceable identities but that’s becoming harder as the internet matures.

Will they become common in business transactions or simply be an investment product?

Distributed ledger technology is already working for us behind-the-scenes to provide security and traceability in online tools, such as building management and access control systems. As markets gain better understanding of the integrity afforded, the technology will become more accepted and greater reliance will develop.

Globally, governments are looking at ways to regulate without killing off these new systems of capital representation. In time, regulation will arise, will most likely be globally replicated and should improve certainty. The products that meet regulatory demands and demonstrate long term stability will survive and become tools of trade. No doubt many will fall by the wayside as their foundations are revealed to be less than sound.

Are cryptocurrencies a suitable investment?

The integrity of a cryptocurrency is only as rigorous as its creators decide it to be. There are many methodologies employed in the foundation of each and these also need to be considered to gain an understanding of fundamental value.

Consider the differences between regular and cryptocurrencies:

  • Regular trading currencies are backed by sovereign states and released through regulated central banks. They rely on faith in the system and a global imperative to maintain stability;
  • Cryptocurrencies are created by programmers, using unregulated standards, with foundations and rules based on the limits of their imagination. They may adhere to a very intense protocol that delivers integrity, security and traceability but they may not. Establishing which ones are secure requires considerable research.

Bitcoin’s market capitalisation was US$321bn in mid-December, it was US$143bn a week ago and is US$183bn as I write. As an investment vehicle, its volatility alone classes it as speculative and high risk.

Weighting risks within a diversified portfolio provides balance and improves potential rewards and security. If you are unsure about where to start or would like a second opinion on your individual circumstance, contact our financial advisors on (08) 9367 8133.