As investors become more sophisticated, they increasingly look to alternative investments to diversify their portfolios and, in turn, generate strong returns, reduce volatility and create a steady stream of returns. As such, the alternative investment sector has grown rapidly in recent years, twice as fast as the traditional asset sector since 2005, with global assets under management (AUM) growing at an annualized pace of 10.7%. As new innovative alternatives emerge, none have elicited quite as much debate as cryptocurrencies – specifically ‘bitcoin’, the first and most well-known tech-based currency, created in early 2009.
Hailed by some as a new frontier in the evolution of money, cryptocurrency still generates confusion around its classification as an asset. The Commodity Futures Trading Commission (CFTC) asserts that it is a commodity, while the Internal Revenue Service (IRS) deems it property. The debate around how (if at all) bitcoins should function in an investment portfolio has certainly not deterred the seven million people who have invested in it globally, helping to propel its unit price to $750 and push its market capitalization to $8 billion. While still not widely recognised as a medium of exchange, there is no doubt that bitcoins and other cryptocurrencies are slowly changing the financial arena.
In Switzerland, the national rail operator, SBB, has launched a service that allows passengers to exchange Swiss francs for bitcoins using the company's ticket machines, as part of a two-year trial that will test Switzerland’s appetite for the cryptocurrency. Meanwhile, earlier this year, the Cabinet of Japan approved new regulations relating to cryptocurrencies and now recognises digital currencies, such as bitcoin, as a legal form of payment fulfilling the functions of currency.
In May, Japan’s National Diet approved a bill to regulate operators of virtual currency exchanges in the country in order to help ensure better protection of users. And more recently, ResuPress Inc., a Tokyo-based bitcoin exchange operator, plans to allow customers to pay utility bills with the virtual currency. This service is the first of its kind in Japan, where bitcoin is still regarded as a novelty in daily consumer life – with only 2,500 stores (approx.) currently accept bitcoin as a means of payment for shopping and dining in the country.
Even a relatively receptive country like Switzerland has a limited number of physical stores that accept bitcoin. But make no mistake, the landscape is shifting: leading online businesses including eBay, Amazon and Expedia now accept bitcoins as a form of currency, and experts predict an increase in the adoption rate of the cryptocurrency next year.
Acceptance of bitcoin has been marred with controversy – most famously through the 2014 collapse of Mt. Gox, one of the largest exchanges for the cryptocurrency, after a suspected theft worth $350 million (744,408 BTC), and more recently through the hacking of Bitfinex, the largest bitcoin exchange, on 2 August 2016, with a suspected theft worth $60 million (119,756 BTC). However, blockchain technology, the underlying infrastructure of bitcoin, has garnered the interest of the investment industry.
A simple way to conceptualise blockchain is a permanent ledger that records transactions, with multiple copies of the ledger (called nodes) contained within a network. If a new block of data is to be added to the blockchain, a majority of the nodes within the network must verify the proposed transaction. A key feature of this multiple node structure is that it enables unknown counterparties to trade with each other securely and uses a cryptographic key to authenticate participants.
With its ‘cleaner’ image than bitcoin, banks are eagerly exploring implementing blockchain into their banking practises. The harnessing of this technology has been likened to the effect that the introduction of email had on communication, and it has been noted that blockchain could revolutionize financial services and even help firms meet Customer Due Diligence (CDD) and Anti-Money Laundering (AML) requirements more efficiently. In a recent paper, the German regulator BaFin identified blockchain as potentially establishing a new standard in the financial market.
Earlier this year, the People’s Bank of China stated that it is looking to launch its own cryptocurrency in a bid to boost financial transactions within the country and abroad, while Sweden’s central bank, Sveriges Riksbank (which was the first central bank to issue paper notes in 1660), is reportedly considering the issuance of a national digital currency, ‘ekrona’, in an effort to address the significant decline in cash-usage in the country. Citigroup is testing its own ‘citicoin’, while Goldman Sachs (GS) has filed a patent for its ‘SETLcoin’, which will offer instant trade settlements. In addition, GS has recently invested $50 million into a small bitcoin startup. The fledgling company intends to start using the bitcoin network to create a global payment system in which customers will get paid by bitcoin, but the value is instantly translated to their currency of choice.
As more businesses embrace cryptocurrency and the investment sector builds financial systems based on blockchain, its appeal as an alternative investment will continue to grow. Unquestionably, its current popularity largely derives from its ability to serve as an asset class and, as such, cryptocurrency may have more conceptual similarities to commodities such as gold rather than money.
It may be difficult to comprehend how a virtual currency could become a mainstream alternative investment, however keep in mind that it was just over 25 years ago that deregulation in the oil and gas markets suddenly offered opportunities for investor trading of these commodities.
Moore Management currently administers the first and only cryptocurrency fund regulated by the Jersey Financial Services Commission. The concept of the fund is to provide access to the bitcoin market for expert and institutional investors. While it is the case that bitcoin can be purchased by anyone relatively easily, the fund adds a number of unique features that make it attractive to its target client base – primarily, it provides exposure to the price movements of bitcoin while managing the risks associated with being involved in an exciting new market.