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Sunday, April 29, 2018

Are Cryptos the Dot-Com of this Stock Market Cycle?

by Amy Erixon, Toronto

Many investors are scratching their heads over the mania around crypto-currencies.  In 2017, the number of new crypto initial coin offerings soared as the spot price of Bitcoin rose from $726 the day following Donald Trump’s election (all figures in this blog in USD) to near $20,000, one year later.  (As of this writing Bitcoin is trading at $9302, up from $7000 just a month prior).  Amidst this dizzying apparent tulip bulb market for Bitcoin, it is easy to miss the importance of  the distributed ledger technology that underpins the currency, and the increasing legitimization of Initial Coin Offerings (ICO’s) in the form of digital tokenized securities.  Token sales representing, for example, limited partnership interests in properties, oil or venture capital pools are growing rapidly - and like internet-based technologies that preceded them, offer the promise (but not necessarily the reality) of improved democratization and integrity of the investment industry. 

Properly designed, these investments look like any other form of security investment, except that they is traded on a distributed ledger technology platform (vs conventional public or private regulated market exchange).  Many of these tokens have hard asset backstops (ranging from gold to oil, to property limited partnerships or actual securities), while others don’t, which makes the space very confusing.   For a look at how quickly, and globally, this market is growing, refer to this interactive chart from elementus.io:  https://elementus.io/blog/token-sales-visualization/.    The size of offering is shown in size of the circle and region in which the offering originated is shown by color. 




Did you do a doubletake?  You read that right, as of November of last year, ICO’s had raised more than $6 billion, and the volume continues to rise exponentially, (a whopping $1.2 billion was raised in December 2017 alone).  For context, the worldwide supply of gold is estimated at a current market value of $6 Trillion, so even at this growth rate these ICOs are a long way from dominating securities markets.   Even so, the wild volatility of various crypto-currencies and the fact they trade largely on unregulated exchanges has banks and regulators scrambling to understand what should be done about the space.    In March 2018 the G-20 meeting included as agenda item #2 (following denuclearization of North Korea) discussion of the need for harmonizing regulations in this sector.   Canada and Luxemburg are two of the early adopter countries. 

According to a report published by International Data Corporation, worldwide spending on blockchain solutions is forecast to grow with a five-year compound annual growth rate (CAGR) of 81.2% to $9.7 billion in 2021.    Everywhere you look symposiums are being organized to discuss distributed ledger technology, its cybersecurity, and the wide range of utility for these software platforms – from identity to title registries, from health care to supply chains.   Proponents, such as Bill Fearnley, research director of Worldwide Blockchain Strategies, suggest: "Interest and investment in blockchain and distributed ledger technology (DLT) is accelerating as enterprises aggregate data into secure, sequential, and immutable blockchain ledgers, transforming their businesses and operations."  

Blockchain technology records transactions digitally, and uses software techniques to validate, secure and save transaction information in a distributed database in the form of a ledger.  The more distributed the information storage is, the more difficult it is to alter.  This represents an innovative way to keep track of many types of assets, commodities, currencies and smart contracts, bypassing conventional market exchanges and “market makers” (often costly intermediaries).    This technology is important for numerous reasons, among them: optional confidentiality, improved cybersecurity, and its potential technological integrity against revealed problems with our current centralized clearing systems - such allegations of “rigging” (LIBOR), manipulation (currency), and stock market latency inequality (highlighted in books like Flash Boys: A Wall Street Revolt, by Michael Lewis).   

Money has been digitized for 40 years in the form of wire transfers.    Why not investment securities, commodities and ultimately fiat currencies?  The digital revolution for commerce began in earnest in 1996 with the development of the hypertext transfer protocol (HTTP).  The commercialization of PayPal as a non-bank digital payment protocol came in 1998 – the very same year Google incorporated to market it’s search engine, designed to organize the rapidly increasing world of digital information on the world-wide web.   E-commerce app developers leaped into action, and poorly designed products gave us the dot.com bust.    But e-commerce didn’t go away, it simply learned from these failures how best to serve consumer demand. 

The world-wide web and e-mail, are technologies that work over internet infrastructure, but those two applications - now integral to personal and business life - are by no means the only platforms for utilization of the internet.   E-commerce is another and distributed ledgers are yet another internet-based platform.  We are just at the beginning of understanding the internet’s transformative potential. 
Crypto currency has great potential if it can be made more immune to counterfeit and fraud, less vulnerable to political manipulation, and function as a globalized store of value and basis for trading.  Poorly designed cryptos, like the dot.coms will surely fail along the way.  But distributed ledgers and crypto-tokens as a platform for trading securities, commodities, properties and even stocks may become significant exchange players in the medium future.   Betting against this may turn out to be akin to betting against Google and Amazon in 2003. 

For more information concerning distributed ledger networks, refer to my July 2017 paper entitled Distributed Networks and Artificial Intelligence, Architecture of the Fourth Industrial Revolution. 

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