For a digital asset that began its life in 2009 and began the year trading around $1,000, the fact that Bitcoin is set to break the $10,000 ceiling is certainly impressive. Other than the many celebrations that will surely follow this milestone, interspersed with a mix of investor remorse or Casandra’s calling this the digital twin of Tulip Mania, many questions remain about the advantages and disadvantages of digital assets. Crypto numismatists who have been collecting Bitcoins are surely happy these days.
Investors and early adopters like these assets because they are untethered from the regular economy where fiat currencies, more traditional forms of exchange and value transfer reign the day. It is not without a sense of irony that part of Bitcoin’s rapid ascent this year is owed to the fact that traditional economy players are now paying close attention to this asset class. While some of this attention remains negative, profoundly confused or ambivalent, such as China and South Korea banning initial coin offerings (ICOs), along with ongoing attempts to regulate a fundamentally decentralized platform. Add to these negative views Jamie Dimon’s full-throated attack on Bitcoin including the threat of terminating any JP Morgan employee caught trading in the digital asset, and the unwelcome news levied against digital assets continues to mount. With each puff of hot air, however, as if in open revolt to traditional economic order, Bitcoin continues to defy the odds taking investors to stratospheric heights where the air begins to thin and bubbles traditionally deflate.
And yet the appreciation in Bitcoin’s value is buoyed in no small measure by serious institutions, like the CME Group, which is going long on the digital asset class. CME’s announcement that they will soon offer futures trading on Bitcoin marks a serious development and coming of age for digital assets. Herein lies the irony for an asset that is completely untethered and ungoverned by traditionally centralized structures. The fact that Bitcoin is gaining its greatest appreciation the more it plugs into the traditional economy, says a lot about its strengths, weaknesses and limitations. Against this backdrop, questions remain as to whether Bitcoin is an asset, currency or a collectible. Perhaps more permanently, 2017 may very well mark the year when digital assets, in the otherwise fleeting world of investor interest, gained their permanence.
One of the principal advantages of digital assets is the fact that they are largely uncorrelated to the market. This creates an interesting opportunity for investment diversification, with the caveat that these instruments are not readily liquid, and their convertibility is far from universal. An additional advantage is the high volatility, which counterintuitively results in more aggressive risk-reward trade-offs in investment portfolios. Bitcoin’s implied volatility, higher than any other asset class, is the stuff roller coaster rides are made of and may make even seasoned high-speed traders flinch. Similarly, the relatively low barrier to entry, when compared to more sophisticated asset classes, which require heavier purchasing power because they are much harder to fractionalize, makes digital assets compelling for their ability to democratize asset ownership and wealth creation. All of this, however, presupposes that they are tethered to the real economy and transferable in many more ways than they are currently. For example, an announcement that Amazon will accept Bitcoin as a form of payment (which requires more stable valuation) would go a long way in legitimizing this asset as a currency. The fact that it needs legitimacy at all in the eyes of its staunchest proponents is something of an insult to the genius that underpins this innovation, which is its scarcity by design with no more than 21 million Bitcoins to be digitally minted.
The disadvantages of this asset class are the fact that they are all digitally correlated and subject to high degrees of individual and group social engineering. For example, a great deal of the theft or loss of digital assets typically results from people locking themselves out of their digital wallets, losing their encrypted keys (or access) or people gaining unwanted access, after which point the assets are easily transferred and hard to track down. In short, like so many cyber threats, the loss or theft of digital assets often lies between the keyboard and the chair. This type of theft or mysterious disappearance and the fact that no regulatory regime or risk transfer mechanism currently exists to systemically offset this risk is one of the principal deterrents to broadening the adoption of digital currencies. A digital equivalent of the Federal Deposit Insurance Corporation (FDIC), which universally protects depositors and shores up the banking system from 1930-style bank runs, would help build trust in digital assets. For this reason, many established financial institutions and a growing number of insurers are turning their attention to Blockchain, the distributed ledger that underpins Bitcoin’s rise to prominence. For many, Blockchain is the killer app and Bitcoin is the first major use case of this foundational technology. Neither Blockchain nor Bitcoin are free of negative externalities or limitations.
While it appears Bitcoin is winning the standards war on which digital asset will rule the day, this despite internecine fighting, a standards war continues to rage on digital assets and their utility. Herein lies the domain of a great deal of experimentation and value creation, where CME’s move to offer futures trading is but one example of how virtual assets are meeting the real world. The more traditional players and crypto enthusiasts push the bounds of interoperability, the more it seems Bitcoin’s implied value will rise. Contrary to popular belief that Bitcoin and its users thrive in the shadows, some entrepreneurs in this space, like Gabriel Abed, a Barbadian tech entrepreneur and co-founder of Bitt, are rushing to work with central banks. This move will help bridge the technological divide and the need for legitimacy, oversight and, perhaps most importantly, interoperability between digital assets and the real world. As these enduring linkages are formed, it is reasonable to expect the world of low-friction value transfer will create a new economic order while minting a few Blockchain Billionaires along the way.
