Cryptocurrency: The next big thing or fool's gold?

The volatility is not for the faint-hearted but looking at how prices have moved, the clear trend for these cryptocurrencies is up. James Quinn, managing director of Hong-Kong-based digital asset financial service provider Q9 Capital, believes that it was a “perfect storm” of positive factors in 4Q2020 that drove this crypto-craze.

He points to a spike in institutional narrative speaking in favour of cryptocurrencies, with Guggenheim Partners chief investment officer Scott Minerd estimating that Bitcoin ought to be worth an eye-popping US$400,000. Dollar debasing due to flush liquidity, adds Jeremy Ng, Asia Pacific managing director of crypto exchange Gemini, was also partly what drove renewed market interest.

“It all kind of hit critical mass starting in November, and December, and really picked up speed into the beginning of this year,” Quinn tells The Edge Singapore. With economic recovery sparking talk of inflation reigniting over 4Q2020, there was a groundswell of interest in Bitcoin — the most established of the cryptocurrencies — as an inflation hedge. The finite supply of 21 million Bitcoins, as claimed by its anonymous founder, who goes by the nom de guerre of Satoshi Nakamoto, gives it an inherent scarcity that makes it a good store of value.

Q9 Capital has seen a spike in interest in cryptocurrencies in the past month, with many new and inactive investors seeking them out. Ng also remarks that most of Gemini’s clients have been tech-savvy millennials between 20 and 40 years of age — a rich vein of adopters that promises to drive the “cryptocurrency movement” into the future. He believes that more steps need to be taken to help older investors learn more about trading this asset class.

But the subsequent rapid Bitcoin correction also suggests that investors remain uncertain about cryptocurrency’s viability as an asset class. Price volatility has typically been cited as a reason as to why the technology cannot serve as a store of value.

“Bitcoin has now shed nearly US$10,000 a digital tulip in the past few sessions, and I am still waiting for signs of the so-called “institutional tulip money” espoused by apparent experts, to appear,” Jeffrey Halley said on Jan 13. Halley, OANDA’s senior market analyst, Asia-Pacific, was referring to the 16th century Dutch Tulip bubble.

But Ng of Gemini predicts that as financial institutions increasingly replace retail investors and a few “whales” — individuals with large Bitcoin holdings — in cryptocurrency markets, price volatility will reduce since the former tend to have longer investment horizons and more financial staying power than the latter. Ultimately, he believes that with greater scarcity, portability and divisibility, cryptocurrencies can serve as a viable alternative to gold as inflation returns.

Going mainstream

Recently, there has been significant interest in Bitcoin from mainstream financial institutions. DBS has recently launched its own digital exchange in partnership with Singapore Exchange (SGX) that offers spot exchanges from central bank currencies (SGD, HKD, JPY and USD) into four cryptocurrencies — Bitcoin, Ether, Bitcoin Cash and XRP.

Despite claiming that cryptocurrencies were not an asset class in May 2020, Goldman Sachs is now considering developing its own cryptocurrency. Its global head of commodities research, Jeffrey Currie told CNBC this month that he sees growing maturity in Bitcoin as an asset class. Fidelity Investments recently set up a digital asset arm as well as its first Bitcoin fund, although director of Global Macro Jurrien Timmer had urged the average investor to be “buyer beware” in 2017.

“Why would the banks disrupt themselves by introducing a digital currency that would make it easier for consumers and businesses to disintermediate the banks,” wonders Darrell Duffie, professor at Stanford University’s Graduate School of Business. The answer, he believes, is that this growing institutional involvement is a sign of cryptocurrency going mainstream. Mainstream finance, says Gemini’s Ng, no longer sees “cryptos” as a threat, but rather as an opportunity.

“The exponential pace of asset digitalisation provides immense opportunities to reshape capital markets. For Singapore to become even more competitive as a global financial hub, we have to prepare ourselves to welcome the mainstream adoption of digital assets and currency trading,” DBS CEO Piyush Gupta explained when launching the bank’s digital exchange.

One reason for this trend, says Q9’s Quinn, is due to improved infrastructure for cryptocurrency trading, like regulation and storage. Large institutions feel more comfortable seeing this expanded and matured set-up and are thus more willing to explore these assets. Still, institutions prefer established tokens like Bitcoin and Ethereum to volatile newer arrivals or “oddcoins” like DeFi tokens, which are traded by more experienced investors with a higher risk appetite.

Cryptos for all?

To secure this sector, the Monetary Authority of Singapore (MAS) is regulating cryptocurrency businesses under the Payment and Services Act. Ng celebrates this move as a legitimation and institutionalisation of cryptocurrencies. The Securities and Futures Commission (SFC) of Hong Kong is also initiating a consultation process on licensing virtual asset exchanges; deVere Group CEO Nigel Green has even called on the G-20 to develop an international regulatory framework. Regulation will likely ease investor concerns about exploring cryptocurrencies.

But others in the crypto-space fear that growing regulation would hinder the evolution of the industry. “Without regulation, [cryptocurrency] will increase in value at a much greater rate than with regulations,” notes an exasperated Zhu Juntao, CEO of financial services firm Hodlnaut. He claims that an over-regulated cryptocurrency industry would limit the creativity of smaller firms while giving an added advantage to larger firms, who can then dominate the market more easily.

To protect retail investors from volatility, many exchanges and institutions restrict cryptocurrency access only to sophisticated investors. Michael Sonnenshein, managing director of cryptocurrency firm Greyscale Capital, tells DBS chief economist Taimur Baig in a Kopi Time podcast that only accredited investors are allowed to trade with them. The firm is developing better ways to value cryptocurrencies to improve asset picking. DBS’s own Digital Exchange is off limits to retail investors, welcoming only accredited and institutional investors, as well as private banking clients for now.

In contrast, Gemini sees cryptocurrencies as a “movement”. Founders Cameron and Tyler Winklevoss think cryptocurrencies can benefit society by reducing costs associated with financial intermediaries, as well as to “bank the unbanked” of the world. Nobody above 18 years old is excluded from buying cryptocurrencies on Gemini. The firm believes investors can be best protected via an extensive programme of education, and instituting a ban on leveraged trades so that when bets go wrong, the damage is somewhat contained.

And things are just getting started. “The banks are not involved yet. None of the [local] private banks are offering [cryptocurrencies] except DBS. Most asset managers do not have a cryptofund,” Ng says. Should financial institutions enter this space, he tells The Edge Singapore, cryptocurrencies could see exponential growth going forward. Nasdaq-listed tech firm MicroStrategy has even shifted much of its corporate treasury into Bitcoin.

The other two local banks, known to be more conservative than DBS, are not quite into this new territory yet. But both have made tentative forays into digital assets and blockchain. Oversea-Chinese Banking Corp (OCBC) was the first Singapore bank to join JPMorgan’s Interbank Information Network and completed a pioneering remittance transaction with Union Bank of the Philippines over an Ethereum-based ledger. UOB is hiring for a “vice president — crypto security administrator” role, hinting at a potential foray into custody solutions. It is also looking into using digital tokens for trade financing.

“Cryptocurrencies have a modest but still useful role as an alternative asset in future,” says Mansoor Mohi-uddin, chief economist at OCBC’s private bank unit, Bank of Singapore (BOS), in a report on Jan 22. “Digital currencies may partially displace gold over time by offering an electronic — rather than physical — store of value once important hurdles including trust, volatility, regulatory acceptance and reputational risks have been overcome.”

Fool’s gold?

But sceptics remain suspicious of cryptocurrencies because of their alleged lack of underlying value. Legendary investor Warren Buffett, for instance, told CNBC that for an asset to be truly worth anything, it must yield some additional value to the investor by virtue of holding it. Having not yet fulfilled its promise of serving as an alternative means of exchange to fiat currency, critics claim, Bitcoins are essentially nothing more than a form of speculation.

“When you buy non-productive assets, all you are counting on is whether the next person is going to pay you more because they are even more excited about another next person coming along,” says the Oracle of Omaha in the interview — a stance that has seen him express scepticism about investing in gold. It is similar arguments that have led experts like DBS’s Gledhill to draw parallels between cryptocurrencies and “Ponzi schemes”.

Yale professor Robert Shiller, on the other hand, sees the Bitcoin rally as a form of irrational exuberance driven by a compelling narrative. The Nobel Laureate — who has often dabbled in investments himself — argues that it was the compelling narrative that government is unnecessary and untrustworthy as well as the mystery behind the identity of Bitcoin founder Satoshi Nakamoto that has driven investor fascination. Still, he believes that the “Bitcoin bubble” could be with us for as long as a century.

“True believers’’ like Zhu maintain however that what investors are buying into is, in fact, the large network of users that participate in Bitcoin transactions. While the coins themselves are intrinsically worthless, the network of users who recognise the value of cryptocurrency and transact in it is a form of utility in itself. Cost and time savings arising from bank disintermediation, as well as the security of the blockchain networks underpinning cryptocurrencies, can also be said to be an additional source of value too.

But faith is a fickle thing and Canadian-based financial blogger Cam Hui, better known by his moniker Humble Student of the Markets, sees this as a big “if” that will define the future of cryptocurrencies. Comparing them to art investments, like purchasing a rare Rembrandt painting, he notes that there is always a risk that markets will no longer attach value to cryptocurrencies. This is especially if technological advancements consequently make cryptocurrency mining easier, thereby reducing their relative scarcity.

Much of the public suspicion towards cryptocurrencies arguably stems in part from a lack of awareness. Ordinary people fear the complexity and apparently risky nature of cryptocurrencies. On the other hand, supporters complain that critics often condemn cryptocurrencies without fully understanding how the technology actually works. Gemini is offering online webinars and resources to educate retail investors, while Ng has been meeting with institutional and high-net-worth investors to explain the technology to them.

Education is also necessary to ensure that investors are able to make an informed investment in cryptocurrencies rather than blind speculation.

“We would be the first to always remind investors that investing in [cryptocurrencies] is certainly not for the faint of heart,” warns Sonnenshein of Greyscale. The same advice often bandied about by traditional investment advisors is applicable to cryptocurrencies too. For example, nobody should invest more in cryptocurrencies than they can afford to lose, he warns.

Hui sees nothing wrong with investors hitching on the crypto “hype-train” in the short run as a momentum play, so long as they are careful to “abandon ship” before the perceived bubble bursts. But Rosenberg Research chief economist David Rosenberg sees the day of reckoning coming sooner rather than later. “The parabolic move in Bitcoin in such a short time period, I would say, for any security, is highly abnormal,” he told CNBC in December 2020.

Ultimately, perhaps the single most potent argument that cryptocurrencies have in their favour is resilience. “A lot of different asset classes really ‘fell out of bed’, crypto more so even than equities and other asset classes. But what we have also seen is how much crypto has snapped back and really outperformed pretty much everything else out there this year,” says Sonnenshein. Having already rebounded twice from previous post-exuberance slumps, it remains to be seen if “third time’s the charm” for cryptocurrencies as an asset class.