Global in­vestors are putting real value in bit­coin and other dig­i­tal cur­ren­cies

Houston Chronicle Sunday - - BUSINESS - By Jon­nelle Marte

Bit­coin and other vir­tual cur­ren­cies are on a tear this year, sur­pass­ing the re­turns seen in stocks, bonds and most other investments.

The price of bit­coin has tripled since the be­gin­ning of the year, surg­ing above $3,000 for the first time last week be­fore drop­ping by more than 10 per­cent the next day. Re­turns for ethereum — a lesser known but quickly grow­ing cryp­tocur­rency — have been even more dra­matic: It’s gained nearly 5,000 per­cent, touch­ing a record price of $407 Mon­day be­fore com­ing down.

Mean­while, the amount of cash in vir­tual cur­ren­cies has bal­looned. The mar­ket cap for cryp­tocur­ren­cies is now more than $100 bil­lion, up from roughly $20 bil­lion at the be­gin­ning of the year, ac­cord­ing to cryp­tocur­rency tracker CoinMar­

So what is go­ing on? Some re­cent events may have con­vinced in­vestors that these cur­ren­cies are here to stay — in­clud­ing a move from the gov­ern­ment of Ja­pan to make bit­coin le­gal. But that only ex­plains part of the rise, cryp to cur­rency ex­perts say.

In­vestors have been clam­or­ing for a slice of the vir­tual mar­ket based on po­ten­tial uses that have yet to ma­te­ri­al­ize, says Gar­rick Hile­man, a re­search fel­low at the Cam­bridge Cen­ter for Al­ter­na­tive Fi­nance. For in­stance, the cur­ren­cies have the po­ten­tial to dis­rupt the way start ups raise money or how cer­tain fi­nan­cial trans­ac­tions are han­dled, ex­perts say. But they’re also known to b evolatile.

To give you a bet­ter un­der­stand­ing of the dig­i­tal cur­rency world, we an­swered some key ques­tions about these tools and high­light some of their perks and risks: What are they?

A cryp­tocur­rency is a dig­i­tal al­ter­na­tive cur­rency. That means it doesn’t have phys­i­cal bank notes or coins and is not is­sued by a gov­ern­ment.

Bit­coin, one of the best­known cryp­tocur­ren­cies, was started in 2009 by a soft­ware de­vel­oper us­ing the pseu­do­nym Satoshi Nakamoto. At the start of the year, bit coin made up 87 per­cent of the cryp­tocur­rency uni­verse, but that mar­ket share has dropped to about 40 per­cent as other cryp to cur­ren­cies have gained trac­tion, ac­cord­ing to CoinMar­

Bit­coin gained pop­u­lar­ity as a way to send money quickly and pretty much anony­mously, since trans­ac­tions don’t need to be linked to a cer­tain iden­tity. Trans­ac­tions are tracked on an on­line data­base called blockchain.

Peo­ple use bit co into send money to friends and rel­a­tives in other coun­tries. But bit­coin has also been used for il­licit trans­ac­tions, such as to buy and sell drugs or to pay hack­ers dur­ing ran­som ware at­tacks. What is ethereum?

Toronto na­tive Vi­ta­lik Bu­terin de­vel­oped a younger cryp­tocur­rency called ether in 2013, but most peo­ple re­fer to the dig­i­tal cur­rency as ethereum, the name for the blockchain it trades on. Ethereum sets it­self apart for its abil­ity to in­cor­po­rate so-called smart con­tracts, or com­put­er­based con­tracts that only pay par­ties af­ter cer­tain con­di­tions have been met and ver­i­fied. (Imag­ine if you could set up an al­go­rithm that au­to­mat­i­cally pays your dog walker only af­ter you have ev­i­dence that your dog has been walked the agreedupon dis­tance, Hile­man says.)

In­vestors are ex­cited by the po­ten­tial for these smart con­tracts, which could make it eas­ier for star­tups to raise money and for busi­nesses to com­plete in­ter­na­tional trans­ac­tions, says Eric Piscini, a prin­ci­pal at Deloitte Con­sult­ing who fo­cuses on cryp­tocur­ren­cies. One com­mon use for the smart con­tracts is for com­pa­nies to raise money through what’ s known as an Ini­tial Coin Of­fer­ing, which gives in­vestors a chance to buy a new kind of dig­i­tal to­ken. Why are prices so high?

De­mand for bit­coin and ethereum has soared over the past few months af­ter a few changes contributed to their le­git­i­macy. In April, Ja­pan rec­og­nized bit­coin as a le­gal cur­rency, boost­ing de­mand for the vir­tual coins.

Some in­vestors ex­pect that other coun­tries in Asia, in­clud­ing South Korea and Malaysia, may follow Ja­pan’ s reg­u­la­tory frame­work and be­gin to ac­cept bit­coin as a le­git­i­mate cur­rency, says Dmitry Lazarichev, co-founder of Wirex, a plat­formwhere peo­ple can send and re­ceive dig­i­tal cur­ren­cies.

But some ex­perts say the ris­ing prices of these cryp tocur­ren­cies maybe based on spec­u­la­tion. In­vestors are fo­cus­ing on what the dig­i­tal cur­ren­cies will be worth in the­fu­ture—and not on how they are be­ing used to­day.

Be­cause the mar­ket for cryp­tocur­ren­cies is still small, the price of these dig­i­tal cur­ren­cies can swing wildly-up—or­down—af­ter a big de­vel­op­ment like what hap­pened with Ja­pan, ex­perts say.

Cryp­tocur­ren­cies are also de­cen­tral­ized, mean­ing no gov­ern­ment or cen­tral bank is reg­u­lat­ing the cur­rency or is tak­ing steps to make sure it doesn’t move too much in any­one di­rec­tion, Hi le man says.

Prices for bit­coin and ethereum have also jumped this year in part be­cause there’s been a flurry of ini­tial coin of­fer­ings, or ICOs, which start-ups use to cre­ate new dig­i­tal cur­ren­cies. Sim­i­lar to a com­pany is­su­ing stock for the first time through an ini­tial pub­lic of­fer­ing, in­vestors can use ICOs to pur­chase to­kens is­sued by the com­pany. But in­stead of buy­ing own­er­ship in the com­pany, in­vestors are buy­ing ac­cess to the com­pany’ s prod­uct or ser­vice, Hi le man says.

To­kens can be­come more valu­able if a startup — say a com­pany try­ing to de­velop a new on­line stor­age sys­tem — is suc­cess­ful, he says. The to­kens can also be­come worth­less if the startup fails. How do I track them?

Sev­eral web­sites track the price of cryp­tocur­ren­cies, in­clud­ing CoinDesk. com and CoinMar­ketCap. com. What are the risks?

Be­cause the mar­ket for cryp­tocur­ren­cies is still small when com­pared with tra­di­tional cur­ren­cies, prices can be ex­tremely volatile. That means peo­ple who own the cur­ren­cies could face sud­den losses. “There is no guar­an­tee that the ex­change rate for vir­tual cur­ren­cies will be the same or higher the next day — or the next minute,” Lazarichev says.

Since the cur­ren­cies are vir­tual and un­reg­u­lated, the trans­ac­tions and ex­changes can be vul­ner­a­ble to hacks. The lack of gov­ern­ment over­sight also means that in­vestors have no guar­an­tee they’ll get their money back if some­thing hap­pens, Lazarichev says.

Peo­ple stor­ing money in a tra­di­tional bank ac­count, how­ever, have up to $250,000 of their de­posits at each bank in­sured by the Fed­eral De­posit In­sur­ance Cor­po­ra­tion.

The lat­est run-up in prices also has many ex­perts wor­ried that some of the cryp to cur­ren­cies, in­clud­ing bit­coin and ethereum, may be in a bub­ble that’s ready to pop. Don’ t put any money into vir­tual cur­ren­cies that you can’t af­ford to lose, Pi sci ni says. And if you can, you should di­ver­sify by buy­ing more than one cur­rency, he says.

In­vestors should also be skep­ti­cal of the star­tups try­ing to raise money through ICOs, ex­perts say. If the creators don’t pro­vide a de­tailed white pa­per ex­plain­ing their plans, that should beared flag. How do I buy them?

The eas­i­est way for peo­ple to buy cryp­tocur­ren­cies is to use an on­line plat­form, such as Coin­base, Blockchain and BitGo, which lets you ex­change dol­lars for dig­i­tal cur­ren­cies. In­vestors can also buy cryp­tocur­ren­cies from other own­ers us­ing peer-to-peer net­works such as Lo­calBit­coins.

In­vestors could soon have other ways to take part in the mar­ket. The Se­cu­ri­ties and Ex­change Com­mis­sion is re­con­sid­er­ing an ap­pli­ca­tion from the Win­klevoss twins for an ex­change-traded fund that in­vests in bit­coin.

Such a n ETF would track the price of bit­coin, but in­vestors would be able to buy and sell the fund as eas­ily as a stock.

The reg­u­la­tor ini­tially re­jected the ap­pli­ca­tion in March, cit­ing a lack of reg­u­la­tion in the ex­changes that are used to buy and sell bit­coin.

Karen Bleier / AFP / Getty Im­ages

The price of bit­coin has tripled since the be­gin­ning of the year, surg­ing this month above $3,000 for the first time. Some re­cent events may have con­vinced in­vestors that cryp­tocur­ren­cies are here to stay.

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