By: Nicolas Forget Managing Director Finance and Structuring

Allow me to add my voice to the discussion about Cryptocurrencies and blockchain. While the former is an interesting economic phenomenon, the other is both the application of the very old concept to a new medium and a very exciting development.
Let’s start with blockchain which is, in my opinion, the more interesting of the two: at its simplest level blockchain is a list of buyers and seller of a specific item — blockchain’s innovation is that (a) there are thousands of identical lists for each item that are disseminated across the world but are updated instantaneously — the impact is a reduction of risk of fraud, and (b) its free!

This is important stuff because the trick with fraud is to alter the ownership chain, but with thousands of identical lists, it’s impossible to update them all, and a fraud will be quickly revealed. The question is always the same — in what kind of transaction can blockchain be used? There are many from stock transfer to other types of securities transfer the fact is that blockchain provides an ownership track for specific goods — you could use blockchain to confirm the sale of an asset that can be specifically identified, you would not use blockchain to secure the sale of butter, but you may use blockchain to confirm payment at the checkout counter without ever giving your own information…

Cryptocurrencies are a different animal altogether; cryptocurrency have zero intrinsic value, but they have an market value (i.e. what someone is ready to pay for something), strictly speaking, it is the same as a Picasso painting; it’s worth exactly what someone else is ready to pay! That’s not the same as a US dollar — which allows you to pay for goods and services from governments (that’s not nothing). Right now, there are more than 1,500 different cryptocurrencies, some were started as a joke (Dogecoins is “worth” US$ 2 billion in market capitalization) others take themselves very seriously, such as Bitcoin. However, it is not a currency, it may be a store of “value” — with some rather extreme volatility; consider not so long ago a Bitcoin was worth $45 per coin, now it trades around US$15,000 — its not divisible and most of the schemes to make it divisible have proved to be scams and fraud.

The concept of intrinsic vs market value is complicated. When you buy a share — you acquire a small percentage of that company and the right to the value of that company’s future dividend stream and stock appreciation (hence the use of p/e as an indicator of risk/reward). That is why shares possess an intrinsic value; the value of a cash flow or the value of the sale of the assets of the company.

Market value is simply what someone is ready to pay for something. You own a Picasso and the market says it is worth $50 million — sure why not. Now there’s nothing wrong with market value, until the market decides that the value should fall. There is also a problem of liquidity; a few months ago, a Leonardo painting was sold – the estimated price was US$ 150 million. It eventually sold for $500 million (that’s good for the seller, but it’s no indication of what the painting will be worth in the future). Liquidity and volatility are the main issues with cryptocurrencies – and they are different but related. Right now theirs is insatiable appetite for Bitcoins – I get it, apparently people are even buying them with their credit cards. However, sentiments may turn since a Bitcoin has no intrinsic value – just what the market is ready to pay. Should this market decided that Bitcoin are not as interesting as they were, or rumors about liquidity emerge (as it did last week in Korea) and in a normal market prices should have dropped (this is not a normal market). Since a lot of Bitcoins have been acquired on debt, once the price starts to fall…

There’s another issue; increase in the absolute value of Bitcoins are getting harder and harder to come by, when a Bitcoin was worth $10.00 and rose to $20.00 a 100% increase the total dollar increase was only $10.00. Now that Bitcoin is at $15,000 to grow a 100% would will take longer – the speculators are certain to move on from the “sure thing” that was Bitcoin for the past 18 months.

Photo by Zach Copley