ETF Securities Research Blog

The problem with cryptocurrencies

Cryptocurrencies are very much an emerging asset class, and the technology underpinning it is steadily developing. However, we believe there are intensifying issues regarding regulatory scrutiny, liquidity, trade execution/confirmation time, scalability, trust in the money creation process and the fundamentals that drive the currencies.

The SEC (Securities and Exchange Commission) made clear in its recent decisions in refusing approval of a US Bitcoin ETF that there is no appropriate regulatory supervision of Bitcoin trading markets that link to traditional regulated markets.

Liquidity of Bitcoin is increasing, but much of that is in unregulated and diverse exchanges located outside of Europe and the US, as mentioned by the SEC. Furthermore, it is not clear how much liquidity is available at any given time, which can have an impact on price and execution of pending transactions in the order book, crucial if it were to be traded as a scalable ETF on regular exchanges.

Distributed ledger systems are slow and as the blockchain matures they are getting slower. The median blockchain confirmation time over the last year is 30 minutes and has been up to 2500 minutes at times this June. Commercial payment card network systems can handle around 2000 transactions per second, versus the Bitcoin network being restricted to a sustained rate of 7 transactions per second due to its inherent protocol. There will be more efficient distributed ledger currencies in the future, but the appropriate solution is not available yet.

Blockchain transaction time

Another crypto currency, Ethereum has had some coding issues leaving it vulnerable to hacking, which prompted the developers to reset the currency with different rules than the original. This has led to a “hard fork” leading many not to trust the currency. It highlighted that the Ethereum Foundation and its coders had total control of the currency, and exposed potential conflicts of interest. The recent flash crash where the price fell from $320 to $0.10, has also damaged confidence despite its rapid recovery back to $317. Ethereum and Bitcoin raise important questions for distributed ledger currencies, should the developers and coders of the currency algorithms have control of money creation or central banks?

Both the Mt Gox (A Tokyo-based bitcoin exchange) Bitcoin related collapse and the Ethereum “hard fork” are examples of technical problems that pose real risks to emergent digital currencies at the moment.

An investor in digital currencies must also ask themselves what are the fundamentals that drive these currencies? We believe there aren’t many established fundamentals yet, trading more on technicals/momentum for now.

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