Meeting the initiated, getting lost in overlapping exchanges, fighting the FOMO.
In George Orwell’s Keep the Aspidistra Flying, Gordon Comstock rebels against the money god. He attempts to rid himself of the want of money, excepting the absolute minimum amount that is needed to survive. His life becomes very bleak indeed.
Over the past few years, I have tried determinedly not to take an interest in cryptocurrency. But like Comstock, who eventually gives in to the ubiquity of money, I too am beginning to waver.
Not many of my peers know much about the stuff I typically cover. Online lending and even digital banking remain fairly niche. But when friends hear that I write about fintech, there’s one area that always springs to mind...
“Ah, so you write about bitcoin and stuff?” At great effort, no (until now of course).
The sudden mass appeal of bitcoin and its brethren currencies (Ethereum, Litecoin, Ripple, etc.) is nothing short of staggering. What is perhaps most amazing is that the craze seems so shamelessly driven by dreams of overnight riches. Let's be honest, the vast majority of people who hold cryptocurrency are not doing so because they believe in the long-term utility of whatever coin they've got. They're clinging on like gamblers at the races, with dollar signs in their eyes.
Let me be clear that I do not necessarily see anything wrong with bare-faced speculation, nor indeed do I profess to know much about cryptocurrencies. What I wish to convey is some measure of the inescapable ubiquity of cryptocurrency in day-to-day life at present. Why has it become so suddenly popular?
Like many, I play football on Saturdays. Most games end in a match tea. Several months ago, as the players were gathered around a table recapping the highs and lows of the game just passed, an epiphany struck. The conversation swerved quite unexpectedly from poor refereeing, to Bitcoin. It quickly became clear that eight of the eleven players gathered at the table owned at least one form of cryptocurrency.
I followed up with one of my team-mates, Richard, in search of an insight into how “ordinary” crypto-investors think. What I found was a surprising level of immersion (journalistic enquiries do not always pan out as planned).
Richard, together with a colleague named Greg (who works with him in telecommunications), have each amassed decent-sized portfolios of cryptocurrency. The prospecting pair were kind enough to talk me through their activities.
“We’ve got similar portfolios,” explained Richard. “Mine’s probably more conservative – and losing money at the minute as opposed to Greg’s which is still up. There’s about 1,400 coins or tokens that are out there that you can exchange on the various exchanges that exist. Of those you’ve got to pick ones that you believe have either utility or have some kind of roadmap that are going to do well in the future.”
He gave an example of one such coin: “There’s one that we’ve just invested in called Coss, which is an exchange – different exchanges have their own coins sometimes, and they can be used to, for example, get referrals. You could gain coins that way. Or you could get split fees in this case – you get a certain percentage of the exchange volume. All the fees they make, they generate part of those fees for all the coins in their exchange. It’s quite complicated in that sense.”
“Looking at it from the outside it looks like a giant ponzi scheme,” interjects Greg. “There is a token which is connected with the smart contract of the platform [Coss], and whenever there is a trade on the platform it appears on the Ethereum network, and whoever is a token holder will get an automated 50 per cent share of the fee that the exchange would take.” Greg believes the business can increase its share of the market and as such will organically generate revenue in the long-term.
Greg went on to describe his broader rationale for investing in cryptocurrencies: “The reason behind being invested in this is that the hallmark of crypto is being trustless. So I don’t have to trust the other party for my contract and my obligations or for my receivables to be accounted for – it happens on the platform automatically and no one can change it once the contract is set in place.”
Greg holds degrees in engineering, economics and accounting, and has worked in banking as an underwriter and as a risk portfolio manager for GE Capital. He holds about 15 cryptos in his portfolio, to Richard’s 12. He said that he would never invest in an Initial Coin Offering (ICO) without first scouring the associated white paper and thoroughly researching the developer’s repository on GitHub. He’ll spend two or three days researching a project that catches his eye before investing.
“My view of crypto is that it’s a huge opportunity to create value, store value and create new revenue opportunities and value opportunities…” he continued. “I don’t believe in the option of having a currency standard traditional industry adding a blockchain functionality to it. What I believe in is having the blockchain reform currently existing industries and changing how they operate. Because currently you have to trust the brand that you invest in or buy a product from or anything like that. With blockchains you can effectively sidestep that issue… Because everything would be transparent on the public blockchain and the ledger and you can track back everything to the single source.”
And how do Richard and Greg store their growing collection of coins? The answer, perhaps surprising to the uninitiated (like me), lies offline.
“I think it’s fair to say that most people keep them all in exchanges,” said Richard. “So you might hear of exchanges called Bittrex, Binance, Qcoin, Coss, Kraken, Coinbase – all those different exchanges. That’s just a storage place that’s owned by an external company, so your coins are all owned by them until the point that you extract them onto a ledger, an offline ledger. Greg and I have both got a Ledger Nano S, and we will take anything that we want to store in cold storage off the exchanges and store it in that for a small transaction fee, which you pay going into your wallet and coming out of your wallet. I think of it as like a USB stick.”
Greg further explained how these exchanges operate. “So effectively how an exchange works internally is they don’t create transactions on the network that they transmit on, they create IOUs within the exchange and the IOU is good until you withdraw your coins from the exchange.” These exchanges, he explained, maintain reserves of cryptocurrency, and will only move them when users withdraw their liquid assets.
Neither Greg nor Richard engage in any investing outside of crypto-markets. So what persuaded them to pile into crypto? It began with the promise of profit. Through word of mouth, Richard invested in Ethereum at an early stage, and was able to ride a price surge in 2017 to considerable percentage gains. He openly admits that his initial foray was a bit of a punt – albeit a punt with money he could afford to lose. After more than doubling his money within a couple of weeks, Richard began to develop more of an interest in the crypto universe, and began reading more and more into it, persuading Greg to do the same. Here we see the spread of crypto-fever from one host to the next.
Richard nevertheless acknowledges that any cryptocurrency could fall apart at any moment. But he also believes that the underlying technology stands a chance of fundamentally changing how society operates. At the same time, he is only investing with money he can afford to lose.
It is difficult to place Richard and Greg within the cryptoverse. Knowing more than me about cryptocurrencies isn’t exactly a badge of honour, but it’s clear that these chaps aren’t rookies. Between them they share a great deal of knowledge that is specific to cryptocurrencies, as well as broader financial services nous. Greg at one stage drew an illustrative analogy. He is invested in an exchange called Loopring, and holds LRC tokens which were issued via an ICO. In exchange for these LRC tokens, holders can submit transactions to a “ring” of exchanges.
“Imagine you are trading on NASDAQ and you are trading on Deutsche Börse, and you want to create one transaction that goes to both NASDAQ and Deutsche Börse for the same stock, and you can fulfil one order at the same time from the exchanges looking at the most competitive prices,” he explained. “There is no arbitrage ability between the exchanges.”
Greg and Richard also share a healthy cynicism. Between them, they admitted to seeing the whole thing as a bubble, joked that certain coins look like ponzi schemes, agreed that hundreds of coin-types would flop, and, crucially, admitted not to knowing what will happen in the future.
They do not seem to exhibit the sort of blue-sky-thinking, “it-can-only-go-up” mindset one might expect to find in crypto-investors. Indeed, I am starting to wonder just how common that kind of naivety really is in the frankly massively complicated world of cryptocurrency.
If anyone would know, it’s Michel Rauchs, Cambridge Centre for Alternative Finance’s cryptocurrency and blockchain lead. Michel, help us out: why have cryptocurrencies become so damned popular?
“It’s really because prices have just been skyrocketing,” said Rauchs. He pointed to a macroeconomic context in which a lot of asset classes are at all-time highs, with returns low, and interest rates low or even negative, leaving a lot of people scrambling around for decent returns. He also said that media hubs have played a key role in popularising the industry (I hope that’s not what I’m doing) with dozens of stories about overnight “crypto-millionaires”. And finally, he noted the popular appeal of a thing that sits “outside of the traditional system”.
Most interestingly, he described the role of fear of missing out (FOMO, in millennial parlance). “The more people who actually get into it [investing in cryptocurrencies], the more you hear stories of people who have made positive returns,” he explained. This then adds what he called the general “mania”, creating a “wave that takes everything with it”.
Until a correction strikes, that is. But hasn’t this already happened? “If you judge the market by its own standards, the past two or three weeks has seen a modest correction,” he said. “A large correction would be 80-90 per cent.” Rauchs bases this assessment on previous corrections in the price of Bitcoin.
Back to the well-informed, moderate and healthily cynical Greg and Richard. Are they representative of the average man or woman investing in this asset class?
Rauchs identifies two distinct types of crypto-investor. “It makes sense to differentiate between long-term investors – the ones that only invest in these so-called blue-chip coins – and shorter-term investors,” he said.
These long-term investors usually know what they’re doing. They buy blue-chip cryptocurrencies like Bitcoin and Litecoin and hold them in cold storage for years at a time, paying little attention to price fluctuations. Rauchs calls them “purists”.
And in the second camp? Three more types of investor – all of them “day-traders”, who’ll happily make bets on any kind of token. The first sub-group is the crypto-millionaires who made their money by investing at an early stage in one of the best-known currencies, such as Ethereum. These people then go on to invest in countless ICOs, not necessarily because they back the project, but because they foresee “crazy returns in the short-term”. The second sub-group is made up of retail investors, but retail investors with enough savvy to access ICOs, which Rauchs notes is “not as easy as it sounds”. However, a lot of these investors “have no experience at all” and can be “very easily influenced”, putting them in a precarious position. More precariously placed still are those in Rauchs’ third sub-group: less sophisticated retail investors who can only gain exposure to bog-standard cryptocurrencies via the most popular exchanges.
“The proportion of each of these is difficult to estimate,” admitted Rauchs. “But the share of categories two and three [within the short-term group] has definitely increased in recent months.” For him, these are the investors most at risk of losing money.
Rauchs has been preaching this for a while...
Further spurring on the mass adoption of cryptocurrencies are a plethora of businesses all getting in on the act by launching “picks and shovels” offerings. Take Revolut, for example. Revolut is one of Europe’s hottest digital banks with over a million customers to its name and a seemingly endless pipeline of new products. In December, a cryptocurrency tool became its customers' newest toy.
Revolut made its name with a currency exchange service that allowed users access to interbank rates at the touch of a thumb. In a little over two years, its popularity has soared. The app now offers a range of services, has raised close to $100m in venture capital to fund global expansion, and is pursuing a banking licence.
Revolut does not typically permit its users to speculate on the price of currencies, precisely because it allows those users to exchange fiat currencies at the interbank rate (which is effectively free). The app allows users 8 exchanges per day on fiat currencies – any more and it would be losing out (to paraphrase Revolut's chief platform engineer Lewis Tuff).
But for Bitcoin, Litecoin and Ethereum, it’s a different story. Revolut charges a 1.5 per cent mark-up on all crypto trades, explicitly to allow users to leverage the services as they wish. In other words, if they want to speculate on the price of cryptos, they’re free to do so.
This is a blatant acknowledgement from Revolut of the primary reason for people’s interest in cryptocurrencies: profit. Were these currencies with any practical utility, Revolut would surely have deployed the same fee structure that it uses for its fiat currencies.
The price of Bitcoin was around $13,000 when Revolut launched its crypto-trading service. After climbing to a high of over $19,000, it has since fallen all the way back to a touch over $10,000 (at the time of writing). Exactly how much has been traded by Revolut customers during this period? The banking challenger refuses to say, for now.
But what we can tell you is that the trading process is easy as pie: upload cash in any of the app’s 25 base currencies and exchange into crypto (without incurring foreign exchange fees) in less than 30 seconds.
Rauchs offered his view on Revolut’s new service at the time of its launch.
“I’m a bit concerned because a lot of these people have no idea what bitcoin really is or how it works, and they tend to just see it as a speculative asset with really high returns on investment,” he said. “You risk magnifying the impact of a crash that will come. There’s no reason to think that there won’t be corrections. It’s exactly these people who will get burned first.”
The big question seems to me to be: who’s driving the crypto-revolution? People like Richard and Greg? One of Rauchs’ four horsemen? It’ll take some time, I’m sure, for the truth to out.
Well, I think that’s about all I can manage. I’m off to buy some Bitcoin and a cold storage unit. I’ll be sure to check in a few years’ time. So long.
Now in its sixth year, the AltFi London Summit returns on 18th March 2019 to 155 Bishopsgate. Last year proved to be a crucial turning point for the key players building the future of finance. Leading platforms launched oversubscribed IPOs, digital banks proliferated and mainstream financial institutions started their own disruptive propositions. With 2019 certain to be another landmark year, more questions will be asked by regulators with investor interest in disruption also poised for more rapid growth.