Successful investors use this one rule when it comes to bitcoin and other cryptocurrencies

The speculative euphoria surrounding cryptocurrencies is akin to the Gold Rush manias of old

PUBLISHED : Saturday, 11 November, 2017, 10:47am
UPDATED : Monday, 13 November, 2017, 10:49am

Over several decades of discussing markets with clients, I’ve noticed one or two personality traits that generally make for a successful investor. The first is the confidence to reject any idea they don’t understand or feel comfortable with, and the second is a willingness to forego the initial upside of a trade by allowing another investor to “cross the road first”.

Why take the risk investing in an ostensibly transformational idea when it could so easily fail? It is true that first time movers are sometimes successful and some early stage investors richly rewarded, but for every idea that made it, the road is scattered with the debris of entrepreneurs – and their investors – that failed.

History is replete with examples of magnificent misses and burst bubbles, from the railroad boom in 18th century America, to 1980s real estate in London’s Canary Wharf, and the dot-com mania in the 1990s. And while the investment thesis behind each strategy was no doubt credible, oftentimes the timing was wrong. Typically, after the debt was written down, subsequent rounds of funding and subsequent technological upgrades were usually more successful.

This phenomenon, which I label the “First Time Second” rule, will apply to the cryptocurrency market. In other words, while I’m convinced the initial bubble will eventually burst, I’m also pretty certain its second incarnation – utilising more effectively its underlying rationale – will succeed.

Without doubt, there are some positives associated with cryptocurrencies. For example, the idea of replacing fiat currencies, disintermediating central banks, and democratising the medium of exchange has a certain anti-authoritarian appeal, particularly to millennials. I also like the idea of cryptocurrencies being an alternative to gold as store of value in challenging times.

But it is also the case that cryptocurrencies have been allowed to proliferate without effective control, management or regulation. As such, the current edifice is an accident waiting happen. I get that being outside the financial mainstream is part of its attraction, but try telling that to someone whose just lost their entire life savings through an unscrupulous hack or developer mistake.

Someone deleted some code in a popular cryptocurrency wallet – and as much as US$280 million in ethereum is locked up

I’m not alone in this view. I cannot remember a single client meeting in the past year where cryptocurrencies have not been raised, often with a wry smile. To be clear, few clients have expressed a desire to actually invest, rather their interest is akin to the morbid fascination associated with a slow motion car crash. If asked, I tell clients that investing in virtual currencies now is a gamble right on the outside edge of a frontier market. And if they ask why, I pull out my “bubble trouble” checklist and start ticking the boxes.

Irrational price gains? Let’s see; in January 2013, a single bitcoin was quoted at US$13.5. This week – some five years on – that same virtual coin will probably close around at a high of US$7,250, representing a price gain of 54,000 per cent, and equivalent to a market capitalisation of roughly US$120 billion, substantially larger in size than the entire banking sector of Singapore. You’d be hard pressed to find that sort of price appreciation of an asset this size anywhere in financial history.

Certainty of market? Has the infrastructure, regulation, and popular understanding of virtual currencies as a store of value and/or medium of exchange expanded at a pace commensurate with its price gains? Or has the opposite happened? My sense is the latter. Increasingly, bitcoin appears the single most popular method now to circumvent foreign exchange restrictions, which is why countries from China to Zimbabwe are trying to crack down on it usage. And more worrying is its use on the dark web for illicit funding of criminal activities. In other words, usage is hardly mainstream.

Market consolidation? There does seem to be some evidence of consolidation. Bitcoin and Ethereum – the second largest virtual currency with a market cap of US$30 billion – are the two most valuable virtual currencies, but they are by no means alone. CoinMarketCap, an online financial tracker of cryptocurrencies, reveals the scale of the virtual currency space, listing 1,269 separate Coin and Token variants, spanning 6,401 different markets. As the market matures, the eventual consolidation of winners and losers will be jarring.

The speculative euphoria surrounding the cryptocurrency space is akin to the Gold Rush manias of old. Typically, tens of thousands of miners would descend on an area, and while a handful of gold miners did strike it rich, in general, it was the entities that “sold the shovels” – or infrastructure – that tended to profit the most.

In other words, it is the providers of, and technology behind, blockchain networks and services that will be the likely eventual, long-term winners. And if the blockchain providers link up with established global financial institutions, which appears to be happening now, the second iteration of a managed, regulated and controlled virtual currency – with broad appeal as a medium of exchange and store of value – may well evolve. A clear case of “First Time Second” rule for the cryptocurrency.

John William Huia Woods is regional chief investment officer APAC at Credit Suisse