Cryptomania: The Devil’s Advocate
Information technology company, Gartner, illustrates how new technologies are adopted through its hype cycle curve for emerging technologies. In a nutshell, the curve reflects society’s tendency to overestimate a new technology’s influence in the short-run, while remaining woefully incapable of accurately predicting its long-term impact.
With that in mind, Blockchain is the latest in a series of mankind’s advances to receive attention. While there are many articles lauding the benefits of Blockchain technology, we look at some of the risks involved with investing in its temperamental stepchild, cryptocurrency (crypto).
Blockchain and Crypto: What’s the Difference?
Blockchain is the digital platform through which transactions are facilitated; it is the network that all individual chains—or processing platforms such as your computer—will tap into. Every participant in a blockchain has a copy of the same ledger, and every transaction is verified by all other participants before it becomes canon. Aside from the participants, no third-party clearinghouse needs to verify these transactions. It is an elegant and deceptively simple method of transacting.
By contrast, cryptocurrencies are a store of value and represent the current and most obvious application of blockchain technology. They are the “currency” in which blockchain transactions are conducted. The Blockchain acts as the medium of exchange, whereas the cryptocurrency is the tender.
Almost every Blockchain features its own corresponding cryptocurrency, but that doesn’t mean that they’re the same thing. Consider the following analogy: Cryptocurrencies are an application of Blockchain technology, similar to how placing a phone call represents an application of your smartphone. While it’s certainly a useful function, it’s not the only function. Much like how browsing, messaging and video streaming are all applications of your smartphone, many alternative applications are currently in development for Blockchain aside from its currency function.
It’s important to draw the line between Blockchain and cryptocurrencies. Many businesses trying to stay ahead of the curve have already begun accepting cryptocurrencies. While first-mover advantage is important, based on the wild ride we’ve seen, they have reason to be cautious.
Crypto valuations can spike by as much as 20% on any given day. Over the past two years alone, Bitcoin, the grandfather of all crypto, reached a market cap of $117 billion, or a high of $16,000 per unit Bitcoin. Since then, Bitcoin has dropped to just under $9,000 at the time of this writing, and continues to seesaw, making the “gold standard of crypto” one of the most volatile investments on the market.
Much of the volatility can be attributed to the laws of supply and demand: The supply of any cryptocurrency is more or less fixed, while demand fluctuates largely with the market; in effect, many cryptos are vulnerable to price manipulation. There exist numerous pump-and-dump schemes, where speculators organize large-scale efforts to bid up the prices of select currencies, while simultaneously directing mass sell-offs. Those participating in these “fire sales” profit handsomely from the artificial price appreciation. Such practices are highly illegal in standard security markets, but regulators are still scrambling to develop protocols for crypto trading.
Empirical evidence also shows that crypto investors are a finicky bunch. Crypto prices often reflect patterns of panic selling coupled with vigorous buying sessions. In fact, a study conducted by ValuePenguin found that the number of crypto-related consumer complaints at the Consumer Financial Protection Bureau (CFPB) skyrocketed with every major dip in Bitcoin prices. During the steepest decline to date (week of Jan. 4, 2018), the CFPB logged a record 358 complaints from Coinbase investors (Coinbase is a cryptocurrency exchange headquartered in San Francisco).
At the time of this writing, there are over 1,565 different cryptocurrencies in circulation. Indeed, the existence of blockchain’s open-source technology helps encourage innovation and remains a unique way for startups to raise funding.
Initial Coin Offerings (ICOs) have raised hundreds of millions of dollars in the past few years, but the market remains largely unregulated. The majority of ICOs have been legitimate requests for research funding, however, the complexity of technical jargon and lack of information in some cases raise red flags for investors. Most recently, Telegram’s widely-anticipated ICO, which targeted a record $1.2 billion in funding, was plagued by scammers hoping to dupe investors into investing in fake ICO websites.
Additionally, while Blockchain is reputed to be hacker-resistant, the entities that host them may not be as robust. In January 2018, Japanese crypto exchange Coincheck suffered a major security lapse that resulted in the theft of its users’ security keys; affiliated investors were robbed of a sum of $530 million.
While proponents of crypto have argued that the underlying Blockchain technology was not at fault, it’s clear that as long as cryptos remain in the spotlight, crypto exchanges will continue to be popular targets for cyberattacks.
Technology in History
Like all new technologies, Blockchain will continue to undergo significant changes in development. Returning to our Gartner analogy, for every meteoric rise in expectations there inevitably comes a drop back to reality. We believe this exercise to be useful, as it will bring us closer to the reality of what Blockchain will actually achieve.
Parallels can be drawn to the dot-com bubble of the early 2000s, when those eager to gain exposure to the burgeoning internet revolution rushed to buy up stocks of unproven companies. Suddenly anyone holding a dot-com address became worth millions overnight. Investors didn’t buy the intrinsic value of the companies, instead, they brought the potential that they represented. Stock valuations soared, and speculators poured millions into these untested companies.
Eventually, that bubble burst and many investors were left holding empty bags. To be fair, some of those companies justified their valuations and went on to become foundations of the new internet economy. However, as with any revolution, some players prove their worth while others inevitably become duds.
New applications for blockchain technology continue to be developed, and many won’t involve the use of cryptocurrencies at all. These include practical applications like smart contracts and data storage. As with any untested technology, business owners should be vigilant and conduct their own due diligence.
Case in point, we neither encourage nor discourage businesses from investing in Blockchain technology, but instead mean to shed light on the inherent risks of crypto trading and the over exuberance of the markets.