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Why cryptocurrencies are tricky investment targets

The stumbling and subsequently calamitous start for cryptocurrencies 2018 must have felt like vindication to detractors that called bitcoin a “fraud” and a passing fad last year.

The bullishness that fuelled their rise has all but vanished — as have any near-term prospects of their inclusion in mainstream investment, according to a major asset manager.

“[Cryptocurrencies’] market capitalization has reached nearly US$500bn after dramatic price increases in 2017, but we don’t see them becoming part of mainstream investment portfolios soon,” BlackRock said in a recent commentary. “Crypto markets are highly volatile, fragmented, largely unregulated, and come with unique liquidity and operational risks.”

Looking at Thomson Reuters data from the start of 2016 to February 21 this year, BlackRock found that the annualized daily price volatility of the three biggest cryptocurrencies — Bitcoin, Ethereum, and Ripple — made gyrations in US equities during the global financial crisis “look placid”.

Aside from drastic price swings, cryptocurrencies have other features that make them “tricky investment targets”. Weak regulation and inadequate security at crypto exchanges present major challenges and valuation is difficult because of the absence of cash flow, earnings or interest-rate information for crypto-assets, whose uses range from being a speculative bet to an obscure payment medium.

While the market is evolving, it’s doing so at a slow and cautious pace. The reception to recently launched bitcoin futures at established exchanges has been lukewarm, thanks in part to high margin requirements. Meanwhile, the question of cryptocurrency regulation will be tackled at a G20 meeting set this month

BlackRock noted that investors are relatively more bullish on blockchain, the technology that underlies cryptocurrencies. With possible applications in a wide range of industries, it has significant disruptive potential — but challenges exist.

The firm said: “Take the financial industry. A blockchain-based, single shared financial database could eliminate inefficiencies and risks associated with human processes, but adoption at scale would require a massive shift in software development and a well-constructed maintenance model.

“Regulators and central bankers would also need to play a big role, we believe.”