A somewhat dubious bond salesman once said to me: “You can fool all of the people some of the time, and some of the people all of the time and that’s the market I am going for!”.

I suspect that he is probably heavily involved in initial coin offerings today. When every person on the street talks about bitcoin, it is not difficult to think that 2018 will see a bitcoin crash.

Blockchain technology may well be a super way of undertaking many types of transaction processing in a more efficient manner than current software technology allows. The question, justifiably perhaps for most people should be, so what? It may well significantly reduce transaction costs for share dealing and other activity, but is this going to represent a game changer in any sense?

It is difficult to see why this should be the case. For long term institutional investors, as against high frequency traders, transaction costs are important, but not necessarily the critical issue when it comes to investment.

It is crypto-currencies, of course, that are driving interest in blockchain technology rather than transaction processing. Bitcoin has made the initial investors millionaires or even billionaires, at least on paper.

But if, as appears to be the case, most of the market capitalisation of bitcoins is held by a very small number of initial investors, the majority of later investors face a serious risk of massive losses. The initial controlling investors need to sell their bitcoin investments to monetise their value. Selling requires an ever-increasing number of willing buyers. For an asset that produces zero income, and whose increasing value is solely determined by increasing numbers of buyers, it smacks of a Ponzi scheme. Initial investors, whether the famed Winklevoss twins – who, it seems, may have owned 1% or so of bitcoin at one stage – or others, would have to find willing buyers to monetise paper gains. Any large-scale selling by major investors is very likely to trigger a selling panic.

The supply of bitcoin may be limited, but the supply of crypto-currencies as a whole is unlimited with no major barriers to entry.

Bitcoin mining entrepreneurs are reputed to be setting up facilities where power can be accessed cheaply. But electricity consumption required to “mine” bitcoins is estimated to already be larger than the consumption of 159 countries including Ireland and Nigeria. One report claims that if electricity consumption keeps increasing at current rates, bitcoin mining will consume all the world’s electricity by February 2020. That in itself suggests that there will be a reaction, if only from countries like China who are focussed on reducing pollution from coal fired power stations. If most new bitcoins are being manufactured in China at a time when pollution control is at the forefront of China’s policy drive, it seems inevitable that there will be a clampdown on such non-productive activity.

It is true that crypto-currencies are not fiat currencies subject to central bank manipulation. The argument that drives investment in bitcoin is that the supply of bitcoin is limited. That may be true, but the supply of crypto-currencies as a whole is unlimited with no major barriers to entry. Money has many uses, particularly as a medium for transactions and as stores of value. Bitcoin was touted as a medium of transactions, although its popularity here seemed to rest on the ability to hide illegal transactions. That usage looks set to decrease, however, as its popularity has increased with transaction costs and transaction times increasing to unacceptable levels quite apart from the high intra-day volatility that makes any transactions subject to ridiculous amounts of currency risk.

As a store of value, crypto-currencies may have as much long-term stability as tulips in 17th century Netherlands. Many crypto-currencies, as regulators in the US and the UK are warning, are clearly scams. Some are well intentioned, others are circumventing listing rules to crowdfund possibly interesting investment opportunities.

But the ultimate killer of crypto-currencies as alternative money is that there are no unique characteristics that would make one crypto-currency preferable to another, unlike real currencies, which are backed by central banks and whose valuations, for better or worse, are ultimately backed by the reputation of the central banks themselves. Cryptocurrencies perhaps, are better regarded in the same way as having a flutter on the national lottery. Worth having a bit of fun with maybe, but perhaps not worth mortgaging your house for! 

 

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