Bitcoin: Desperately seeking Satoshi Nakamoto

Cryptocurrencies generally and Bitcoin in particular have been under the cosh over the last week or so, as the Chinese financial services regulator and others have sought to tighten up on the way such blockchain-technology-based are traded and sold to investors.

As reported, concern seemed to focus in particular on so-called initial coin offerings (ICOs), which are newly-created cryptocurrencies offered by fledgling companies instead of shares in the business. 

Below, John Wyn-Evans, Head of Investment Strategy, Investec Wealth & Investment, pictured above, considers what all the fuss is about. (Satoshi Nakamoto, btw  – for all you cryptophobes out there – is the name ascribed to the Japanese (or so we’re told) mystery inventor of bitcoin.) 

All the ingredients for life on earth were available in the primordial soup, but it took some unknown catalyst to create the right combinations. Similarly, all the technology to enable cryptocurrencies was around from the 1990s, but it took the financial crisis to provide the impetus required for Satoshi Nakamoto, whoever (s)he might be, to launch Bitcoin in early 2009.

Like all good manias (and I believe we are witnessing a mania of sorts), the enthusiasm for Bitcoin has credible roots.

Bitcoin was born out of the chaos of the financial crisis. With banks going bust, the global financial system seizing up and no counter-party deemed reliable, an alternative currency suddenly had real attractions.

Crucially, it was a currency that could live in its own closed system, using the blockchain distributed ledger technology to authenticate and record transactions made over the internet.

It was free from government interference, and it bypassed the traditional banking system.

Not surprisingly, it initially attracted technology geeks and those of a more anarchic bent, but was quickly adopted by more criminal elements, not least through the Silk Road website, a hub for drug dealing. (That website’s founder, it should be noted, currently languishes in a US prison, sentenced for life with no possibility of parole.)

Be that as it may, and despite the ongoing attentions of regulators, Bitcoin has continued to flourish – and has spawned a raft of other alternative currencies.

At last count there were more than 1,100 of them, some quite large (Ethereum, Ripple, Litecoin), and many very small.

Disturbing aspect

It is this proliferation of alternative alternatives that is, in many ways, the most disturbing aspect of the story. It seems inevitable that even if an alternative currency system were to gain greater traction, only a minority of these upstarts could feasibly survive.

I suppose they could all be acquired in return for Bitcoins, but more probably, they will end up being worthless. And there is no impediment to issuing these things through what are known as initial coin offerings (ICOs), which lends them a spurious air of respectability.

Let us now consider the key characteristics of a currency – to be a “store of value” and a “medium of exchange”.

On 21 August, the price of bitcoin was US$3,997. It has since briefly moved past US$5,000, and last Friday traded in a range between $2,975 and $3,842. That’s difficult to describe as a store of value.

What’s more, it doesn’t have any sort of yield attached to it, so it’s impossible to value on that basis.

And unless you “mine” your own Bitcoins – an activity that takes huge amounts of computing power and energy to extract anything meaningful – you have to buy and sell Bitcoin through an exchange of some sort, and this is the weak link in the system – the so-called “trusted third party”.

The problem with this, as was seen most notably in the hacking of the Mt Gox exchange, when half a billion dollars’ worth of Bitcoins disappeared into thin cyber-air, owning Bitcoin is not necessarily risk-free.

So who has been buying Bitcoin? As I said, initially it was the geeks and their buddie,s who liked the idea of getting in on the ground floor of a subversive concept.

The big buyers in 2015 and 2016 were the Chinese, as money flooded out of the country when the currency was devaluing. As the government tried to close the official floodgates, the easiest route out was on-line.

Meantime, canny Japanese housewives, sometimes described collectively as the world’s biggest currency hedge fund, also latched onto the trade.

Bitcoin is also the currency of choice to subscribe to the afore-mentioned ICOs. Does that sound like a pyramid scheme of sorts?

‘The FOMO crowd’

Then the FOMO crowd arrived.

If there is one guarantor of speculative mania, it is the Fear Of Missing Out (FOMO), and this is stoked by “clickbait” advertising on otherwise respectable websites. I spotted one with the attention-grabbing headline “Kid from Luton becomes a millionaire after buying Bitcoin” – and so clicked through to find no mention of the lucky lad, but plenty of other exhortations to buy Bitcoin, which led (very conveniently) to a website where you could unload your hard-earned pounds and, yes! buy some Bitcoin!

Given the UK consumer’s propensity for on-line shopping, why not stick a few Bitcoin in the cart?

Having spent all this time debunking Bitcoin, I have to admit that I can also see why people might want to buy some as an option against the tail-risk of cryptocurrencies becoming the norm – even if governments, central banks and banks are going to fight it tooth and nail. A misdirected nuke from Kim Jong-un could be the catalyst.

But Bitcoin and its lesser-known cryptocurrency counterparts do not constitute an asset class in its own right, as some of the more over-excited supporters claim.

And we at Investec have no current intention of adding it to client portfolios, though we accept that it is up to the individual to decide what to do on their own account.

It is inevitable that we will hear more stories about people who have made a fortune, just as one hears of people who bought Apple or Amazon for peanuts. Do you feel visceral regret at having missed those opportunities, and would you have bet the farm on them?

I think not.

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