Ever had frustrating dealings with banks? Tired of high charges for international transfers and other services? Weary of meeting compliance requirements and the difficulty in Bali especially of having to prove where you live when your home doesn’t even have a physical address?
And now we have the Common Reporting Standard to which almost all countries in the world have signed up allowing the balances in your accounts to be automatically reported to the tax authorities in your country of residence. Wouldn’t it be good if we had an alternative, cheaper and less intrusive method of conducting financial transactions? Well, we now have one, namely the facility of cryptocurrencies, although as yet its acceptance is very limited.
What are cryptocurrencies?
By definition a cryptocurrency is a digital or virtual currency that uses cryptography for security, making it difficult to counterfeit. Furthermore it is not issued by any central authority, rendering it theoretically immune to government interference or manipulation.
The best known is Bitcoin, which was set up under the ficticious name of Satoshi Nakamoto in 2009 at the time of the Global Financial Crisis when the world’s banking system was teetering on the brink of collapse. It is not based in any jurisdiction, it has no central bank, it has no regulator and is accountable to no-one other than Bitcoin holders. The coins are not minted anywhere; they don’t even have a physical form. They are created in cyberspace via a system of complex logarithms which when solved create new Bitcoins.
The supply is not infinite; it will be limited to 21 million coins. The coins are ‘mined’, not in the ground like gold but by computers. Anyone in theory can become a ‘miner’ but to stand any chance of success you would need huge computing power. The reward for ‘miners’ comes in the form of being able to charge service fees on transactions. These charges are low compared to those of the banks but even a few cents multipled by tens of thousands of transactions can add up to quite a nice income.
Bitcoin doesn’t care who you are or where you are
You can buy it without having to prove identity, proof of address or source of your income. You can trade anonymously with other Bitcoin owners or purchase a growing range of goods and services. All transactions are conducted on the Internet and they are technically visible to all Bitcoin owners. All Bitcoins are connected via a ‘blockchain’ which is a digital peer-to-peer register that records and stores transactions between parties. All users are effectively the ‘bank’. The coins themselves can also grow in value. In fact they have grown exponentially in value since they were first created. In 2013 Bitcoin gained 5,500%. At the start of 2017 it was still worth less than US$1,000 but during the course of the year rose to almost $20,000.
Sounds great – but is there a downside?
There is a huge downside. The events of 2008 caused us to worry about the security of the banks and even today we should avoid having too much money in any one bank. We are also concerned about the growing trend of banks to close or ‘freeze’ accounts where they have any grounds to suspect the source of funds or are not happy with tax or other information provided to them. Hence the attraction of cryptocurrencies.
But at least the banks have regulators; they have a degree of protection from governments who cannot afford to let them fail and they are very much in the public view. Should Bitcoin or any other cryptocurrency fail there is no recourse. There is no regulator or Ombudsman to appeal to; there is no government that can step in to help you because there is no central organisation that can be brought to account. The ‘bank’ consists simply of users around the world.
Although considerable efforts have been built in to protect users there have already been tales of hackers and fraudsters who have quickly found ways to cheat the system. It has even been estimated that as much as 10% of the supply of Bitcoins has been stolen.
Your security is as good as your password and hard disk. If you lose either you could also lose all your money. Freedom from regulation and the prying eyes of institutions and governments, while a welcome relief to honest citizens, has also proven very attractive to criminals who now have a means of conducting illegal activities with impunity. Early last year thousands of people and companies were held to ransom by a hacker or organisation that had immobilised their computers. To ‘free’ their computers they were ordered to transfer a sum of money in – you guessed it – Bitcoins. It is also widely suspected that Bitcoins are being used in drug and illegal arms trafficking.
Finally, while the price of a Bitcoin has rocketed it has also periodically fallen steeply. While it almost reached $20,000 last year it is now worth ‘just’ $16,000 at the time of writing. So while the impact of cryptocurrencies on the global financial system is still relatively small, governments are waking up to the potential dangers. China and South Korea have already banned their use. Others are likely to follow. This could lead to a collapse in the value of Bitcoin which has already seen huge price volatility.
An even worse case scenario, feared by some, is that if the current rate of growth of Bitcoin and its copycats is not stemmed it could create a new financial bubble on the scale of the sub-prime lending fiasco in the US that contributed to the near-collapse of the banking system. Or even the scale of the great tulip bubble of 1637. No space to go into more detail on that one but it would have provided good material for this column had it existed then!
Any lessons for investors?
Inevitably quite a number of people have asked me if they should be investing in Bitcoin as they have seen the phenomenal gains made last year. After the event of course it is easy to see a missed opportunity but when others have filled the bandwagon it is not a good time to jump on top. That’s when the bandwagon tips over. If you enjoy the excitement of a risky investment then by all means join in with a very small percentage of your investable assets but only if losing it all would not be an issue for you.
It is quite likely that the Bitcoin phenomenon will lead the financial industry and regulators to explore some of the more positive aspects such as the blockchain concept. The present banking system is far from perfect and it needs a bit of ‘disrupting’ to put it into better shape. Whatever happens to Bitcoin the technology could well change the way we do business now.
In the meantime, it is best to see cryptocurrencies as just a distraction and to focus on solid wealthbuilding with an emphasis on diversification and ample liquidity so you can weather the next ‘crash’ and come through unscathed. Don’t forget to keep a small amount of gold in your portfolio as an insurance against mayhem. It has been a tradeable asset for centuries and as its supply is finite it will continue that way. And it can only be mined in the ground, not in cyberspace.
Colin Bloodworth, Chartered Member of the Chartered Institute for Securities and Investment (UK), has spent over 20 years in Indonesia. He is based in Jakarta but visits Bali regularly. If you have any questions on this article or related topics you can contact him at colin.bloodworth@ppi-advisory.com, colin.bloodworth@yahoo.co.uk or +62 21 2598 5087
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