Last year there was one word on everyone’s lips: bitcoin. Exploding overnight and bringing the world of cryptocurrency to public attention, prices soared before later plunging. But was this a short-term mania or a long-term trend investors should take seriously?
It was December 2017 and stories abounded about those who got-rich-quick (on paper at least), buying virtual currencies no one had heard of before that were valued at far more than the money in their wallet.
Taxi drivers lectured passengers on digital coins with names like ‘ripple’ and ‘dash’ as crypto prices soared to unfathomable heights. Caught up in the hype, proponents claimed that bitcoin was going to the moon. A few months later it seemed they’d fallen back to Earth along with cryptocurrency valuations.
Some supporters still proclaim cryptocurrency is the way of the future, banishing traditional currency to the history books while others decry it as a glorified ponzi scheme.
So which is it? And perhaps just as importantly, what is it?
Building with blockchain
IT entrepreneur and cybersecurity advocate Julian Plummer can help with the latter.
“Cryptocurrency is a currency and a payment network at the same time and that’s the big thing that’s got everyone in a state of unbridled enthusiasm; that people can exchange currency without getting the government or banks involved,” he tells Your Money.
What sets cryptocurrencies apart from banknotes and coins is that every transaction is recorded into the very network it’s traded on. These records, called blocks, are all linked together cryptographically in a public and ever-expanding digital list called a blockchain. Using this blockchain technology, every transaction and coin is encrypted creating a non-centralised record of who owns what. This ability to encrypt data in this way is what makes up the basis of cryptocurrency.
“Cryptocurrency is just a branch of cryptography,” says Plummer, who runs software company Midwinter and cybersecurity firm Kamino.
“Back in Roman times, if I wanted to get a message to you we would have used a cypher, a code that only we would know so you could decipher messages from me.”
Developed in the late 1970s, public-key encryption – which Plummer calls “probably the greatest invention that mankind has ever produced” – paved the way for the internet, allowing complete strangers to send messages in secret.
Cryptocurrency went one step further, allowing people to privately send money anywhere in the world.
While bitcoin (the first prominent cryptocurrency) seemed to come from nowhere to dominate news cycles last year, its origin story is far more humble.
The domain bitcoin.org was registered on August 19, 2008, two months before it showed up in a discussion paper circulating in the cryptography community. The author was Satoshi Nakamoto, the pseudonym of bitcoin’s mysterious founder.
Much has been made of the possible identity of Nakamoto, with rumours that the founder could be anyone from early bitcoin developers to an Australian computer engineer. Even an elderly Japanese man living in California who shares the same name has been embroiled in the speculation.
In it Nakamoto (whoever that may be) proposed that bitcoin, a new online currency, could be used to circumvent traditional currency and centralised banks. He/she/they wrote that the problem with traditional currency was that the banks had a torrid history of abusing the very trust required to make it work. While bitcoin was not the first effort to create a cryptocurrency, it would become the most well-known, promising to use the blockchain to make money anonymous, safe, and secure.
“that’s the big thing…that people can exchange currency without getting the government or banks involved”
In 2009, bitcoin became publicly available, meaning anyone in the world could access it and ‘mine it’ (i.e. provide a computer to organise all this information and store it in the network in order for it function). Miners are rewarded with a small amount of bitcoin in return, incentivising them to continue mining. The problem was that early miners ended up with a currency that no one would accept and that most average people didn’t know existed. Thus, it was a currency that held no monetary value.
In fact it wasn’t traded until 2010 when a savvy Florida-based developer Laszlo Hanyecz posted online that he would pay 10,000 bitcoins for two pizzas. According to media reports from the time, a net surfer in the UK saw the offer, ordered two pizzas from Papa John’s online, paid USD $25 (AUD $35) for them, and claimed the 10,000 bitcoins from Hanyecz. At the time, the 10,000 coins were basically worthless, but a few years later would have been worth millions, making those pizzas the most expensive ever purchased.
From pizza to pills and beyond
Cryptocurrency’s utility soon catapulted it to infamy when it was used on ‘dark web’ marketplaces, most notably Silk Road, allowing people from around the world to buy and sell illegal goods and remain comfortably anonymous.
At the same time, other developers began releasing alternative cryptocurrencies, known as altcoins, offering either an improved version of bitcoin or offering some other feature.
Despite its growth and the proliferation of other cryptocurrencies, bitcoin remained largely unknown to the wider public until it skyrocketed in 2013 and breached the USD $1000 mark (AUD $1406) for the first time. In a sign of things to come, a few weeks later its value halved. The embattled digital currency struggled being banned in Thailand, refused to be recognised as a currency in Germany, and was outright prohibited in China.
However these would prove the least of bitcoin’s worries. After making a promise that the new secure decentralised system would dethrone untrustworthy bankers, cryptocurrency suffered its largest blow in 2014.
Mt. Gox, the world’s largest bitcoin exchange, declared it had been robbed, went offline and declared bankruptcy in Japan, where it was established. 850,000 bitcoins went missing, essentially defrauding customers of loot that at the time was worth a whopping $600 million, and called ‘the biggest theft in history’. Today the same coins would be worth billions.
It is breaches like these that lead some in the more traditional investment world to remain cautious.
“It’s untraceable so it’s just bad luck that you’ve lost your money,” says Australian fund manager Michael Glennon.
“Who do you get recourse from if your bitcoin goes missing? No one.”
Boom and Bust
The Mt Gox collapse is the most notable but not the only incident that has highlighted cryptocurrency security concerns and no doubt slowed widespread adoption. Indeed it wasn’t until last year that the beleaguered bitcoin would finally find traction in the mainstream media as its value multiplied seemingly overnight.
“[The price of bitcoin] escalated so dramatically that it spiked a lot of public interest…it was gold fever”
On 1 January 2017, bitcoin was trading at around $1,300. By June its price had quadrupled and by end of the year it had spectacularly surpassed the $25,000 mark.
It was “gold fever” says Warrick Pleash, partner at Consensus Group Australia, a crypto-trading service.
“The price of bitcoin and virtually all the other altcoins escalated so dramatically that it spiked a lot of public interest,” says Pleash, who worked for a time for now-collapsed crypto outfit Bitcoin Trader.
Some currencies such as ‘bitcoin cash’ doubled almost overnight. With every run up in prices, spectators became fearful they would miss out on the mania, many throwing money into a craze they didn’t quite understand, driven by fear of being left behind. After all, you could have bought some of the smaller coins and woken up the next day having reaped high double-digit returns.
Unfortunately for those caught up in the hype, this was the top of the crypto wave which was soon to crash back to reality. Four months later, bitcoin had slunk back below $9000 while altcoins returned to their pre-mania trading prices.
With those huge price peaks and troughs, there were opportunities to make or lose a fortune. Early and enthusiastic adopters of the tech who sold out at the peak became multimillionaires.
However far more common were those who bought in at hyperinflated prices only to find themselves red faced and selling for just a fraction of that a few months later.
Others found themselves the victims of online scams with the Australia’s competition regulator, the ACCC, receiving over 1,200 complaints totalling more than $1.2 million in losses.
“The unsuspecting person that buys them…finds out they’re actually worth nothing…that’s a ponzi scheme.”
Michael Glennon says that’s the risk cryptocurrency buyers run when new coins are created and have their supply deliberately restricted.
“The unsuspecting person that buys them ends up with these things in their portfolio or wherever they keep them and finds out they’re actually worth nothing,” says the Glennon Capital director. “That’s a Ponzi scheme.”
Where to now for crypto?
Although crypto-hysteria appears to have quietened, the market remains volatile and speculation is rife about what will happen next.
Pleash says although he believes that cryptocurrency will become part of everyday Australians’ portfolios, they won’t be buying it themselves.
“They’ll just wake up one day to find that their super fund has five per cent of their portfolio in cryptocurrency or something in the same way as they might have some in property or international shares,” Pleash explains.
Adrian Przelozny, chief executive of Independent Reserve, Australia’s first regulated cryptocurrency exchange, agrees that there is widespread anticipation of money flooding into crypto from large financial institutions.
“We’ve seen super funds and [self-managed super funds (SMSFs)], as well as hedge funds and US funds looking into this area, while at the same time there’s a lot of crypto funds being formed and [exchange-traded funds] waiting for [government] approval,” Przelozny tells Your Money.
“Even a number of Australian banks, whose names I can’t mention because we’re under NDAs [non-disclosure agreements], are looking at providing various solutions to their customers around crypto.”
However not everyone is convinced.
“In my opinion cryptocurrency isn’t a separate asset class which means that large super funds cannot invest in it and that’s the main problem with it at the moment,” says Julian Plummer.
“They may be able to in the future if it does become an asset class but right now it’s simply not.”
While bitcoin was the star of 2017, Przelozny says it might be the smaller altcoins that steal the show next year as some of their long-running projects come to fruition.
“I would expect a lot of this work to start paying dividends in the next 12 months so we’re going to start seeing a lot of projects actually release things which are usable by people and are actually going to solve some real world problems,” says Przelozny.
Glennon says that while there are “massive opportunities” for blockchain technology to reform the financial services industry, he has serious reservations about anyone investing in cryptocurrency.
“I can’t understand when people tell me they’re diversifying with virtual currencies in case their stocks go down when they don’t even know what you’re buying and they don’t know about the security of the coins,” he says.
“I would advise them against trading any currency. I think it’s gambling.”
As for the likelihood of paying for a cup of coffee with crypto, there’s a lot of work still to be done if bitcoin were ever able to support everyday transactions.
“The best comparison is to think that in the 1990s there were companies like Yahoo, and AltaVista and a whole range of companies that don’t exist anymore but that their failure didn’t destroy what the internet has emerged to be,” Pleash says.
“There will probably be a lot of tokens and currencies that disappear that don’t have legitimate business cases but there will be the emergence of some underlying crypto-based currency.”
“It may be that some other coin that doesn’t even exist yet emerges to do that.”