By Lawrence Hecht
For many casual observers the cryptocurrency world just came to their attention with the big run-up in the value of the flagship of the group, Bitcoin, in the first two weeks of December.
With crypto mania having reached the mainstream, this is a good time for a discussion of the basics of a space that has been around for almost a decade.
We spoke to Eder Holguin, CEO of OneQube, for a conversation on cryptocurrency as investment. OneQube is a platform to build and manage both social media content and audiences. Eder and the company’s understanding of token economics provide the context necessary to support the community management efforts associated with token generation events. The following is his guided tour of what cryptocurrency is and how, if at all, an individual investor can reasonably expect to make money on them.
“By standard definition, a cryptocurrency is a digital asset that is designed to work as a medium of exchange and (here’s the part that justifies the name) that employs cryptography, both to control the creation (mining) of new assets and to verify transfers…perhaps even more important than what it is, is what a crypto is not. There is no physical representation – there is nothing that you could pull out of a wallet or purse and hand to a merchant. Also, there is no central bank, whether of a nation-state or of a continent, whose decisions investors will have to second guess. There is no discretionary control over value – value is set by supply and demand as mediated through computer programs, algorithms transparent to anyone with the math skills.”
Eder also noted that in 2009 when Satoshi Nakamoto invented Bitcoin in 2009, “The key innovation in the creation of this asset class was the trick of distributing the task of transaction verification across a whole network of computers.” And although Eder believes that Satoshi is almost certainly a pseudonym, at least one of the individuals sometimes said to be the Satoshi does actually bear that name. “The rough consensus at the moment, though, is that Australian entrepreneur Craig Steven Wright is the surviving half of what was once a composite “Satoshi,” and that a U.S. based computer forensics scientist, Dave Kleiman, who passed away in 2013, was the other half.”
Historians will be asking further questions about Satoshi. Everyone else is asking whether they should own some cryptocurrency, and whether it should be Bitcoin or otherwise? “Maybe. First, though, you should understand that given the emerging practices of the world’s tax authorities, any profit you make from buying and selling cryptocurrencies will likely be taxable as a capital gain. You’ll want of course to talk to your tax advisers to be clear on this,” Eder explains.
“Also understand that there are risks. The absence of any physical token doesn’t imply the absence of the risk of theft. In February 2014, an online bitcoin exchange based in Tokyo announced that it was suffering from technical problems and that it would cease permitting withdrawals. Approximately 850,000 bitcoins had gone missing from its books. A year later a security company issued a report on the losses at Mt. Gox, saying that “most or all of the missing bitcoins were stolen straight out of the Mt. Gox hot wallet over time, beginning in late 2011.”
“The other varieties, Bitcoin imitators, so to speak, is another issue that has arisen.” Eder believes in some respects they may have improved on the original; however, they didn’t improve on the risk of theft. “The most important of the imitators is ‘Ethereum,’ and its units are called ethers.” Talking about an infamous June 2016 attack on a decentralized automomous organization, Eder noted, “An organization called ‘The DAO’ was thrown into confusion when a hacker exploited vulnerability in its code to steal millions of dollars’ worth of ethers from its account.”
“There are also compliance risks. Again, The DAO offers an example. In July 2017 the U.S. Securities and Exchange Commission said that the DAO’s ethers were securities under federal law and that there may have been violations of securities law on the part of The DAO itself, and associated entities and individuals. And you have to consider the ancient risk of buying high and selling low. Just before the release of that SEC report, the value of an ‘ether’ was above $370. But over the following month, that price fell to just $198.”
Is this a warning to stay away from these assets as investments? Eder suggests that it’s not and adds, “I simply wouldn’t want you to invest in anything without being aware of the risks. If your idea of investing in a crypto is simply to buy some, through one of the online digital currency exchanges, and later sell it again at a higher price for U.S. dollars or some other national fiat currency, then you may be assured that the exchanges involved have devoted a great deal of ingenuity to the issue of security, and have worked to learn the necessary lessons from the two notorious incidents I’ve just mentioned. As to volatility: this is as always principally a risk for those with shorter time horizons. If you can wait out the periodic crises, the investment can be a sensible one.”
In considering some numbers, Eder explains, “Yes, before the Mt. Gox fiasco bitcoin was worth roughly $750, and soon thereafter its value was down to $420. A year after that is was below $230. Still, functioning markets remained, by early 2016 the trend lines were in its favor, and anyone who bought a bitcoin for $750 before Mt. Gox could have sold it for $15,000 in December 2017. Likewise with Ethereum. As noted above, it can be quite volatile, and it lost 46% of its value soon after that unfavorable SEC report. But it was in no danger of expiring, and it passed quickly through the pre-report price level, heading upward, in November 2017.”
Regardless, cautious observers still think that cryptocurrency may be a big bubble. That it will rise and expand until it pops and is no more, however Eder doesn’t believe in this school of thought.
“I don’t think that either bitcoins in particular or cryptos in general are mere bubbles. Certain run-ups in value have had a bubblicious taste to them but – even after the burst a significant underlying value has remained. The cryptos have a firm and practical role in finance. They constitute a medium that is self-executing, transparent, and stateless. Indeed they have worked themselves into the fabric of 21st century finance in a way that makes the facile comparisons to 1990s dotcom companies or 17th century Dutch tulip bulbs specious.”
So with the notion that bitcoins and cryptocurrency are here to stay, and hearing more and more news about bitcoin ‘mining’ operations, what ways are there to invest? Eder continued, “Since, as I mentioned at the start, there is no physical token involved, “mining” is a somewhat figurative term. But remember that one of Satoshi’s key insights was that the work of authenticating transactions can be distributed. A digital currency doesn’t require a central bank. What this means in practice is that “mining” computers regularly package recent transactions into units, called ‘blocks.’ A miner that creates a block is rewarded, and the reward is in bitcoins, or the other crypto involved.”
This means that there are new bitcoins that have come into existence as the reward and even implies that Bitcoin and other cryptos are subject to inflation. Eder agrees, but notes, “The Bitcoin system allows for a total, in due course, of 21 million Bitcoins. As the number in existence approaches that ceiling, the task of getting them via mining becomes more difficult, requiring ever more computing power. Think of this as akin to literal mining. There is only a fixed amount of gold in the planet. It is an element, so no more gold can be created. A higher number of gold coins can come into circulation as more gold is pulled out of the earth, but that becomes more difficult over time. The same is true of bitcoins. Instead of the planet earth, think of a realm of mathematical possibility. This realm contains those 21 million bitcoins. The easy ones have already been found and put into circulation. That is why it was once possible to mine them, profitably, on one’s home PC; but it now requires a data center, quite specialized hardware, and access to low cost electrical power. Heck, you could in principle create a ‘mine’ through an app on your Android phone. But you might make one penny a year from this, and you’ll be using up a lot of your battery power all year to do it. Not a great investment play. With Bitcoin, Ethereum, and the others, the best investment play for some might be a surprisingly old-fashioned one: buy equities.”
Eder concludes the cryptocurrency conversation by saying, “I’m not going to offer recommendations. If you want to look into these matters further, though, you could start with the Marathon Patent Group (NASDAQ: MARA), the owner of Global Bit Ventures, a mining company. Or Digital Power (NYSE: DPW) which is a manufacturer of power-supply products for specialized apps, and which has been moving further into the crypto mining world of late. Or Riot Blockchain, (NASDAQ: RIOT) a former biotech firm that has recently pivoted into the crypto tech space.”
“Each of these is, of course, a very speculative investment. Proceed with caution.”