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Cryptocurrencies are a bubble, but blockchain is the future: analysts

Despite their frothy valuations, cryptocurrencies are unlikely to become a mainstream means of exchange. But blockchain, the underlying technology, is likely to flourish because of its wide-ranging applications

PUBLISHED : Monday, 16 October, 2017, 3:12pm
UPDATED : Tuesday, 17 October, 2017, 9:03am

The sharp rise in cryptocurrency valuation in recent months is a speculative bubble and the future of digital money as a mainstream means of exchange is highly doubtful, according to UBS.

On the other hand, blockchain, the underlying technology, will become increasingly mainstream and is likely to have a significant impact on industries ranging from finance to manufacturing, health care and utilities. The technology could also add up to US$300 to US$400 billion of annual economic value globally by 2027, said a group of UBS analysts led by Sundeep Gantori in a recent research note.

The market capitalisation of cryptocurrencies has soared more than nine fold this year, thanks to investors’ growing interest in a type of digital currency that taps demand for secure and anonymous online transaction platforms which fall outside government control.

As of Monday morning, the total market cap of cryptocurrencies was US$174 billion, up about 880 per cent this year, according to CoinMarketCap, a cryptocurrency market tracker that follows more than 1,100 cryptocurrencies trading in over 5,500 markets worldwide.

The number was bigger than the market cap of either IBM or McDonald’s.

And bitcoin accounts for 54 per cent of this.

“ … with each of the other characteristics of typical bubbles in evidence, a twenty-fold increase in bitcoin prices in just two years, and an absence of any fundamental economic backing, cryptocurrency prices are almost certainly a bubble,” said the UBS analysts.

The analysts are also doubtful that cryptocurrencies, which lack the two basic functions of conventional currencies, will ever be adopted for a majority of transactions in an economy.

Firstly, it could fail as a standard medium of exchange because it is unlikely to be accepted for paying government taxes, the single most important transaction in most economies.

“Governments set taxes, and tax is the largest single payment in almost any economy.”

Governments are “highly unlikely” to accept cryptocurrencies for tax payments, UBS said, as they generally prefer taxes to be raised in the same currency as their liabilities, and also generally prefer to issue liabilities in the same currency that they can control.

In developed economies, over a third of all economic activity that takes place in a year is paid to the government in the form of tax. For this reason, people will always demand government-backed currencies for the purpose of paying tax.

The analysts cited one of the earliest examples of this in Chinese history. The emperor of the Jin dynasty, which ruled northern China in the 12th and early 13th centuries, decreed in 1192 that certain taxes be paid in the new paper currency instead of the earlier copper coins. The order validated and subsequently created demand for paper money.

Secondly, cryptocurrencies could fail as a store of value, as people need to believe that what their cash can buy today will have the same purchasing power tomorrow, the analysts said.

Central banks try to maintain the value of a currency at a fairly stable level by ensuring that the supply of money generally matches demand.

However, cryptocurrencies cannot be relied on to manage this delicate balance, which explains their volatility, they said.

“Cryptocurrency supply cannot go down. A fall in demand for a specific cryptocurrency will therefore cause that cryptocurrency’s value to collapse as supply outstrips demand.”

While cryptocurrencies will “almost certainly never” be used for a majority of transactions in an economy, they could be used in illegal transactions, such as money laundering, because of the absence of transparency and regulations, the analysts said.

On the other hand, the underlying technology of cryptocurrencies, blockchain, is likely to have a significant impact on a wide range of industries, the analysts predicted.

“Just as internet has transformed our lives with email, e-commerce, or smartphone apps, we believe blockchain as an infrastructure technology can power future disruptive technologies through distributive ledgers, smart contracts, tokens or identity management.”

The People’s Bank of China wants to accelerate the application of blockchain and artificial intelligence in financial information technology in the next five years, it said in its 13th Five Year Plan in June.

China’s central bank has already set up a research centre for cryptocurrencies and had a test run of a blockchain-based transaction platform for bill financing.

Potential applications for blockchain in the financial industry include enhancing banks’ trade finance services by enabling so-called “smart contracts”, or agreements where the terms can be preprogrammed to self execute and self enforce.

In manufacturing, blockchain can be used to improve supply chain management.

In 2016, Walmart teamed up with IBM and China’s Tsinghua University to develop a system to track pork shipments from China to the US using blockchain technology.