11 December 2017

Bitcoin is bigger than the bubble


There may be people who still haven’t heard of Bitcoin, but there can’t be many and they must live a long way back from the road. From its beginnings as a niche of niches somewhere on the outer belt of the internet, this strange and next-to-impossible-to-understand mathematical construct has turned into a phenomenon that has transformed the loose change of its earliest adopters into millions.

Is the cryptocurrency boom a bubble? Yes. Will the bubble burst? Yes – and probably quite violently. Will Bitcoin and its crypto-brothers vanish, leaving not a wrack behind? Not at all. Bitcoin – or rather the underlying technologies of blockchain and the distributed ledger – are bigger than the bubble.

Cryptocurrencies certainly look like just another get-rich-quick investment craze that happens to fit the times. Only seven years ago one Bitcoin was worth a tiny fragment of a dollar. Today, one bitcoin is worth somewhere between ten and twenty thousand dollars, depending. It goes up, it goes down, but mostly it goes up. It is traded online, in exchanges, in digital shops, and even on the street. (Yes, you can easily arrange to meet someone over a crushed avocado on toast, trade some real cash for twenty or so digits of blockchain address code, and get your Bitcoin fresh).

But what are you buying? Intrinsically your Bitcoin (or Litecoin, or Ethereum, or Ripple, or Next – this list is a long one) is worthless. It is worthless in the sense that there are no tangible assets or rights attached to it. The value of a share in a company goes up and down, but at least you have the backstop of whatever plant and machinery and intellectual property there is in the company. Even if your company goes bust there is “book value”, which means stuff that can be sold or traded. If you buy a bond, that might go down too – but it will still pay interest so long as the company or government that issued it stays in business.

Even a conventional “fiat” currency like the pound or dollar has backstops that prevent collapse. There are central banks which buy their own currency to stop a downward slide. And there is also a built in correctional system. If one currency starts to trade downwards, everything priced in that currency suddenly becomes cheaper for anyone with a different currency. That creates demand for the devalued currency. It can fall, but only so far.

None of that applies to a cryptocurrency like Bitcoin. It pays no interest, and while anything can be priced in Bitcoin, nothing has to be. There is no floor for Bitcoin to fall to, except zero. In that sense Bitcoin is a classic bad investment: the upside is limited but the downside is 100 per cent.

But all that tells us is that you should not be investing in cryptocurrencies, which you probably already knew. The Bitcoin price surge is pure momentum – it is going up because it is going up. This is familiar to anyone in the investment world – momentum investing is a bread and butter technique in the fund business, and the first thing any would-be portfolio manager is taught is that “the trend is your friend”. Crypto enthusiasts are only doing what pension funds do: the tried and tested practice of following the herd.

Is there anything you can predict about Bitcoin with any certainty, apart from the fact it will soon displace London house prices as the default dinner table conversation? One thing: crash or no crash, the crypto technology has only just begun to take hold. It is a game changer. The cryptocurrency boom is merely a diversion from the main story. Decentralised blockchain records will change the way data is stored, the way that people and companies communicate and the way that value is transferred.

Blockchain – the underlying record that underlies the crypto-currencies – is an immutable account of transactions. That alone is a kind of revolution. Any conventional record of events, or agreements, or transactions – say a will, or a bank statement, or a contract – has the weakness that it can be counterfeited or spoofed or altered illegitimately. That is why we have trusted intermediaries like banks and lawyers to authenticate our records. But with blockchain, the intermediary is out of a job.

Remember that blockchain “ledgers” are kept not in a vault or a computer, but duplicated in billions of digital nodes all around the internet. Altering one instance of the ledger immediately creates a conflict with all the others which is automatically resolved in favour of the correct record. It means that in practice the ledger is unhackable – although there is a theoretical possibility that a quantum computing attack could compromise the total ledger, that is only theoretical. Practical invulnerability is what counts.

This is clearly a technology with useful applications. Imagine for example you needed a record of supply chain transactions for any kind of product. A complete account of where and when all the ingredients or parts originated, a record that is visible to anyone but proof against falsification, and readable on any smartphone. Quite useful. And that is an application that has already been developed.

Cryptocurrencies stand accused of being used for nothing but speculation and dark web transactions beyond the law. That mistakes the case. I only have anecdotal evidence for this, but it seems likely that Bitcoin and other currencies are being used quite widely for legitimate business uses. Given that the world still stumbles on with an international electronic payments system that is slow, inefficient and very costly (a £1,000 Swift transfer across currencies can eat up as much as 10 per cent of the money being transferred), why wouldn’t businesses pay each other in cryptocurrencies that can be transferred in moments at a low and diminishing cost?

There is only one thing holding this revolution back – and that is the cryptocurrency boom itself. The huge volatility of the currencies (as I write I see that Bitcoin has both risen and fallen by 20 per cent in the last 24 hours) makes pricing in cryptocurrencies rather challenging. The surge is also straining the capacity of all the exchanges where currencies are traded – many of them are rather amateurish anyway, although it cannot be long before some serious money is invested in more credible online systems.

So the quicker this boom turns to bust the better for everyone who has not bet their house on Bitcoin futures. It has been a delightfully profitable ride for the lucky few. But the slow serious work of embedding this technology in the real world is only just beginning.

Richard Walker is a journalist and communications advisor to financial companies