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Cryptocurrencies

Most of what you've been told about the cryptoworld is wrong

Some of it is deliberately deceptive. Much is wrong-headed.

No intrinsic value

As the inventor of Ethereum, Vitalik Buterin, has pointed out: crypto tokens have no intrinsic value. But then neither does gold, and nor do most stocks.

Not currency?

Crypto tokens, often called digital currency or crypto currencies, are not currency as most people understand them: everyone will accept and trade them. But, often, fiat currencies (the ones created by governments) may not be either. Do you want some North Korean currency? Or Hungarian forints?

Please, no currency wars

How does this differ from so-called fiat currencies, the legal tender governments create? A top European Central Bank (ECB) official in Davos last week warned against a potential "currency war" as the U.S. pushed the dollar to a three-year low against the euro. ECB board member Benoit Coeure described it as "the last thing the world needs".

Don't compete with exchange rates

"We live in a world where exchange rates are not and should not be targeted for competitive purposes," he said in a panel."We see lots of volatility created recently by different statements and I think that’s just not helpful. Volatility is not helpful and if that would reach a point where it would create any unwarranted consequence for us, any unwarranted tightening for monetary policy, we would have to reassess."

Which sounds as much like a threat of retaliation at the same time as a plea.

Tokens are not investment as we know it

When you buy crypto tokens, it may count as investing but you are not an investor. If you buy stock, you own a piece of the company with rights to a say in how it is conducted (small ones but rights), a claim on its assets and a chance of dividends. That's not so with tokens. Read the small print.

You are not crowdfunding

When you buy tokens, you are not a crowdfunder. Crowdfunders get their money back if the project does not deliver. For your tokens you won't. Unless you cash out early.

Look at the volatility

Then there's the daily volatility in the price of crypto tokens, and how they vary over time. You'd have to be in Venezuela or Zimbabwe to get something so uncertain.

But then look at the U.S. dollar's price over the past 50 years against, say, the Swiss franc. Betting on the dollar was a losing game. And now the Swiss National Bank is forcing down the franc's price against the euro by buying up large amounts and sitting on them.

Better than casino odds

In contrast, bitcoin and ethereum have bounded up by thousands of a percent over the year. Many other cryptos have risen by hundreds of percentage points. It may be a gamble but the odds look better than at the casino or racetrack. If you are throwing your money away, why not put it into crypto?

Who's trading

Look at where the crypto trading is taking place: Korea — where people worry about a nuclear war, Japan — with a high savings rate and moribund economy and China — whose citizens (and kleptocracy) seem desperate to get their money abroad and out of the hands of Beijing.

Don't forget the killer whales

Then there are the sharks (known as whales in the trade) who specialize in pumping up the price of a minor crypto, then dumping it at its highest price. Don't look for rhyme or reason in the fundamentals or the news for the swings up and down.

Here come the margin traders

Clearly the margin exchanges in the United States wanted a piece of the action. They got it in December 2017. So we can expect even more volatility, usually on the downside (because traders can gamble against the token price with a smaller amount of money, as well as in favour of a higher price) — once they have figured out how to manipulate the market together.

What are tokens?

So what are cryptos? Legal tender, assets, securities? It depends on the authorities and what they want to tax.

The U.S. Internal Revenue Service has taken a tough line, suggesting each transaction using tokens is subject to capital gains tax. By contrast, the European Union's Court of Justice has suggested transactions in bitcoin are VAT exempt because "virtual currency has no purpose other than to be a means of payment".

What's wrong with the big tokens?

Waiting three days for confirmations of a transaction, as can happen with crypto exchanges using bitcoin, does not cut it. If cryptocurrencies stay that way, they can never replace credit cards, except for people who need to get out of cash no matter what the risk (Koreans and, it appears, millions of Chinese, Japanese, Venezuelans and Filipinos).

How crypto is like investment and crowdfunding, how not

Cryptocurrencies are more like investments or assets, such as initial public offerings (IPOs) when private companies raise capital by going public. Or crowd-funding. Ups and downs with IPOs are quite common, and some are a bust. IPOs, however, are highly regulated. However, unlike crowdfunding, if the product does not appear, you don't get your money back. And "investing" your cash does not give you any ownership rights in the enterprise.

Token buyers are stakeholders not investors

Altcoin promoter Joseph Lubin does not even call cryptocurrencies financial instruments. He told Don and Alex Tapscott, the father-and-son authors of a World Economic Forum study on 16 June 2017, discussing Ethereum: "There are no investors. There are stakeholders who bought a software product called Ether that enables business and software developers to build on and use the decentralized application platform."

What are distributed ledgers?

The digital ledgers that record the transaction information are available to every computer with an Internet link under the blockchain technology. In fact, the encrypted details of the ledgers are stored on every computer that has signed up to be part of the system. No longer does one book or site or office hold all the details.

So nobody can feasibly make changes retroactively once they have become part of the blockchain. The details are distributed to all participants. Hence the alternative name of distributed ledger systems.

Recording anything of value that can be expressed in code

The Tapscotts note: "Innovators are programming this new digital ledger to record anything of value to humankind: birth and death certificates, marriage licenses, deeds and titles of ownership, rights to intellectual property, educational degrees, financial accounts, medical history, insurance claims, citizenship and voting privileges, location of portable assets, provenance of food and diamonds, job recommendations and performance ratings, charitable donations tied to specific outcomes, employment contracts, managerial decision rights and anything else that we can express in code."

The key problem

The key problem facing blockchain businesses is managing the validation process for transactions, and that is allied to its phenomenal growth. The Tapscotts quote Matthew Roszak, Co-Founder of Bloq Inc.: "Bitcoin is a car going down the road at 1,000 mph. Developers are not the drivers of this car, yet they are tasked with repairing and upgrading this car without turning it off, stopping it or rebooting it."

Validation of blocks is taking longer and longer

One result is that validation is taking longer and longer. Which means that transactions are taking much more time to go through. Some dealers have stopped owners from cashing out their tokens because of the slowdown of the system, and with the amazing volatility in the tokens' prices, this can cost investors huge amounts of real money.

Speed fees privilege the rich and the whales

Similarly, you can opt to pay a higher transaction fee to go to the head of the queue for processing. That can privilege the big investors, and may have been responsible for the "flash-crash" of 21 June. On 1 August 2017 the blockchain system changed, freeing up the block handling process to speed up transactions.

We need to meet regulators' rules

But the blockchain technology also needs platforms that can meet the requirements set by regulators of capital markets for transactions, Jesse McWaters of the World Economic Forum argues. The anonymity of cryptocurrency may be appealing to drug users and criminals, but not to legislators concerned with ensuring people meet legal disclosure requirements in buying or selling a house, for example.

Crypto 'wars'

And then there is the "open war" between developers and different "cryptocamps" about how blockchains should go forward, report the Tapscotts. A board member of the Bitcoin Foundation has been arrested for embezzlement, and the Ethereum original developers have split over the device used to stop a fraudster siphoning off $70 million (in value at that time) via a faulty contract.

Undermining changes

Ethereum re-established the accounts of those whose stop-loss accounts sold off their tokens. So they still held the same number, and no-one lost tokens because of the fraudster, though it took time for the value to bounce back. But the split between developers continues, and over the long term may undermine the changes launched on 1 August.

No shared, inclusive vision

"Making decisions in a decentralized system is not easy," notes Roszak. The Tapscotts document some of the vituperative postings in the debate. They conclude: "The bitcoin community needs a shared and inclusive vision for the future and a mechanism not just for sorting the important signals from the noise of trolls on social media but also for mobilizing to address them as an ecosystem."

The SegWit issue

August 1 put the collaborative spirit of system maintainers to a hard test. Three different proposals have been put forward. In theory, the people with the computers that keep the blockchain system going can each accept any of the ideas, or none. They are known as miners, but that's a terrible term for what they do, using their computers to validate transactions and be rewarded with tokens. These days they are mostly "mining farms", huge collections of computers in places like China.

What's at risk

The most popular proposal doesn't have any of the current Bitcoin Core (original) developers on board, the Tapscotts point out. "If the network fails, all the unconverted bitcoin they'd earned (or could earn) through mining would be lost, worthless or at risk," they note.

As of now, there are two kinds of bitcoin and two kinds of ethereum, and more are likely in the pipeline. The latest fork, creating Bitcoin Gold, took place on 23 October. Another one was due on 16 November until it was suspended on 8 November because of lack of consensus.

Rising costs

Another difficulty facing the blockchain is that as it grows, so does the cost of keeping it going. "The energy consumed is unsustainable," the Tapscotts warn. "Estimates liken the bitcoin network's energy consumption to the power used by nearly 700 average American homes at the low end of the spectrum and to the energy consumed by the island of Cyprus at the high end".

The cost of keeping cool: one trade uses as much as a house for a month

Add to that the cost of keeping the computers cool (roughly 50%). One company has set up in Iceland and Georgia, and others in similar places, to reduce electricity costs through cold climates and renewable power.

Teunis Brosens, senior economist at the Dutch bank ING, has calculated that bitcoin transactions use so much energy that a single trade could power a home for almost a whole month: 200kWh.

Comparing the amount of energy used for a bitcoin transaction to running his home in the Netherlands, Brosens said in the report published on 15 October: "200kWh is enough to run over 200 washing cycles. In fact, it's enough to run my entire home over four weeks, which consumes about 45 kWh per week costing Ä39 of electricity (at current Dutch consumer prices)."

Visa uses 20Kx less

Ethereum, by contrast, uses 37 kWh. "Visa takes about 0.01kWh (10Wh) per transaction which is 20,000 times less energy," Brosens noted.

Incentives issue

Allied to the energy cost is the incentives problem: the blockchain pays people to use their computers to keep the system going but most computers used for the blockchain must be replaced every three to six months.

Ethereum has promised to move to a less-energy-intensive system (known in the trade as proof-of-work), and talked on its website of making the switch in 2017. But a coindesk reporter has written: "Since [the switch] has been pushed back several times, detractors see this hybrid as the latest evidence that [the new system] won't ever be fully implemented successfully on Ethereum."

If so, then it seems obvious that the problems will only get worse. Meanwhile, the recommendation for those who hold bitcoins is to keep them offline.

Fortune 500 firms are in

Nevertheless, more than 100 Fortune 500 companies, cryptographers, academics and veteran Ethereum developers have joined in the Enterprise Ethereum Alliance (EEA) to develop roadmaps for enterprise and industry-wide applications on the blockchain. Even in 2016, the World Economic Forum said, more than 90 central banks were holding discussions on blockchain systems. Some 80 percent of banks were predicted to have started projects by the end of 2017.

Sweden, Estonia and CryptoValley, Switzerland

Sweden is already using the blockchain to record its property transactions. Estonia uses the system for registering its inhabitants and carrying out many business transactions. In Switzerland's CryptoValley, Zug (population 29,000) you can pay for public utilities with bitcoin at the local council up to a maximum of CHF200.

Even accounts is a misleading term

In an article published by the cryptocurrency platform called Monetas (based in Zug), author Graham Tonkin says terms like accounts, virtual currency, and digital currency "are misleading, or outright wrong when describing both the currency and technology of Bitcoin."

It's all about the cryptography

Cryptography, producing a unique identifier for transactions, is what makes bitcoin unique rather than it being digital. These days, only a small proportion of our currency in circulation is physical.

Your leather account

"Referring to where one stores bitcoin as an account is akin to saying that you have a leather account in your back pocket or purse," he writes. "An account is managed by a third party, a bank. A wallet [where you hold your cryptocurrency] holds value directly and is only accessible by the person who is in control of it."

All tokens are not equal

Nor are all tokens equal (any more than currencies). Over 1000 tokens are on the market. But fewer than 20 account for more than 1% of the marketplace.

So picking a token from outside this list is pretty much a roulette gamble, unless you do a lot of investigating for yourself.

Of course you can make a killing if you choose the right one. But no-one has a formula for picking the one that is going to succeed, over the short term or even the long term.

Favourite tokens

If you want a rundown on the favourite tokens, try this or

this.