BAD CURRENCY
One of the main concerns is that it is literally difficult for investors to get their hands on them. The digital currencies exist online and are strings of computer code rather than securities. They differ from so called real world currencies such as the dollar or pound in that there is no central bank such as the US Federal Reserve or the Bank of England managing the money. Nor is there any regulator overseeing these instruments, although that will change.
Launched in 2009 by a mysterious developer using the alias Satoshi Nakamoto, the goal was to create a “peer-to-peer version of electronic cash”, allowing “online payments to be sent directly from one party to another anywhere in the world without going through a financial institution,” according to a white paper issued at the same time.
So far, institutional investors have been wary. “At Coutts we base investment decisions on fundamental data, and crypto-currencies do not possess the metrics we would look for to gauge its underlying value,” the bank’s multi-asset investment manager Monique Wong says. “As far as we can see, these returns are based on pure speculation about their future potential, with no hard data to back it up.”
Paul O’Connor, a portfolio manager at Janus Henderson, echoes these sentiments. “One potentially attractive feature of bitcoin from an asset allocation perspective is its low correlation to other assets. However, that is it. Bitcoin is hugely volatile, impossible to value and has many other substantial shortcomings. We think it is uninvestable. It is a speculative, immature financial instrument based on an experimental technology,” he adds.
From an investment perspective, O’Connor notes that the crypto-currencies score low against the three classic essential characteristics of a currency: medium of exchange, unit of account and store of value.
“When assessed as a medium of exchange, the issue is simply that crypto-currencies cannot be easily used as payment in everyday transactions,” he says. “Also, when compared with fiat currencies, transaction costs are too high and settlement speed is too slow to be relevant for anything other than black market or criminal transactions.”
There have been several high-profile scandals. Most recently there was the $500m theft of XEM coins by an anonymous hacker on Tokyo-based virtual currency exchange Coincheck. It was the market’s biggest heist and brought back memories in the country of the hacking and subsequent collapse of Mt Gox in 2014, which ruined investors’ and brought an unseemly end to the first bitcoin boom.
O’Connor also notes that there have been issues with the market infrastructure with Coinbase, GDAX, Bitfinex and Kraken reporting outages while trading execution at dealing platforms has been sluggish and investors were reporting difficulties in selling bitcoins. “Decentralisation has its problems too – there is no resolution process for disputes, and if you lose your password (private bitcoin key) you’ve lost your bitcoins: the decentralised nature of bitcoin means you can’t call someone to restore your access,” he adds.
Coutts investment strategist Lilian Chovin also points to high transaction costs as a major stumbling block. Figures from bitinfocharts.com show that as demand for bitcoins took off in the past few months, the cost jumped to as high as $40 per transaction.
“A little high if you are trying to buy a sandwich for lunch,” she adds. “By comparison, debit card transactions typically cost around 30 basis points of the transaction – a £4 sandwich might come with a transaction cost of around a penny.”
Chovin also notes the number of transactions that can be processed each minute is limited by the way bitcoin is designed. “Only about 2,000 transactions can be contained in each block in the blockchain, so the more transactions there are the more blocks there are to process,” she says.
Currently, it can take up to 92 minutes to process a transaction, but transaction times recently peaked at almost 24 hours. This compares to Visa which is widely quoted as being able to process 50,000 transactions per second.
