Bitcoin, Fool's Gold? Unearthing the World of Cryptocurrency.

Bitcoin, Fool's Gold?
Unearthing the World of Cryptocurrency.

In October 2008, an entity known as Satoshi Nakamoto published a paper entitled Bitcoin: A Peer-to-Peer Electronic Cash System, proposing a revolutionary money and payment system in which transactions are conducted using cryptocurrencies and recorded on a public ledger, called the blockchain. Because of the characteristic of not requiring a third party or central administrator, these cryptocurrencies are sometimes called decentralised digital currencies. Instead of using a third party, a network of computers, which serve as interconnected “nodes” within the network, maintains and verifies a record of consensus of transactions. Since then, a plethora of cryptocurrency enthusiasts and companies created their own cryptocurrencies, known as altcoins, which are alterations or enhancements of Bitcoin. As at 31 December 2017, there were over 1,300 cryptocurrencies with a combined market capitalisation of USD 569 billion listed on CoinMarketCap. At its 2017 peak, the market capitalisation of all cryptocurrencies neared USD 650 billion, higher than the 2016 GDP of countries such as Saudi Arabia and Sweden.

A plethora of inter-related industries have also been spawned, including wallets and payment services, crypto exchanges, and mining, as entrepreneurs across the globe look to capitalise on new revenue pools that have opened up on the back of this technological revolution. To appreciate the recent rise of cryptocurrencies and their future potential, one must understand the underlying technology, surrounding ecosystem, and the place of cryptocurrencies in financial markets and the wider economy.
However, currencies have, for many centuries, needed to meet a number of specific criteria to be recognised as such acting as a unit of account, a medium of exchange, and a store of value. Despite fulfilling most of the characteristics of a traditional fiat currency, cryptocurrencies are largely being utilised as speculative investment assets, leading to considerable volatility in their value. This lack of stability, together with soaring valuations, means they are rarely used for payments. In order to achieve status as a legitimate currency, the public must spend cryptocurrencies widely to determine a credible benchmark for their actual value, encouraging businesses to accept them as a medium of payment.

In the earlier part of the year, many of the gains could be tied to ongoing discourse around its potential regulatory legitimacy. Since then, however, its popularity has appeared to fuel a widespread “fear of missing out” , a classic characteristic of most bubbles. Yet, consensus regarding its future value remains literally non-existent, with valuations ranging from USD 0 to as high as USD 1,000,000. Moreover, the majority of these predictions do not appear to be based on any robust, quantitative methods, but are more a reflection of individual opinion.

To value BTC as a currency, I estimated its utilisation for both legal, retail transactions payments and payments in the black market, as well as functioning as an international FX reserve. After significant testing, I calculated the price of BTC 1 to be USD 1,780. Irrespective of the valuation methodology employed, I found the price of BTC deviates significantly from its current price of up to USD 14,000. For the longer-term, I are even less optimistic around the future price of BTC and believe it will ultimately be ruled out as a mainstream form of payment. I see this exerting greater downward pressure on its price and forecast it to trade at up to USD 810 by 2020, if not even lower. I therefore believe that BTC, at its current valuation, is a bubble waiting to burst.

Existing cryptocurrencies that were designed to replace fiat currencies, such as BTC, are unlikely to act as viable substitutes to the money or currency system I have in place today, due to their inherent challenge to central bank and government functions – namely, fiscal and monetary policy. However, cryptocurrencies with associated utility applications, as well as fiat cryptocurrencies attached to a sovereign nation, are likely to grow in significance, given the ability of the underlying blockchain technology to provide meaningful enhancements to current payment systems, as well as their broader applications beyond being used as speculative assets. Although a sharp decline in the price of BTC in 2018 is likely to take the value of other nonutility cryptocurrencies with it, I see the correlation with utility cryptocurrencies being much less pronounced. I forecast total market capitalisation of private cryptocurrencies to be USD 407 billion by 2020. I also see fiat cryptocurrencies gaining momentum as governments accelerate their research and piloting efforts, with potential to be a USD 150 billion market by 2020. While I believe BTC can largely be viewed as fool’s gold at present, digital currencies will continue to unearth major enhancements to the global payments system in years to come.