The established wisdom is clearly now that there are three ‘serious’ cryptocurrencies – Bitcoin, Ethereum and Ripple, which have specific purposes and USPs – goods and services transactions, smart contract functionality and trade finance respectively – should now be classified as an investment sub-class in their own right. They have the liquidity, and low correlation with other assets. There is also a mass of amateur, if not positively fraudulent, imitators which according to the latest research from the University of New South Wales should all be avoided. Whilst it is the job of cryptocurrencies courses really to analyse this problem in depth, it is certainly possible to provide some pointers in advance.
It is right to identify some Initial Coin Offering (ICOs) of altcoins – the generic name for cryptocurrency offerings – as fraudulent. Over 10,000 people have downloaded fake cryptocurrency apps. In China alone, Xinhua reports that this year the authorities have investigated thousands of potential fintech frauds and have closed down 107 altcoin Ponzi schemes including one, Asia-Euro, that scooped up over $600m of gullible investor money. In the USA, following on from successful SEC action against REcoin Group Foundation and DRC World, most recently, the CFTC has prosecuted PlexCoin founders. In Switzerland, regulators have proceeded against the fraudulent ‘E-Coin’ – the list goes on, and is growing monthly. The volume of ICOs is beginning to slow as regulatory warnings and media exposure of frauds takes effect.
It is also right to point to the increasing maturity of the ‘Big Three’ – bitcoin, Ethereum and Ripple. Merrill Lynch suggest that Ethereum’s focus on smart contracts and issuance, and Ripple’s FX orientation, seem to have significant potential. And the introduction of bitcoin cash exchanges such as Coinex, CoinDash and the development of bitcoin futures is evidence of a market that is now attractive to institutional investors as well as speculators, even if the combined ‘market capitalisation’ of all cryptocurrencies put together is as yet only one thousandth of listed equities.
Yet the established wisdom is not the end of the story, for several reasons.
Firstly, there are potential fraud pitfalls in bitcoin investment as well as in altcoins. The SEC is currently pursuing Gelfman Blueprint and its principal in relation to the bitcoin cash market, for example.
Second, for now, we know that total cryptocurrency ‘market capitalisation’ compared to the ‘Big Three’ oscillates as wildly as altcoin prices themselves, of course, but it has been as low as 37%. As liquidity deepens in other altcoins – and not all will succeed – and opportunities for trade grow – such as so-called ‘atomic swaps’ as well as specialised investment funds and ETFs – the strict division between the ‘Big Three’ and all others will begin to fray – though it is doubtful whether it will evaporate – and their market dominance will also begin to retreat.
Third, other altcoins amongst the over a thousand that have been issued, such as Zcash, Dash – perhaps Litecoin in particular – are developing their own following and specific USPs, such as IOTA’s potential synergies with the IoT. The price volatility of individual altcoins can reasonably be expected to depend on both technical issues (chart analysis) or their fundamentals – specific altcoins based on e.g. holidays to Bali, or agricultural performance in a particular region or for a type of production will vary in price depending on those markets. Accurate forecasting in either dimension will produce good results. ICOs are funding start-ups, and just as some of them will succeed – and most will fail – so their cryptocurrencies will follow in value.
Fourth, bitcoin fees, hard forks in the blockchain, and multiple issues associated with bitcoin mining, together with bank dominance of Ethereum and Ripple, may combine to choke off their advantages by comparison to other coins. Their very advantages may be turned against them. Their prices may stagnate, and eventually even fall.
Finally, and perhaps most importantly, the regulatory and tax structure for altcoins is far more opaque than for the ‘Big Three’. There may be, at least for the immediate future, some arbitrage opportunities available to skilful traders.
Taken together, these are reasons not to be entirely dismissive about altcoins. Probably the right way to think about ‘the Big Three’ on the one hand and altcoins on the other is to compare dollars, sterling and euros, say, with emerging market currencies, albeit that some altcoins can end up much more easily with the kinds of valuations Zimbabwe currency has experienced than can emerging market fiat currency. Those investors with high risk tolerances will naturally prefer to include at least some altcoins in their portfolio – probably a changing mix depending on both fundamental and technical analysis.
Author Julian Roach of Redcliffe Training