The myth of value
Leo investigates the likelihood of cryptocurrencies becoming the next dot.com bubble.
I recently got engaged and, whilst trudging (romantic terminology has always been my forte) around Birmingham’s Jewellery Quarter, I began to wonder (romantically) why engagement rings are so expensive.
As you may know, diamond engagement rings surged in popularity in the 1940s off the back of an ad campaign for the DeBeers Mining Company that proclaimed ‘A diamond is forever’. It’s a great line – and both demand and prices rocketed.
The intrinsic value in precious gems and metals is not their utility nor rarity but their desirability. Humans think they look pretty and are willing to exchange money to obtain that value. It’s the basic concept of supply and demand.
What are cryptocurrencies and why are they valuable?
Ring happily in place on my fiancée’s finger, I extended my musings to cryptocurrencies.
Cryptocurrencies are a hot topic, with huge valuations being attributed to the likes of BitCoin, Ripple and Ethereum.
Now I’m no cryptocurrency expert, so I’ll rely on great articles like this to explain how virtual currencies work. Here’s a quick summary: cryptocurrencies are digital transactions that don’t require a third party (i.e. a bank) to verify that a transaction has taken place.
Verification is conducted by other members of the cryptocurrency network, via a process called a Blockchain. A blockchain is essentially a digital ledger of every transaction that has taken place on the cryptocurrency network and is seen by everyone on the network.
If a transaction doesn’t have a record of every other transaction, it is not a valid transaction, and can’t be verified.
There are no physical elements (i.e. bank notes, coins, cheques etc) in cryptocurrency. Transactions can take place online all over the world instantly. It is anonymous (i.e. your transactions are just bits of code, there is nothing linking a cryptocurrency transaction to an individual name), secure, and because there is no third party charge for brokering the transaction like with a bank, the service is, to all intents and purposes, free.
Cryptocurrency seems to have all the facets to be a workable currency of the future, but then the value question rears its head again.
Cryptocurrency vs ‘real’ currency
The news channels tell us that one Bitcoin (just one of the flavours of cryptocurrency available) is worth a vast sum of ‘real’ money (at the time of writing one Bitcoin is worth £2,107) but that its value fluctuates much more than a ‘regular’ currency.
‘Real’ (or to use the proper terms, fiat or commodity) currencies are backed by Government - and while they do fluctuate, wild swings up or down are usually few and far between.
But cryptocurrency isn’t backed by Government, nor is it readily accepted everywhere - which begs the question: why is one Bitcoin worth so much ‘real world’ money?
True’s home town of Bristol has its own alternative currency, ‘The Bristol Pound’ Launched to try and encourage local spending, shoppers could exchange pounds sterling for Bristol pounds (i.e. £5 sterling bought £5 Bristol pounds) that could only be spent within BS postcodes.
Now, I can’t speak for the entire citizenship of Bristol, but I know many people wondered ‘What’s the point? Why should I exchange my currency which can be used anywhere for a currency which is limited?’ Some shops did offer additional discounts for customers using Bristol pounds, but the benefits had boundaries.
So what is driving the high valuation of cryptocurrency, which, like the Bristol pound, has limited real world application? It’s the same as diamond engagement rings. Desirability.
Speculation and Bubbles
Throughout history, speculation has created bubbles, whereby something ascends in value and people, seeking to profit from it, purchase more, driving the price up. When that something is no longer desired and valued by the market, its value plummets. In this fascinating article Ben Thompson compares the situation with cryptocurrency value with the tulip bubble in the Netherlands in the 1600s.
The most recent IT bubble was the dot.com bubble in early 2000s, where values for Internet companies soared, then crashed when the actual output of these fledgling companies fell far short of the prices they were sold for.
This is something I feel we are seeing with cryptocurrencies. Few people are talking about the benefits of its peer to peer validating process or its anonymity. Largely, it’s touted as “a good thing to get into now, as it’ll be worth a lot more later”.
The time lag of innovation and Cryptocurrency
In my last post, ‘The time lag of innovation’ I discussed the conditions needed for a new innovation to come to market and the time it takes for the innovation to take hold.
I think we are seeing a bit of that with Cryptocurrency. Bitcoin was introduced in 2009, and so, as a concept, isn’t even 10 years old. There are benefits to adopting cryptocurrency, but for widespread adoption, an innovation needs to solve more problems than it creates.
There are many legacy institutions (namely Government and Banks) which could prove to be obstacles in its path.That’s not to say it’s impossible. WePay and AliPay in China have shown that we can change how people transact on a wide scale, but it takes time and the right conditions.
Value may not lie in money, but in the making of the money
I believe that greater value in cryptocurrencies for digital systems and content creators is not the currency itself and its associated services, but the process which drives the generation of the currency. In other words, Blockchain.
There is a great deal of buzz in financial markets around uses of Blockchain technology, both as a means for transacting funds (with banks looking to charge a fee for the service, even though the underlying process is technically free) or reducing the overhead in financial processing.
The concept of peer to peer validation and a shared ledger with a complete history of transactions has a wealth of business uses across the digital spectrum.
Services can be built up around the blockchain process which would have real world application, over and above speculation.
As with all new innovations, the technology won’t match the initial hype. But as the technology is more understood and the costs to develop and maintain services which use the Blockchain process drop, it has the promise to be real game changer for organisations across many industries.
If you like to find out more about how blockchain and other Fintech solutions could improve your business, we’d love to talk.
(*Full disclosure, I do not own any Bitcoin or any other cryptocurrency, nor should the opinions cited in this piece be taken as investment advice.)