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New ideas, inventions and ways of doing things take time to mature. Along the path to maturity, there are typically bumps and bruises. The internet, email and automobiles started humbly and went through a maturation process before being mainstream. The cryptocurrency ecosystem seems similar.
The FTX bankruptcy is a reminder of the unregulated, speculative world of cryptocurrency. Fallout from the stablecoin terra and its sister coin, luna, that led to the collapse of Three Arrows Capital, and more, have shaken the confidence of investors. The lack of confidence is displayed by the astounding fall in cryptocurrency prices and now desolate non-fungible token space. Remember NFTs? Few remember Mt. Gox, the exchange that went bankrupt in 2014. At one point, it was processing over 70% of bitcoin transactions, per Investopedia.
So, what is ahead for the crypto space – is it here today and gone tomorrow?
Let’s start here: There are three parts of the ecosystem – the blockchain, which underpins everything; the tokens, either cryptocurrency or NFTs; and companies such as exchanges, trading firms, custody and investment firms.
The blockchain is thought to have value and use, but the concept is over a decade old and still not widely used. The blockchain itself is a utility, similar to the internet, that can be used to simplify or speed up processes. Think of the internet leading to online shopping as a replacement for buying from a paper catalog. The blockchain creates no value on its own, it can simply facilitate the creation of value. There is no way to invest directly in a blockchain.
Tokens capture the most attention. Tokens, such as NFTs and cryptocurrency, have prices, but whether they have value is an open question. There are cryptocurrencies, such as bitcoin, that are thought to be like currency. To be considered currency, these three functions must be met: medium of exchange, unit of account and store of value. Bitcoin is the only cryptocurrency that might be able to claim all three, but the claim is tenuous at best. There is some adoption, but it is not widespread. Cheerleaders for cryptocurrency reference the country of El Salvador, which adopted bitcoin as legal tender. Serious investors will take their cues from larger economies in the United States, eurozone and China. For perspective, El Salvador’s gross domestic product is over $24 billion per year, according to The World Bank, making its economy roughly half the size of Vermont’s. Conversely, in China, where The World Bank reports a $17 trillion economy, bitcoin was outlawed. In larger economies, the standard unit of account is the native currency, such as the dollar, euro or renminbi. Currently, NFTs and cryptocurrencies fail the store of value test for most people. However, gold is considered a store of value and has experienced volatility. Time will tell whether cryptocurrencies can regain or exceed their previous high prices and become less volatile to be more widely considered a store of value. There are several ways to invest and speculate in cryptocurrency.
Companies make up the rest of the ecosystem. Regulation has been slow in coming for the various exchanges, investing, custody and trading firms, but now it seems that rules will be expedited. These companies should be evaluated like those in any industry by examining governance, financials and operations. The research is easier for firms registered in the U.S. Investing in or using a company likely poses the highest risk, as many are dependent on the token price to underpin the operation. As token prices fall, they are exposed to losses that are compounded when investors pull cryptocurrency or cash. Investors using the FTX exchange may lose all their money while the fall in prices combined with nefarious practices caused the company to fail, trapping investor investments and cash. Investors in Three Arrows Capital, a hedge fund, were punished when prices crashed and capital was short. Even Coinbase, a U.S.-based exchange, is struggling with outflows and decreased trading revenue. There are several ways to invest in or use companies involved with cryptocurrencies and NFTs, but caution is warranted.
As the industry matures, many companies, NFTs, cryptocurrencies and blockchains will be here today and gone tomorrow. For interested investors, the trick is navigating the space to make sure their money isn’t gone as well.
Jason Flores is a senior vice president and senior portfolio manager at Central Trust Co. He can be reached at email@example.com.
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