The roller coaster for cryptoassets (digital assets that use cryptography for security) hit a euphoric point in late 2017. Since we published “Time to Bet on Bitcoin?” in October, bitcoin, the largest cryptoasset, has appreciated from around $4,000 to almost $15,000. Despite this move, bitcoin’s prominence among cryptoassets has shrunk: bitcoin was 80% of total cryptoasset market in March 2017 and 50% in October, but has fallen to 35%, as other cryptoassets gain prominence. This article explores dynamics impacting the broader cryptoasset market boom, its risks, and our approach to cryptoassets.

Cryptoasset Boom

The market value of non-bitcoin cryptoassets has launched from $75 billion to almost $500 billion since October. During this time, the number of cryptoassets has spiked over 50%, and now has more than doubled since 2016. Two major factors are driving this boom: fundamental technological improvements and speculation.

Technological Improvements

Technology goes in generations. The first generation cryptoasset, bitcoin, uses a technology called  blockchain. In simplistic terms, it is a ledger that records data (the “block”) and links (the “chain”) them together.

The first generation of any technology is improved by future generations. Blockchain is no different. New blockchain-based technologies are addressing issues inherent in the first generation like speed, privacy, and flexibility. These improvements stoke excitement in the marketplace. A very high level description of the largest cryptoassets, none of which we endorse as investments, and the issues they are addressing, is shown below:

Speculation

The potential of blockchain technology has led to hype that it could lead to the creation of a new internet. This hype, along with bitcoin’s boom, has led to speculation on what cryptoasset will be the next bitcoin. Greed takes over and risks are ignored.

Signs of the speculative fervor include:

  • We’re Blockchain, Too: Publicly traded companies, including beverage and biotech companies, have recently changed their names to include “blockchain” in a supposed strategic pivot towards blockchain technology development, and gotten market value increases over 200% in a day. This type of activity was common during the dot-com bubble.
  • No Project Needed: Entities with only a cryptoasset whitepaper and no actual project launched have been able to raise capital by simply issuing coins that a) offer no equity or debt ownership stake in the potential project and b) accrue value only if the project leads to a service that generates demand that significantly outstrips token supply. Some cryptoassets, with no project launched, trade with valuations as high as $20 billion.
  • Fear of Missing Out: The most downloaded iPhone application in the United States in December was one that supported cryptoasset trading. Numerous cryptoasset exchanges have closed to new participants because they cannot handle the volume of demand. The largest cryptoasset  exchange in the United States now has more retail accounts than Charles Schwab. Internet search interest in “buy crypto”, on a 0–100 scale, went from 8 in October to 100 in December, according to Google Trends. Anecdotes include people cashing out their 401Ks to invest in cryptoassets. Of the 1,384 tradable cryptoassets, only 43 have market values above $1 billion, and the top 10 cryptoassets make up around 80% of the total cryptoasset market value. Many of these assets are like penny stocks, where low prices encourage speculators to place bets, chase momentum, in order to make returns seen by Ripple in 2017 (up 35,000%). An example is that a cryptoasset parody project named after a dog recently hit $2 billion, more than doubling in a couple weeks.

 

This fervor ignores risks like:

  • Quality: The quality of applications built on public blockchains (e.g., ethereum) has proven in many cases to be inferior to mainstream applications. Purchase of cryptoassets tied to the applications or the blockchains themselves implies belief in widespread usage, but this requires quality products.
  • Infrastructure: For public blockchain technology to support the creation of a new internet, the technology’s infrastructure must improve. Solutions are being developed to increase transactional throughput by 1000x. But this takes a long time, whereas the cryptoasset market appears to have become an impatient, fast-money market.
  • Fragmentation: Infrastructure solutions can lead to disagreements among developers, triggering fragmentation of blockchain technologies. More technologies may lead to interoperability hurdles among blockchain technologies and act as a headwind to large scale user adoption of cryptoassets, which are being bought with anticipation of large scale adoption.
  • Disruption: Addressing the infrastructure issue can have the unexpected outcome of leading to innovations that displace existing cryptoassets.
  • Regulation: Often cryptoasset bulls cite the blockchain technology’s ability to work around issues like regulation, central governance, and censorship. This implies a belief that governments will allow cryptoassets to develop unchecked.
  • Value Accrues Privately: Private blockchain technologies, created by businesses like banks to use internally or with other enterprises, usually do not involve a tradable cryptoasset. Cost efficiencies and other value created for the enterprises, therefore are captured privately, not by cryptoasset buyers. Given the momentum behind consortiums of enterprises and technology service companies working together to develop private blockchain solutions, there is a real possibility that more value is created by private than public blockchain technologies.
  • Ignorance: When asset prices decline, knowing the asset’s fundamentals and being able to assess a fair value can help an investor make profitable decisions, either buying the asset or avoiding selling in a panic. The high complexity and early stage nature of technologies underpinning cryptoassets make fundamental knowledge difficult for the average cryptoasset speculator. In addition, there is disagreement on how to value cryptoassets since a) they have no revenue or cash flow and b) value is largely driven by future user demand for networks and applications that are still in development. This lack of fundamental knowledge by the average speculator and inability to value the assets creates risk of pronounced selloffs.

Conclusion

While the crazed nature of cryptoasset trading and the risks facing cryptoassets make investment in cryptoassets unattractive to the Investment Team, we believe there is value in tracking cryptoasset developments because of the potential impact on public companies, currencies, and government policy. Watching, not riding, the cryptoasset roller coaster seems most prudent.