How New Ruling Will Curb Crypto, Bitcoin Bubble
The way markets are supposed to work is that there's usually consistent transparency on prices, buyers and sellers. That way you avoid excessive speculation found in bubbles and rascals trying to "corner" the market.
With cryptocurrencies, the problem hasn't so much been on price transparency, it's been on who the buyers and sellers are. Are a handful of traders manipulating the market? Are transactions being made for illegal purchases? Since the crypto market is largely unregulated, no one knows with any degree of certainty.
A recent court ruling could alter this picture. A federal judge ruled recently that cryptocurrencies such as Bitcoin should be regulated as commodities.
If the ruling survives the appeals process - it could be reversed - it means that regulation may not be far behind. The Commodity Futures Trading Commission (CFTC) has openly discussed monitoring the market. So has the U.S. Securities and Exchange Commission (SEC) and other government agencies outside the U.S.
To date, the SEC has been the most proactive regulator on crytocurrency issues. The agency recently issued subpoenas to look into possible abuses in the Initial Coin Offering business, which offers digital coins to the public as if they were newly listed stocks.
Are investors getting fleeced on crypto ICOs? Although investor losses in ICOs have been estimated at some $400 million out of a total world market of more than $4 billion, the accounting firm Ernst & Young estimates that money flowing into ICOs has been like a torrent: about $300,000 per second.
Investors are streaming into crypto investing mostly out of a fear of missing out on future profits. For millions, the spectacular rise in crypto valuations has generated a global frenzy. With Bitcoin rising from nearly nothing to $10,000 in a few year's time (it's since fallen back), the public's interest is not going away.
What would regulation mean? With ICOs, it would translate into registration of companies selling cryptos. They would have to tell agencies about the capital invested in their firms, officer backgrounds and how they will maintain transparency on pricing and transactions.
Greater regulation also shines a spotlight at how a commodity or security is valued. How do firms arrive at a price of say, a stock? They look at earnings, sales and book value, or the tangible assets of a company. With cryptocurrencies, you can't use those metrics since digital entities have no intrinsic value.
Would regulation depress the price of cryptos? Possibly. If investors realize that they are simply buying the expectations of other investors, that would have a major impact.
There's also the question of relative value. If the only thing separating a new crypto from Bitcoin is name recognition, why is one worth more than another? Regulation would attempt to highlight those questions, but the end result may be lowering prices across the board.
Another common investor fallacy is that somehow you can buy the "next" Bitcoin. Since there are thousands of cryptocurrencies out there and seemingly anyone can create a new one, that's a perilous road.
A better solution would be a basket of cryptocurrencies offered in a transparent exchange-traded fund (ETF). The leading crypto exchange Coinbase is launching such a vehicle that would hold all the digital currencies they currently trade.
While this vehicle sounds like potentially a more prudent and less risky route for most investors, the jury's still out. As an ETF, it would be subject to regulation. It still has a lot of hoops to jump through, so stay tuned.
John F. Wasik is the author of "Lightning Strikes," "Keynes's Way to Wealth"and 15 other books on innovation, money and life. Follow him on Twitter and Facebook.