Crypto: Tulip Mania all over again?

The idea of a blockchain has significantly challenged the conventional manner of "transaction" since a report written by developer Satoshi Nakamoto was first published. Over the past decade, Blockchain technology extended its application to various sectors. One major application is cryptocurrency transactions. Although cryptocurrencies have gained significant popularity among investors, their classification as an asset is yet to reach a global consensus. Amid a worldwide economic recession, the cryptocurrency industry faces enormous challenges following the plunge in crypto prices.

Many investors are confused about crypto and blockchain; a simple analogy could explain this. Think of crypto as your credit or debit card and blockchain as the banking system that allows transactions to happen. Blockchain is a digital payment system that doesn’t rely on banks to validate transactions, making it decentralized. Peer-to-peer technology makes it possible for anybody, anywhere, to send and receive payments.

Various Types of Cryptocurrencies

Credit: Blockgeni

Payments made using cryptocurrencies are digital entries to an online database that records individual transactions. A public ledger keeps track of all bitcoin transactions that involve money transfers. A Blockchain ledger differs from a typical accounting ledger as it is shared and immutable, meaning transactions cannot be hidden or deleted once they have occurred.

Over the past few years, crypto has raised controversial debates about whether it is an asset. We believe crypto is not an asset. An asset, in our view, is an entity that generates cash flow. Since crypto cannot generate cash flow, it has no intrinsic value and cannot be valued. If Bitcoin’s intrinsic value cannot be determined, there’s no telling whether it’s worth $1,000 or $1 Million. To learn more about evaluating an assets’ intrinsic value, access our previous white paper here.

People have considered Bitcoin to be digital gold, however, we see several differences between crypto and gold. Gold is considered a stable asset and is viewed as a favorable hedge against inflation. Gold is said to protect the owner from inflation as the value of the dollar erodes, the cost of every ounce of gold will rise as a result. This is because that gold has a rarity component to it, as it’s created inside massive stars when they explode into a supernova and are brought to earth from asteroids. This precious metal is hard to extract and impossible to recreate, holding a strong demand and functioning as a good store of value.

Bitcoin, on the other hand, is easily accessible and can be duplicated as a unique coin by anybody. Bitcoin has a limited supply because of mining restrictions, but it is not a rare commodity. To meet market needs, people can always design new kinds of coins. In our view, bitcoin is not an asset that can hold value compared to actual asset like gold.

Gold Volatility Hedging Against Inflation

Credit: Funds Europe

According to our CIO Siddharth Singhai, " We don't know what cash flows Bitcoin produces- it is sort of an exotic car, where you think it's worth a lot and it will hold its value because there are only 100s of it. But it might not be the case as it does not produce any cash flow and is not rare, there are many other cryptocurrency and you can create your own cryptocurreny. It is not like gold or like some alien metal that arrived on Earth and is limited where you can’t produce anymore of it. Saying of this, Hedge funds will embrace it as long as it does well" Click here to watch the full video on a seminar about value-investing with students from Western New England University.

There are two key defining features of cryptocurrencies that make it difficult for them to be accepted as a currency; the first is their volatility, and the second is their inability to store value.

For instance: If you have one bitcoin and it's currently worth $100,000, you can buy a Tesla with it. Cryptocurrency prices are very volatile; you might wake up the next morning to find that the price of bitcoin has fallen significantly to $80,000. Since the value of the currency just dropped by 20%, a business transacting through bitcoin would suffer a significant $20,000 loss in a single day. Therefore, no company will permanently accept cryptocurrency as a currency due to the volatility stated above.

Volatility of Bitcoin Over the Past Decade

Credit: Bitcoinist

Since cryptocurrencies do not produce cash flow and are not a naturally scarce resource like gold, it is difficult to estimate their worth. From a risk-reward investment perspective, we do not consider cryptocurrency a good option to invest in as there is no real way to identify the upside or downside with this investment. We believe the value of most cryptocurrencies will go to zero or some small notional value in the long run.

By: Siddharth Singhai, Darpan Saluja, Emily Yang, John Siguencia

Disclaimer:

Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. The views and strategies described may not be suitable for all investors. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.?