Cryptocurrency; flash in the pan or long-term investment opportunity?

Cryptocurrency; flash in the pan or long-term investment opportunity?

By Arianne King, Managing Partner, Al Bawardi Critchlow

Cryptocurrencies have dominated media headlines over the past few months, and no wonder with the value of a single Bitcoin – the original digital currency – growing by more than 1000% in 2017. It would be hard to think of another investment opportunity capable of delivering those returns.

Of course, these figures don’t paint the full story of Bitcoin. 2017 was a rollercoaster ride, with plenty of spectacular price fluctuations along the way, especially during the month of December, when the value of a coin rose from approximately £8,100 to in excess of £14,500 in just a matter of days. Since then, Bitcoin’s crown has slipped a little. At time of writing, a single coin is valued at approximately £8,700, but it’s still worth bearing in mind that this still represents a healthy profit for anyone who invested prior to December’s remarkable rise.

It’s not all about Bitcoin though. Other cryptocurrencies have also begun to attract the attentions of potential investors. Ethereum, Dash and Ripple are just three of note, but there are countless others springing up on a seemingly daily basis.

Investors must of course exercise extreme caution before entering this market, especially as many industry experts consider Bitcoin’s recent slide could be a sign of things to come. But nevertheless, governments, traditional banks, financial regulators, and both commercial and hobby investors are increasingly investigating how they can participate in the market.

So, could this be the year when cryptocurrencies gain traction with everyday investors?

Crypto’s image problem

To achieve mainstream appeal, digital currencies must first shake off their close associations with the criminal underworld. Their links to the Dark Web, for money laundering, funding terrorism and drug trafficking, as well as many other illegal activities, represents a major barrier to investors.

The market still has a long way to go to disassociate itself with these shady beginnings. While there are now many legitimate Initial Coin Offerings (ICOs) of new currencies, regulators – most notably the US Securities & Exchange Commission (SEC) – are still warning investors to be on the lookout for bogus ICOs. Scams are so problematic that in China the government has banned ICOs altogether.

A lack of adequate security is another factor inhibiting mainstream participation. November 2017’s $31m hack on a Tether Treasury Wallet was just one in a long line of thefts.

While it’s easy to paint a bleak picture of cryptocurrencies, it is still worth remembering that not every ICO is a ruse and not every wallet is vulnerable to hackers. The modus operandi of virtual currency operators vary considerably, as do their underlying technology infrastructures. Due diligence should be undertaken before contemplating any type of investment, however small.

The role of regulation

Digital currencies have gained momentum because, for the most part, they fall outside of the jurisdiction of governments, regulators and central banks. As true global currencies, they do not recognise trading arrangements or geographic boundaries. This frictionless quality is their appeal, but it also makes them hard to monitor and regulate.

That hasn’t stopped traditional financial institutions and law makers from trying to get involved. Indeed, over recent months many of the more traditional players have shifted from being mere observers to taking a more active role.

In particular, regulation is set to be tightened. Laws being muted by the UK and some EU governments recognise the need to update anti-money laundering legislation so it is fit for the digital age. As a by-product, it could also bring much needed credibility and stability to what is an immature, volatile market.

Of course, cryptocurrency-related regulation is itself immature and in a state of flux, as law makers attempt to keep pace with this rapidly evolving market. Even though the crypto-market is open to everyone via the internet, legislation and regulations vary considerably between countries. Activity that is perfectly legal in one country, might be illegal in another. For example, in Bangladesh, crypto is outlawed completely; anyone investing could be found guilty of money laundering. At the other end of the scale, SBB, the Swiss rail operator, accepts Bitcoin as payment.

While some countries will undoubtedly use regulation to inhibit or even ban adoption, more openminded regulation may provide the impetus required to take digital currencies mainstream. That said, if momentum continues to build, the day will soon arrive when it is almost impossible for any regulator to outlaw or restrict their use.

Blockchain: the real opportunity?

Blockchain is the technology that underpins cryptocurrencies and, despite the headlines about wallet hacks, it is inherently secure.

Each blockchain contains a decentralised ledger of all transactions which can neither be amended or deleted. Each individual block in the chain has a timestamp and a link to the previous block; this forms a chronological chain that is encrypted to ensure records cannot be altered by others. Theft or fraud is extremely difficult, not just because of the encryption, but also because copies of each blockchain are distributed throughout a peer to peer network. No changes can be made to the blockchain without that change being applied to all blocks in the chain.

This represents a major advancement over traditional banking systems, which are often based on older technology with known vulnerabilities. Indeed, the Australian Stock Exchange recently announced its plans to replace its current clearing system with blockchain technology.

Blockchain security is likely to be the crypto market’s greatest attribute as it strives to establish its mainstream credentials.

What next for crypto?

Few people would have predicted what has happened to Bitcoin’s value over the past few months. What will happen in 2018 is largely anyone’s guess. However, there are signs that it – together with other cryptocurrencies – are beginning to appeal to a wider set of investors.

Increased interest from the regulators, coupled with mainstream financial brands incorporating blockchain technology into their daily business operations, is beginning to provide credibility and stability to what is still a very immature and unpredictable market. While it’s still very much in its adolescence, it will be interesting to see the rate at which the market grows up.