Are cryptocurrencies just for drug dealers and murderers?

As digital coin use grows, watchdogs warn of potential bubble and call for greater control

Irish investors are no strangers to bubbles and yet many appear drawn toward the latest potential burst. Emerging from the recent white noise surrounding cryptocurrencies, a note by Cantor Fitzgerald in Dublin said both that it had observed a "material increase" in inquiries and yet "on the face of it, it looks like a classic bubble".

"Investors [are] buying for one sole reason," explained David Coffey, senior portfolio manager. "They believe that prices will keep going up and they can eventually sell to others at a higher level – the greater fool theory of investing."

Dominated by the might of bitcoin, cryptocurrencies are at the same time currency, investment opportunity and technology (blockchain). They exist, of course, online, held in digital wallets in exchange for traditional or “real” money.

Their popularity is reflected in their growth, with over 1,500 different cryptocurrencies available. The top 100 are thought to be valued at about $170 billion (€142 billion), of which bitcoin alone is responsible for $77 billion (€64.5 billion). Ether, the second-largest, has grown 5,000 per cent in value this year, says Cantor Fitzgerald. Speculative investors are buying the currencies based on this type of movement.

"It would be my view that the buyer/seller dynamic is going crazy," Coffey told The Irish Times. "If you can make 50 times your money, there is a massive amount of risk involved.

“It’s very hard to value all of these things because there is no cash flow coming from them. But then how do you value gold?”

Possible bubble

In his note to perspective Irish investors, Coffey cautions of a possible bubble with the worrying reality that “it is impossible to establish, in real time, at what stage you are in the life cycle of a bubble: beginning, middle or end?”

Whether property or cryptocurrencies, such bubbles come and go and the trick is not to get sucked in. Or at least to get out in time. Coffey invokes the great Dutch tulip bubble of the 17th century in which the price of the bulbs reached vertiginous heights before spectacularly crashing in what is considered one of the first speculative bubbles in European investment.

"Any time an established process – in this case payment systems – can be replaced by another better/faster/cheaper one, there are repercussions," professor of business technology Steve Andriole wrote recently in Forbes, citing Amazon's upturning of bookshops and Airbnb's insurrection against the hotel industry.

The seeming spike in interest among investors is indicative of two conflicting stories in the cryptocurrency saga – growing popular interest contradicted by an industry backlash. The former head of the US Fed, Ben Bernanke, is to deliver the keynote address at a blockchain conference next month hosted by ripple, the fourth-largest digital currency.

And yet Bernanke, a heavyweight of the financial establishment, had previously remarked that bitcoin, while a harbinger of the technical evolution of financial transactions, had “serious problems”, not least volatility and anonymity.

"It has become in some cases a vehicle for illicit [online] transactions, drug selling or terrorist financing or whatever," he said in a 2015 interview with Quartz. "I suspect that there will be oversight of transactions done in bitcoin or similar currencies and that will reduce the appeal."

As cryptocurrencies proliferate, similar views have become thornier. In well publicised comments this month, JP Morgan chief executive Jamie Dimon said bitcoin was only good for drug dealers and murderers.

‘Stupid’ and ‘dangerous’

He would, he told a conference, fire any of his employees dabbling in the nefarious market “for two reasons: it’s against our rules, and they’re stupid. And both are dangerous.”

And yet there is something compelling about cryptocurrencies. Earlier this month, Paris Hilton tweeted that she would be participating in the initial coin offering (ICO) of lydiancoin, adding a sprinkling of celebrity to an already accelerating trend.

ICOs are the unregulated means by which projects such as start-ups raise money. While investors in traditional stock market-listed IPOs (initial public offerings) receive a percentage stake, ICOs deliver amounts of new cryptocurrencies on blockchain technology, the permanent record of transaction that buttresses bitcoin and other sales.

The first ICO is reported to have taken place in 2013 and the nascent funding system is already under fire. This month, China banned them as bubble fears, similar to the experience of the late 1990s, grow. Investors in China are thought to have contributed almost $400 million (€335 million) in ICOs between January and June alone.

While views will vary between a need to crack down on dubious investment schemes and the need to embrace the potential of blockchain technology, their popularity is obvious and prodding at regulators to take notice.

In the UK, the Financial Conduct Authority (FCA) watchdog said this month that anyone placing their finances in the laps of ICOs should be prepared to lose everything. Warnings to potential investors relate to fraud, high-risk speculation and warning signs of a bursting bubble pulling the rug from under this latest financial fashion.

“Most of these cryptocurrencies could end up worthless,” David Coffey says in his note. “Some may survive and thrive but I’m sure it is only a matter of time before the central banks start taking a closer look.”

While extolling the promise of blockchain technology, he tells his readers: “I don’t see how any of these cryptocurrencies could find a place in a sensible investment portfolio at this point in time.”

Mark Hilliard

Mark Hilliard

Mark Hilliard is a reporter with The Irish Times