The rising popularity of Bitcoin and other cryptocurrencies such as Ethereum has resulted in the general public becoming increasingly interested in investing. The price of Bitcoin, for example, has increased from $0.50 in July 2010 to $4,560 in early September 2017. The price of Ethereum, another cryptocurrency, has increased by 50,647% in just two short years! Certainly, there are some speculators who have profited handsomely from these rapid price rises.
Simply put, a cryptocurrency is an electronic form of payment. Unlike US dollars, a cryptocurrency is not backed by any government and is, therefore, a completely decentralized form of money. The record of each transaction is kept by thousands of computers on a decentralized ledger called the blockchain. Each buyer is assigned a number which is stored within the blockchain.
Because it is such a new and unique form of payment, there has not been enough time to properly regulate and legislate its use. Therein lies the rub. Since Bitcoin’s inception, approx. 1/3rd of Bitcoin exchanges have been hacked. Without proper regulation and legal recourse, the risks for investors are significant. China, for example, has recently declared the conversion of cryptocurrencies to fiat currencies illegal.
One can argue that the rapid increase in prices has driven cryptocurrencies to bubble territory, with the end result of previous bubbles being well-known.
The cryptocurrency asset class is still very risky and volatile. Whilst we are in favour of investments that have the potential to generate long-term outperformance, we are shying away from investments that hold significant risk and on the face of it, seem significantly overvalued.
Graph source: Bloomberg