Mercer's David Scobie suggests investors not partial to “rolling the dice” sit out the cryptocurrency action and marvel as more of the story unfolds

Mercer's David Scobie suggests investors not partial to “rolling the dice” sit out the cryptocurrency action and marvel as more of the story unfolds

By David Scobie*

Eye-watering cryptocurrency price appreciation was the speculator’s delight of 2017.  The proliferation of new coin launches and widespread excitement around digital currencies hinted at the existence of a speculative bubble which, based on price weakness so far in 2018, perhaps had some basis.  In this article I outline the drivers behind the enthusiasm and consider some of the challenges facing cryptocurrencies as an investable asset. 

Chips off the block

While the goal of this article is not to canvas the mechanical aspects in depth, we can summarise by saying a cryptocurrency is a decentralised digital form of exchange where cryptographical techniques are used to control the creation of new units of currency and to verify the transfer of funds.  With the major examples to date, new coins are created via a “mining” process whereby “miners” are rewarded with coins for solving cryptographical puzzles. Most cryptocurrencies are designed to gradually decrease production of the currency, with some placing an ultimate cap on the total amount that will ever be in circulation, thus mimicking the finite supply of precious metals.

The underlying transaction record for a cryptocurrency is the “blockchain”. The cryptographical puzzle solved by the miners is part of the process of validating transactions.  In a conventional digital transaction, you, the counterparty and your banking provider are aware of a transaction.  However, in the blockchain, there would typically be thousands of “aware parties” keeping a record of such transactions, and this negates tampering via an attack on an individual copy.

It’s important to distinguish between blockchain technology and cryptocurrency. Blockchain is an infrastructure that has been heavily invested in by major players in the world of digital transactions, and applications are also being developed for non-financial sectors.  Blockchain is therefore an exciting development that could have a significant impact on the finance sector and wider economy over the coming decade.

The hope and the hype

The huge interest in cryptocurrencies has been driven by a number of features that distinguish them from government-backed fiat currencies:

  • Cryptocurrencies aren’t controlled by central banks. If a central authority cannot print large sums of the currency, it could potentially have more legitimacy as a store of value (some view cryptocurrencies as a form of digital gold). A motivator behind the introduction of the first cryptocurrency, Bitcoin (which has a limited supply of 21 million coins), was the large-scale quantitative easing programmes introduced after the Global Financial Crisis.
  • Cryptocurrencies offer a degree of anonymity. In May 2017 a piece of ransomware called WannaCry was released globally. For the unfortunate individuals and institutions whose computers were infected, this often meant that they had to pay a ransom to remove the harmful program from their computers, and this was achieved by paying a sum in Bitcoin. Bitcoin’s cloak of secrecy in this case proved to be helpful to the extortionists behind the virus.  Individuals are also able to make anonymous purchases for illegal items using cryptocurrencies. For example, it’s been estimated that just over a quarter of the UK’s drug-users have purchased banned substances on the Dark Net, generally using cryptocurrencies. 
  • Social media excitement and FOMO. The interest around cryptocurrencies has been amplified by the effect of discussion and shared news reports on social media. As with any asset exhibiting astronomical price rises, individuals are drawn in as they act on a “fear of missing out” on further increases. This is despite Bitcoin sporadically experiencing dramatic falls in value – sometimes 10-20% or more over a matter of days (one recent example being the 35% decline in late December 2017).

Bitcoin price history


Digital dilemmas

Cryptocurrencies face a number of significant challenges in attempting to establish themselves as serious alternatives to fiat currency or gold, thereby countering their suitability as an investment or store of value at this point in time:

  • Hacking and theft. In 2016, hackers managed to exploit a weakness in the coding of an online crowdfunding platform (The DAO), which used the cryptocurrency Ether, and stole approximately US$50 million in cryptocurrency. More recently, in January 2018, the cryptocurrency exchange Coincheck was hacked and US$530 million of NEM cryptocoins were stolen. Individuals have also been robbed of cryptocurrency at gunpoint. Thefts occur frequently and are likely to reoccur. Even so, the blockchain itself is rarely, if ever, compromised. What this means is that hackers have so far carried out exceptionally large robberies but have not fundamentally altered the viability of a cryptocurrency – for example, by forgery.
  • Survivorship. There are well over a thousand different cryptocurrencies in circulation and the field is widening with further “ICOs” or Initial Coin Offerings. 41 cryptocurrencies have market capitalisations of over US$1 billion, with Bitcoin leading the way at c.US$141 billion as at 16 March 2018.  Even most of the large players are likely to be surplus to requirements if and when a mature cryptocurrency payment framework emerges. It is therefore possible that many, if not all, cryptocurrencies with very high valuations today will be worth close to nothing at some point in the future.
  • Government intervention. Governments can intervene to outlaw or regulate certain aspects of cryptocurrencies and 2018 looks set to be a year in which such scrutiny comes to the fore. For example, policymakers could make owning, mining or running an exchange illegal and/or increase the compliance burden on exchanges. Some of these actions are harder to do than others - some exchanges have been shut down but it’s very difficult to eradicate ownership of cryptocurrency. Despite this, it would certainly be a large setback if a cryptocurrency were outlawed in a major territory (recently China and South Korea have launched crackdowns on digital currency activity). 
  • Congestion. The network of the predominant cryptocurrency, Bitcoin, isn’t currently able to handle a large transaction volume.  Given the current state of the technology, payments would grind to a halt if there were widespread uptake of the system. This places pressure on transaction fees. Whilst early in the history of Bitcoin transactions were seen as essentially free, the average transaction fee at the end of 2017 was US$25.  Such fees, alongside slower processing speed, mean that Bitcoin cannot function as a high-throughput small payments solution in the same way that credit cards do.
  • Exchange fees. As well as the fees due to the miners for validating transactions, cryptocurrency exchanges will also take a spread on transactions. For example, on Coinbase, one of the major exchanges, spreads range between 0.25% and 1% for purchases of digital currencies. Other fees can be incurred on transferring hard currency to and from exchange accounts, either by your traditional bank provider or the exchange.
  • Sustainability. In terms of energy consumption, the Bitcoin network, for both mining and transacting, consumes about the same amount of energy as Morocco. Whilst some of the large cryptocurrency mining firms have often been using surplus hydroelectric power, this clearly makes it hard to regard cryptocurrencies that involve mining as “green” investments. From a social perspective the link to cybercrime, drugs and money laundering also shadows Bitcoin heavily.

What next? Two sides of the coin

“Bitcoin is the beginning of something great: a currency without a government, something necessary and imperative.” - Nassim Taleb (financial author)

“My best guess is that in the long run, the technology will thrive, but that the price of bitcoin will collapse.” - Kenneth Rogoff (economist)

The above quotes highlight that the future success of digital currencies is far from clear.  The blockchain technology that underlies their use undoubtedly holds promise in areas such as trade processing and settlement, with many other potential applications under active development. However, in our view cryptocurrencies have yet to prove that they offer much more than the benefit of anonymity and the potential for huge price fluctuations.

Although some argue that cryptocurrencies can be considered a form of digital gold, the key difference with physical gold is that it has played a role in financial systems and been seen as a store of value for thousands of years.  With no way of assessing the fair value or longevity of different cryptocurrencies, holders need to contemplate the very real possibility that many, if not all, cryptocoins may be close to worthless at some point in the future. Whilst it is possible that one or more cryptocurrencies might survive and even thrive as the underlying technology and unforeseen applications develop, it is also possible that many will disappear altogether.

Worth a place in portfolios?

In summary, we do not view cryptocurrencies in their current form as a compelling proposition for investment portfolios - either directly, via futures or via hedge funds set up to speculate on price movements. They offer no income to the passive holder of coins (i.e. non-miners) and assessing fair value is close to impossible. In addition, the wave of cryptocurrency launches and the spectacular price rises witnessed in 2017 exhibit many of the hallmarks of a speculative bubble, notwithstanding some deflation seen in recent months. We suggest that investors not partial to “rolling the dice” sit out the action and marvel as more of the story unfolds.


*David Scobie is Head of Consulting at Mercer Investments, based in Auckland.  He advises institutional clients on their investment policies, portfolio structures and fund manager selection. 

This article does not contain investment advice relating to your particular circumstances. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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Wouldn't touch crypto with a barge pole at least for another 10 years. It will take that long, even longer, to sort out the fraud and misinformation and chaos.
Currently most of the time you send a bunch of money to some website, sited who knows where, and they say you now own some bitcoin. yeah right.

Sounds like "paper gold" bound to go well.

Oh and when the "website" gets hacked and you lose it, there is no comeback it seems.

I'd say it'd be silly to put a significant portion of your equity into crypto. I'd also say it'd be stupid not to put any of your equity into crypto, considering the innovation behind it as well as the potential for significant gains.

I ended up putting around 1% of my total equity into it around January last year on the suggestion of a colleague. Even with the recent crash, I'm still up around 30x overall.

If you're really that conservative in terms of investment, then there's nothing that will convince you either way. For the others that are on the fence, putting 1% or even less into crypto isn't going to be some crazy loss if it were to drop by 50%.

Thanks j3y. If you're willing, could you please explain how you went about it (as much or as little as you want), i.e. which exchange did you use? Do you use a wallet? If so, which? How do you secure your crypocurrency now? Offline? Do you have an efficient mechanism to convert back to traditional currency? Did you invest in the biggies (BIT, ETH, LTC) or did you include a smattering of smaller up n comers? With thanks.

Originally I used the Kraken exchange, which had some really good rates at the time. These days there's many more options for NZers (Lykke, Independent Reserve etc.).

All I did was purchase some Ethereum and transferred immediately to my Jaxx wallet (on my smartphone). These days it's stored on a Ledger Nano S hardware wallet, since the value has gone up significantly.

I've tried to keep up to date with some of the newer coins but there's just so many. I do like the look of the non-mining coins though (IOTA, NANO, NEO). Those are just so fast and free to transfer, they really make all the existing incumbents look outdated by comparison.

Thanks very much, J3y. Much appreciated.

Thanks very much, J3y. Much appreciated.

I would suggest that if the wait for a offline ledger/trezor hardware wallet is too long (purchase & shipping time) to use a paper or non connected wallet. Leaving it on an exchange or even a mobile connected device is relatively easier to steal or lose. Only do so if you intend to have frequent trades or use in purchases of cryptocurrency. Hardware fails often and mobile malware & permission hacks are pretty common in the wild. Hence the risk & user interface gotchas with trading with any online exchange also needs to be checked with a fine tooth comb. Read a few guides, support pages of a few exchanges, compare the fees, (and there usually are high fees compared to normal trading so for a normal person you would not be looking at under a few thousand at least), sign up to a few exchanges with different purposes (e.g. one for initial purchases for ease of transfer to your wallet, one for trading with low trading fees & decent pairs, one for cheaper withdrawals to your local wallet or bank, one as a backup in case a couple go down during an update or high traffic etc) and away you go. You might want to also keep tabs on the reddit communities as many exchanges post their notices & updates on reddit, help with support there and a few reddit pages give you a test of the community sentiment (some financial research has gone towards using the community as a rough ph meter but really you might as well be testing a snapshot of guppies with a 3 second memory). Keep an eye on multiple news blogs with different sources. All up treat the investment as a sandwich unattended on a picnic bench around a flock of seagulls, (even when just hoping for value increase for a few months), and you will be better off. Good Luck. Oh have a very healthy distrust and due diligence of ICOs; a lot of pretty shiny websites full of garbage for FOMO cults & frauds around.

Many thanks for the detail, pacifica. V. helpful.

Sorry it may sound slightly negative but from from the tech & security area so when advising anyone I like to let them know the risks (after all savings & livelihoods can be affected quite a bit). I even had a flood where some wallet copies were damaged (secure backups are great but I still lost a few devices & mobile that day which meant they needed to be repurchased & recopied). If you want a brief check of something the information security & tech community groups are good (the cryptocurrency ones are more for memes, & parroting blogs). But even the less well known boards can help, as they have better traffic than a few of the reddit ones (alas with less influence).

... be especially wary of any investment which could be negatively impacted by government intervention ...

And , if any investment was the wild west and was crying out for the sheriff and a posse to ride into town and clean things up , then it is Cryptocurrency City ... Yeeeee-haaaaa , pardners ...

I thought the very idea of a crypto-currency was it was un-traceable and un-manageable by any Government? If not then one of its primary purposes is negated.

In effect I see there is a limit on the number of them in existence so its like gold, unusable as a modern currency except by the fringes.

Quite the reverse for most cryptocurrencies you can link wallets to sources so you can always tell John X brought something from the wallet of Dicks Sensual Nights permanently in the blockchain ledger. The obfuscation is from it being harder to link John X to his wallet if you are a member of the general public and have not traded with DSN before or checked the shared registry or internet for the proprietor. More and more initiatives are going towards identification of address ownership (and even offering that info publically). Hence as more KYC & AML requirements come in the obfuscation is rapidly being lost to financial orgs on the backend and comes back to bite a few more people. Essentially it becomes a good reason to set up multiple shell entities with wallets at their disposal for different purposes or select a few cryptocurrencies that try to have the privacy features baked in. But if you want to advertise your purchase history to everyone it would be relatively easy to do so or find an app to render it with a nice UI to explore the data. Which can be an aid for financial checks, but I would recommend definitely taking steps to obfuscate the details and have another level in between your identity and the chosen exchange, wallet & cryptocurrency, (no one wants to see the purchases from DSN out in the wild, especially the entire world being able to check transaction logs permanently). Often there is a good reason for privacy in purchases, (even in totals transactions out for a given person). The record being publicly available does cause a few issues for an individual, for a company accepting bitcoin and the converting to fiat for purchases not so much.

Is there any investment which isnt at risk of govt intervention if the pollies see enough of the public making noise about that industry?

I held gold for 3 years..idiot move as neither went up or down. I don't even know why its price is reported on this sight as for every time it breaks out, the management bring it back down.
Got into bitcoin last year after lots of research..happy to hold as its here to stay and overall I still up over 50%. Its part of my overall portfolio and will keep adding to it, but amazed how resilient it has been to the constant slam down from the vested interests.

So you have decided the only feature you would idolise in an investment is high volatility? (Expecting that from gold is funny). Well have I got some race tips for you. If you don't grasp the concept of risk with that volatility is seems reckless to be investing anything other than what you would already gamble with bad odds. You probably would get even better odds, less fraud and less market manipulation in the casino.

"idolise in an investment is high volatility?" How did you arrive at that conclusion? But I do agree with you on this point "You probably would get even better odds, less fraud and less market manipulation in the casino." That is good point re the gold market.
Keep idolizing the gold nuggets ..'Ive moved on.

I tend to idolise better GPUs and computing power, frack anything that doesn't grind like a bare rim on the road once it is out of the honeymoon build period (even custom builds can be crippled due to tech availability limitations). I still think the best thing done with gold so far has been the scientific research on atomic particles & electronics. It is traditionally a more conservative commodity (with a theft risk). Artificial digital commodities tend to have more issues & higher risk of theft but at least that is due to them being easy to copy across & multiply. Now whisky is a great group of commodities to get into. You might find you need it with an ever increasing degree.

NO !

Crypto currencies are the biggest Pyramid schemes in human history .

Rule No1 for any investment :-

If you dont understand how it makes its money then dont go anywhere near it

Rule No 2 :-

If you have no idea what its tradeable value is within a range of 10% on a day -to -day basis then dont touch it

Rule No 3 :-

If you cant see it , OR touch it , OR eat it , OR know where its located , OR understand what makes it grow in value ............. leave well alone .