Most investors don’t know what to make of bitcoin. But the best brains see the potential and are flocking to this new asset class, argues Charlie Morris.
This year has seen a surge in the price of digital assets – my preferred term for cryptocurrencies. The original digital asset was bitcoin, created in January 2009 out of thin air. Now this new digital world is collectively valued at close to $200bn. There are many critics, such as JP Morgan’s CEO Jamie Dimon, who has described bitcoin as a fraud for stupid people.
Allow me to disagree. Notwithstanding a sharp correction in price as China cracks down on fundraising, this movement is here to stay. A new asset class has been born.
Digital assets are a mania, not a fraud
Consider how rare it is to see a new asset class. Hedge funds were promoted as such, yet when the credit crisis came, most collapsed alongside risky assets. Infrastructure was another – but in reality, it is probably a sub-set of property, or just equity in disguise. Digital assets are different from everything that has come before. Dimon claimed that bitcoin is a fraud, such as a Ponzi or a pyramid scheme. Yet it can’t be a Ponzi as the blockchain (the underlying technology) provides a high level of transparency.
It’s true the cryptography associated with bitcoin doesn’t tell you who owns what, but at least you know the bitcoins are there. And it isn’t a pyramid scheme – the winners in such schemes sit atop large networks, while everyone else sits alone. If bitcoin were a pyramid, parts of the blockchain would be valuable, with the rest worthless – however, all bitcoins are equal, so it can’t be a pyramid scheme.
Bitcoin’s only crime is excessive speculation, and thus intolerable levels of volatility. The FTSE 100 has averaged around 17% volatility over the past decade – similar to gold. Bitcoin has 100% volatility, eye-popping stuff. However, it’s not unusual for a big idea. Amazon trades close to 20%, yet during dotcom 1.0, it too had 100% volatility.
The behaviour of digital assets today is comparable to the dotcom boom in the late 1990s. That’s entirely natural in exciting new markets – digital assets will inevitably end in an almighty bubble, but don’t forget what George Soros said: “When I see a bubble forming, I rush in to buy.” A bubble forms when lots of people rush to take part. Think of your family, friends, and colleagues – how many are buying digital assets? Probably not many, and far fewer than we saw in the dotcom boom.
Bitcoin isn’t a currency
Dimon also bashed bitcoin’s role as a currency. But it’s not a currency. It’s a digital asset. It can be bartered for goods, but so can a grand piano. The difference is that, given its digital origins, bitcoin can be bartered in a highly efficient manner. A start-up called TenX (which came from PayPal’s incubator) provides debit cards so that digital assets can be spent on the high street.
The fact that an asset must be sold for cash, then spent, shows that bitcoin isn’t a currency. If it were, more shops would accept it. They don’t, and I doubt they will.
Bitcoin has also been described as electronic gold, but that’s only half the story. It is like gold in the sense that supply is limited. Newly minted bitcoins lead to an inflation rate of 4.2% a year, which will fall in the future on a pre-set path. (On the same basis, gold has an inflation rate of around 1.5% if you take into account what has already been mined, and what will be in the future.)
Despite the wide fluctuations in price, scarcity has brought a longer-term degree of confidence in bitcoin, just as it has for gold. The demand side is another issue, however.
Gold is a long-term inflation hedge, whereas the value of bitcoin is directly proportional to the size of the network – the more people that use it, the more valuable it becomes. If the network activity ground to a halt there would be no value – a bit like Facebook with no users. And if the network activity were solely speculative, this would be like the tulip bubble (as Dimon avers). But that’s not the case, because an ecosystem is being built around bitcoin.
New applications and technologies associated with digital assets are changing the world. As a result, a growing portion of the underlying network activity is non-speculative, which means there is a “value” buyer in town (someone who will stock up if the price gets low enough). Of course, tulips had a value buyer, too (florists), but they didn’t need to pay much because a vast number of tulips eventually became available. In bitcoin, that can’t happen.
Going back to the dotcom comparison, the dotcom era was built on a dream of what lay ahead. We knew the internet would change our lives, yet it turned out to be even better than we thought. At the time, Amazon and others made no profits – which wasn’t surprising, given that most people struggled to connect to the internet. I remember the partners at my firm shaking their heads with dismay as younger colleagues enthusing about internet businesses.
So it’s little surprise that digital assets are being driven by the youngsters today. They are sceptical of the system they will inherit. They have their own ideas about how it could be improved, and are doing their best to change it.
In a sense, digital assets are dotcom 3.0. No one quite knows where they are going, but the blockchain offers endless possibilities. It is a new design of database that is freely accessible to all. Unlike conventional databases, once an entry is made, it can never be changed, which makes it ideal for recording transactions. The data is protected by brute-force computing power that makes hacking theoretically impossible – many have tried and failed.
I recently met the creators of Aventus, a blockchain-based ticketing company. Apparently, the ticketing industry is complex and involves numerous resellers. Some are honest, others less so. By using the blockchain to manage events, organisers can prevent tickets being mopped up by resellers within minutes of them going on sale and then put back on the market at dozens of times their face value.
It also means event organisers will know exactly who has a ticket, and whether they are on the premises. This is terrible news for touts and great news for the emergency services – if there were an incident, they would have a roll call at the touch of a button. Aventus is just one of many projects financed using initial coin offerings (ICOs) this year (see below). Within a few years, the blockchain could become integral to our lives. We probably won’t even notice it as it just ticks away in the background.
Many bankers, including Dimon, have embraced blockchain. It can settle transactions more efficiently as it allows third parties to collaborate in a secure manner. But the blockchains favoured by banks are private, with access tightly controlled. In the brief history of computers, open-source projects have won the day.
Open-source blockchains create networks, which, in turn, create value. The more people who come together and collaborate, the more value is created. That’s why this mania has a future. Just as VHS beat Betamax, so open-source digital assets will thrive. Dotcom 1.0 was a dream, yet dotcom 2.0 proved it right. With dotcom 3.0, the internet is learning how to create value. It will succeed.
ICOs draw the best brains
Having been used to raise more than $2bn already this year, the initial coin offering (ICO) market has become the new way to raise funds for digital projects. For example, events company Aventus raised $20m in just seven minutes. Founders Annika Monari and Alan Vey met at Imperial College and plan to hire 25 people to roll out their business and take over the global ticketing industry.
It’s a huge market, and Aventus enables resellers to operate independently while the event organiser maintains overall control. Without blockchain technology, this interaction between networks would be impossible. Digital assets are creating thousands of jobs and attracting some of the best brains in the land.
The Crypto Composite Project
Charlie Morris founded the Crypto Composite Project in 2013. The aim was to provide high-level analysis of blockchains. Having identified the connection between network activity and network value, the project is building tools to help investors better understand the ecosystem within blockchains.
Greater transparency will improve the credibility of digital assets, and help to improve price discovery. The software now encompasses 1.2 million lines of open-source code and can handle multiple blockchains in real-time. After 46 months in development, this mammoth project will be launching soon, so keep your eyes peeled for news at CCData.cc.
• Charlie Morris is chief investment officer at Newscape Group. He also writes AtlasPulse.com, a free newsletter on gold and bitcoin.