The Cryptocurrency and Blockchain World

Who are the winners and losers?

Originally published in the October 2017 issue

Three vantage points have given me an insider’s insight into the growing cryptocurrency sector and who are the likely winners and losers. As an investment manager, I regularly get to see the latest innovations − both good and bad − early. Even a curmudgeonly bear would have kind words to say about the incredible number of new disruptive technologies changing the world including DNA sequencing, virtual reality, drones, 3D printing, robotics and blockchain. None would have been possible without the incredible innovations in microprocessor power over the last 10 years.

In September 2017, the market capitalisation of all cryptocurrencies briefly passed $150 billion. Adding in the value of the exchanges and other ancillary companies the cryptocurrency industry is conservatively worth >$200 billion and growing daily.

My company, Altana Wealth, runs a cryptocurrency trading vehicle (Altana Digital Currency Fund), lends margin to bitcoin traders (Altana Digital Services) and has co-invested in blockchain ventures such as futures exchanges and ATM providers. Over the past three years our clients have benefited from the growth in cryptocurrencies to the tune of ~1000%.

I’m a member of the Young Presidents Organisation, a global platform for chief executives to engage with more than 25,000 members in over 130 countries. In May, I moderated the blockchain panel at their annual fintech event. Amongst a very sophisticated audience discussing a diverse range of subjects (including robo-advisors and peer-to-peer lending) the least followed or understood of all was bitcoin/blockchain.

So, while bitcoin may be a disruptive booming technology, it is not yet properly understood and as with all innovations, it needs to have a profitable niche to grow.

The initial, most common reaction I receive is: “I don’t understand blockchain”.

Imagine everyone could see inside a bank’s online server showing the IBAN numbers and currency amounts going in and out of accounts. However, because the bank servers are correctly set up, you are not able to view the account holder’s name. Now, if you wired money to a friend’s IBAN you would then know it was theirs and they would know your IBAN. That would be a transparent ledger. That is what blockchain is − a database of wallets (IBAN accounts) and amount of coins (currency) completely open and on view to the whole world. No middlemen, just a wallet with your own personal password called an encryption key.

Yes, it is technologically brilliant and modern but it is also just a ledger system akin to those used for over 3000 years.

Blockchain and bitcoin were originally vilified by the mainstream media until in 2016, articles appeared from the Federal Reserve and Bank of England extolling the cost saving potential of blockchain. Slowly the press has become more balanced. bitcoin has made the front cover of Barron’s and even into the British Airways in-flight magazine.

To some extent blockchain grew out of a need to escape the growing global regulation and the exorbitant cost of transferring money though the SWIFT system. Compare the cost ($30) of wiring US dollars through the banking system going through as many as six counterparties and taking two-four days against $0.80 for moving money peer to peer in under 10 minutes on the blockchain. For transactions of low value, say under $100, this is clearly a better system. The winners are all the small businesses, charities and individuals who cannot access the credit card system or afford to pay 2-4% fees when their profit margins are under 10%. The loser longer term is the banking system and Visa, MasterCard etc.

This is the first time in my trading career that the magnificent credit card business model, which has always shown exponential growth, has been under serious threat. It is hard to see how they can compete with mobile payments and blockchain going forward. There are already bitcoin (and gold) backed credit cards available for those who wish to have more flexibility about their long-term currency allocations and counterparty risk.

Initially, central banks and the banking system fought bitcoin, trying to close it down. While Jamie Dimon recently made his views on bitcoin abundantly clear, other bank chiefs are hedging their bets. Now they have realised how blockchain is a potential cost saving mechanism for the booking of trades, they are looking to copy it. I am not wholly convinced that larger funds and the banks want trade settlements to appear in a transparent ledger but a significant amount of venture capital money has been ploughed into this area to the benefit of the founders and hopefully their shareholders.

The crypto exchanges have clearly been big winners as revenues are growing rapidly and given the fixed cost base, profit margins have ballooned. The clampdown by Chinese authorities in early 2017 has reduced the local trading turnover from over 90% to below 20% of global totals. Large exchanges combined are turning over $10 billion monthly, generating revenues of $100 million.

Wallet providers, such as Coinbase, that allow you to buy and sell, are also growing rapidly – from six million wallets in June 2017 to over 10 million three months later. Storage companies holding clients’ wallets and encryption keys safely offline should be making money but strangely are not as yet. However, as institutional money moves into the space this should change.

Bitcoin ATMs are expanding fast. There are over 40 in London including at major tube stations. They look like normal ATMs except you exchange cash for bitcoin, which is scanned into your wallet on your phone or vice versa. Growth has been over 50% each quarter as tourists, game players and others seek bitcoin.

Over 100,000 retailers accept bitcoin and Fidelity allows employees to pay for their lunch with bitcoin. New mobile games and gambling apps have benefited as they can offer better spreads due to lower costs and in some cases avoiding exorbitant bank fees and related regulatory costs.

Some countries and their citizens have benefited whilst others suffer. Japan has legalised bitcoin and made it a key focus for technological growth. Taiwan, which initially benefited from allowing bank accounts to be opened, has, in a potential abuse of antitrust laws, suffered US pressure to close them or else be cut off from the US dollar correspondent banking system. Bitcoin trades at a higher price in Korea due to capital controls on the Korean won preventing arbitrage. Similar premiums exist in Brazil and India.

As ever, the losers are the local people hurt by the stupidity and ultimate futility of capital controls. Young westerners forget that for most people of most nations, capital controls have been in place for decades. The UK and France, bastions of progressiveness, had capital controls from World War Two until 1984 and 1982. For most other large nations they still exist.

The wealthy have always kept a portion of their assets in a‘paranoia portfolio’ just in case they need to leave quickly. History tells us that getting yourself out of a country is simpler than getting your assets transferred − due to war or just confiscation by the state. Almost all the wealthy and mass affluent have a combination of gold coins, diamonds, foreign and local currency, jewellery or even art secreted somewhere safe. Wealth managers recommend their clients hold the aforementioned assets. So why not cryptocurrency? Bitcoin is even easier to move across borders. I have no doubt that several thousand bitcoins are held long term simply for that reason.

What about cryptocurrencies being involved in criminality? Illicit activity takes place in all currencies, US$100 bills are used every day for ransoms, money laundering, drug running and buying arms. The US Department of Defense auditors recently admitted that several trillion dollars are unaccountable over a period of 15 years. Five years ago bitcoin was accused of money laundering and drug running (at a time when it was too small, with a free float of under $100m). Cocaine alone is estimated to account for $15 billion per day in the USA. This makes a mockery of press hysteria accusing a currency that was only worth $15 billion in March 2017 of being the
prime suspect.

I recently had an interesting conversation with a security firm on how ransoms could be paid more easily in bitcoin than dropping bags of US dollars. However, don’t forget, wallets can be tracked and − like watching old films on bank robberies − ultimately the numbered banknotes make it into the real world and the police can trace it back to the criminals. While wallets are pseudo anonymous they are not truly anonymous. Following the hack of the exchange Bitfinex last year $65 million of bitcoin were transferred to a wallet and have never moved. Interpol and other agencies are tracking it in real time. Governments, security services and the tax collectors are adapting to the electronic age that includes cryptocurrencies.

I am, however, very wary of the Initial Coin Offerings (ICO) − a concern shared in the past few weeks by the governments in China and South Korea who banned them. Almost all ICOs will fail, or worse are scams or Ponzi schemes. To be fair those peddling these ICOs clearly state the risks: they are unregulated, you have no recourse should things go wrong, and there is a strong chance that you will lose all your money. This is all very reminiscent of the Dotcom boom when companies promised to chase eyeballs with marketing spend, but did it to such a degree that it was uneconomic for most ventures. If these ICOs were scrutinised by fund managers and other financial institutions many would not see the light of day, never mind the crazy valuations. However, this is also true of many crowdfunding offerings − approved by many governments − that have the same downside but no liquidity, whereas ICOs do have a degree of secondary trading.

I expect either the current cryptocurrencies will evolve or a better version will come along. This is as true here as it was of Facebook versus MySpace or how music delivery evolved from vinyl to the CD and now to streaming.

At the end of the YPO blockchain panel, I was asked about the best opportunity I saw in the space. My view is simple. Cryptocurrencies have to be used for daily transactions to gain global acceptance. If any of the various cryptocurrencies achieve their goals then that will be the case.

Which of these currencies would you rather own? The Argentinian Peso capitalised at $800 billion, the Icelandic Krona at $70 billion, both of which cannot be used outside their country (and often not in them!) or the globally transacted bitcoin currently worth $80 billion?

Since bitcoin’s launch, a benchmarked diversified currency portfolio could have held Rubles and Brazilian Reals of the order of 2% and lost over 1%, held 14% in Euros losing over 5% and a 6% position in Sterling losing 1.5%. Yet holding 1% in bitcoin you would have risked say 0.5% but made 10% plus. Everyone rational should have a global digital currency in their top twenty currencies in the same way they have gold and silver. Indeed, some clients are now telling me that they are negligent not to have a small amount of cryptocurrency in their portfolios.

For me, the best way to ride the blockchain phenomenon is to hold a basket of the top cryptocurrencies. It’s like seeing motorcars in the early 1900s and deciding to be long oil.

Are we in a bubble? Maybe, but $100 billion is not a big bubble. Bubbles typically grow to levels beyond rationality. A global currency in a world of seven billion people, worth the same as the Icelandic Krona from a country of 300,000, is not a bubble. It’s background noise.

Lee Robinson is the founder of Altana Wealth, a UK regulated asset manager that always co-invests alongside their clients.