Cryptocurrencies & Financial Euphoria
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David Coffey
Senior Portfolio Manager

Cryptocurrencies have hit Main Street and the internet is littered with articles hailing their arrival as either a liberal alternative to fiat currency or a bubble akin to the great Dutch Tulip Bubble of the 1600s. At Cantor Fitzgerald, we have seen a material increase in enquiries about the digital currencies: Should I buy? How do I buy? What are the risks (not enough people asking this question)?

With a market value of c. $77bn, Bitcoin is the largest cryptocurrency in the market. It gained another 50% in August and is up over 350% since the beginning of the year. In early August, it split into Bitcoin Core (the original Bitcoin) and Bitcoin Cash (a new version better equipped to deal with digital transactions). The split went off without much drama and the cryptocurrency continues its relentless advance.

Ethereum (Ether) is the second largest cryptocurrency with a market value of c. $36bn and is up almost 5,000% in 2017. It was subjected to a digital hack during the summer that resulted in the theft of $50m. Rather than let the thieves away with it, a technical “hard fork” was initiated which resulted in a new form of the currency that excluded the hackers. Some purists were opposed to the split and have formed Ethereum Classic, which has a current market value of c. $1.5bn.

It doesn’t end there. The top 100 cryptocurrencies are worth some $170bn. New ones are popping up all over the place, eager to cash in on the swarms of speculators looking for the next Bitcoin or Ether. Ripple is the third largest cryptocurrency on the market and has managed to bag none other than the former chairman of the Federal Reserve, Ben Bernanke, to give the keynote speech at a cryptocurrency event it has planned for October. It will be interesting to hear what he has to say.

So how does one go about buying a cryptocurrency? The internet is awash with websites that will enable individuals to convert their euros and dollars into any of the +1,500 cryptocurrencies available in the market and hold them in a digital wallet. The US Securities and Exchange Commission (SEC) has yet to approve an Exchange-Traded Fund (ETF) that tracks the price of Bitcoin or Ether. Speculators can bet on the price movements through some spread betting accounts.

Should you buy? This is a difficult one to answer. On the face of it, it looks like a classic bubble has formed with investors buying for one sole reason. They believe that prices will keep going up and they can eventually sell to others at a higher level – the greater fool theory of investing. The problem with bubbles – and it is my personal opinion that this is a bubble – is that it is impossible to establish, in real-time, at what stage you are in the life cycle of the bubble: beginning, middle or end? Bubbles usually go much higher and last a lot longer than most people could imagine so there may still be time to play the “greater fool” trade.

What are the risks? Most of these cryptocurrencies could end up worthless. Some may survive and thrive but I’m sure it is only a matter of time before the central banks start taking a closer look. The blockchain technology behind some of the cryptocurrencies seems to have real value and may form the basis of digital currencies in the future, ones that will be regulated by governments and central banks.

I don’t see how any of these cryptocurrencies could find a place in a sensible investment portfolio at this point in time. For a good understanding of the nature of bubbles, I would recommend reading John Kenneth Galbraith’s great little book titled “A Short history of Financial Euphoria”.

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