Trying to decipher crypto

When entering this minefield, remember that today’s hero is tomorrow’s zero

If there is one question from clients that’s a nightmare to answer for financial advisers, it’s: “Should I invest in crypto?” Writing about that feels like a fearful rite of passage.

These instruments have experienced eye-watering gains in recent years, making any prudent reply as to their merits look idiotic.

A diligent financial adviser is supposed to look at your asset/liability situation and calculate reasonably how that, in conjunction with the cash flows and extrapolations of your yield-earning investments, will evolve.

Cryptocurrencies have no cash flows. They are just like currencies, collectables, gold and diamonds — they have no intrinsic value. That doesn’t mean they have no value; it means their prices are determined purely by supply and demand. This dynamic hit a new note when Christie’s auctioned a digital art piece by Beeple for an astonishing $69.4m, making him one of the top three most valuable living artists.

It is clear the tech behind cryptocurrencies — the blockchain — has a bright future. Private shares, property deeds, insurance policies, certification of valuables — the list of possible applications is huge. Does this mean that ownership of crypto is critical to accessing this? That’s not fully clear.

Any item without intrinsic value relies on a single factor for the retention of its value — universal acceptance. Most people cannot reliably forecast that.

Frequently the “fiat money” argument for holding crypto gets trotted out — that central bankers and governments can’t be trusted to look after currencies as stores of value. Yet that argument hasn’t really translated well into the precious metals markets. The price of gold has been fairly static; moreover, the market cap of all cryptocurrencies created in 10 years (at about $2-trillion) is starting to look uncomfortably large next to the total amount of gold mined in thousands of years (about $10trillion).

It’s clear that the technologic effort being thrown at crypto is wide and deep, much deeper than most people appreciate. The rub is that where there is a lot of money, a lot of nastiness follows. While there are lots of really smart people building these instruments, there is also a trail of carpetbaggers and hangers-on that you should be really careful of.

The concern about crypto being a source of criminality — given that there’s some anonymity — is a mixed one. But these are, after all, distributed registries in the main, which means any largescale criminal transactions will attract the interest of law enforcement and tax authorities. But small-scale ripoffs of members of the public may go unpunished. So beware — large parts of these markets are unregulated and that means it’s a Wild West.

Suppose you were to tell your financial adviser you had, say, 50% of your assets in art. They would tell you to remember that art prices are determined by supply and demand and do fluctuate, but most importantly, your adviser would tell you that if you are going to persist with such a high allocation to art, you had better know what you are doing. Now, why would it be any different for crypto?

Cryptocurrencies are a market like any other, so won’t be immune to market behaviour. People may recall the cryptocurrency called dogecoin, which started as a joke. It now has a market cap of $9.2bn. Ha ha — quite the joke. There are more than 4,000 cryptocurrencies in circulation. If these markets evolve like cars, browsers or other tech items, there will be many contenders and few winners.

Tech markets advance in exponential ways — today’s hero is tomorrow’s zero. Bitcoin might be secure, but maybe quantum computing could crack it, maybe ethereum will overtake it or maybe the Chinese government might get miffed that 65% of bitcoin mining happens there and block it.

Researching these complexities humbled me. What I can safely say is that on average cryptocurrencies are mostly being sold by people with a lot of experience to people with less experience. Caveat emptor. ●

A reformed stockbroker, the writer is now chief investment officer and a founder at Galileo Asset Managers

Cryptocurrencies are a market like any other, so won’t be immune to market behaviour. If these markets evolve like cars, browsers or other tech items, there will be many contenders and few winners