A 101-guide to building your crypto-portfolio
It’s not for the faint-hearted
In a recent presentation Farzam Ehsani, blockchain lead at RMB, asked a room full of asset managers how many of them had invested in cryptocurrencies. Three timid hands were raised. The risks of investing in this new asset class are well documented and asset managers, as a rule, are not about to take chances with client funds. Ehsani gave the same presentation at UCT and asked the same question. A sea of hands were raised.
Cryptocurrencies are a new asset class, risky and volatile at that, and their long-term sustainability is unproven (see box insert). And while some of the world’s best investors have dismissed them, it seems the brightest young minds are embracing them.
The world of bitcoin and cryptocurrencies has evolved since bitcoin gained mainstream attention in 2017. In March this year, there were more than 1 000 currencies in existence, with a combined market cap of over $460 billion, up from $19 billion just over a year ago, according to statistics on a site for developers, github.com. While bitcoin remains the undisputed bellwether for digital currencies, the remaining growth has come from new coin offerings (tokens, alternative currencies or altcoins), which now account for 60% of the total market. Of these, 25 currencies account for over 90% of the market capitalisation (see graph below).
There are over 1 000 currencies in existence, with a combined market cap of over $400 billion.
Farzam Ehsani, blockchain lead at RMB.
For those who understand the risks, and who are keen to get involved, getting started can seem overwhelming. So Moneyweb Investor spoke to Ehsani as well as Markus Swanepoel, CEO and co-founder of South African digital currency company Luno, and Andrew Pritchard, UK based founder of the 10x Growth Account which enables investor access to a portfolio of cryptocurrencies.
We also spoke to Co-Pierre Georg, who lectures at UCT on risk management in financial markets, for an alternative view.
Tip 1: Familiarise yourself with the market
Most people will have heard of the most common cryptocurrencies, like bitcoin, ripple, ethereum and litecoin. However, the cryptomarket has many more emerging currencies, some of which are yet to see the explosive growth of bitcoin and others, making them targets for investors looking to buy early and make significant returns. Familiarise yourself with the market before you start investing.
The chart below shows the 25 most notable cryptocurrencies on the market, as of March 2018.
Here are the top five cryptocurrencies by market capitalisation as of 20 March, 2018
Note: Cryptocurrencies are volatile and have large swings
in value, so these numbers can change quickly.
And here are the top five cryptocurrencies
by 30-day volume as of 20 March, 2018
Familiarity with the market is one thing, but how does one evaluate the different currencies available?
• Understand the underlying technology and monetary rules. Some currencies, like bitcoin, are decentralised – which means they are not controlled by anyone. Not all of the coins are in existence yet, and can be mined. The rate at which bitcoin can be mined has been calculated to last another 122 years! Other currencies, like Ripple, NXT, Waves, Factom and Maidsafe are centralised and are controlled by one company.
• Understand the business use case. In bitcoin’s case, it serves as a store of value and to effect payment without relying on centralised ledgers (banks). Ethereum on the other hand aims to be a one-stop shop for creating decentralised applications and smart contracts that have no single point of failure and are autonomous. A very different use case is the Monetary Authority of Singapore, which recently partnered with a consortium of banks to develop Project Ubin, a pilot tokenised version of the Singapore dollar that replicates the existing financial payment system without a centralised clearing system. The better the use case, the more sustainable the currency will be.
Development activity – an army of active developers is important; in this world size matters.
Community – who is using the coin, how many exchanges support it?
Trading volume and liquidity – use sites like CoinmarketCap to monitor activity. There is no point holding thousands of dollars’ worth of a currency that does not trade.
Market cap – the bigger the market cap, the more difficult it will be to manipulate the currency.
Public interest in the currency.
The better the use case, the more sustainable the currency will be.
Tip 2: Determine your risk factor
As with all investments, understanding your level of risk will help determine which cryptocurrencies you might do better to invest in. Cryptocurrencies naturally have a higher baseline level of risk as the market is unregulated, but beyond this, there is still a broad range of risk levels associated with different currencies. Newer, less established currencies are likely to be available at rock bottom prices, with the potential to make significant returns should they turn out to become the next bitcoin. Bitcoin is more mature and is unlikely to experience the growth of last year.
Tip 3: Set up a digital wallet
If you want to start buying cryptocurrency such as bitcoin or ethereum, you need to set up a digital wallet. This is what will store all the information relating to your cryptocurrency. You will need to decide whether to store your wallet online (a hot wallet), which is easier and simpler to access, or on your own hard drive or USB stick (a cold wallet), which is safer and more secure. There are many providers of online wallets, so do your homework and make sure you read up on each provider and seek out reviews.
Bear in mind that once you start exploring other less known currencies, you must first check that your digital wallet can store them, as not all currencies are accepted.
If you want to start buying cryptocurrency, you need to set up a digital wallet.
Tip 4: Pick your exchange
South Africans will have to start on a local exchange such as Luno or Altcoin Trader. To venture beyond the currencies offered locally, investors can use their bitcoin or ethereum to buy currencies on a global exchange. This is where research is needed – there are hundreds of exchanges. The better known (but not necessarily recommended) exchanges include bittrex.com (not accepting new accounts), gdax.com (used by traders), coinbase.com, bitfinex, Boston-based poloniex.com, kraken.com, bitstamp.net, Japan-based Coincheck (Japan is one of the few countries to authorise and regulate cryptocurrency exchanges) and binance.com.
All have different offerings and different fees and some, such as Bitfinex and Coincheck have been hacked before.
Tip 5: Small and regular investments
Whilst it can be tempting to invest large sums of money in order to potentially gain larger returns, it is sensible to begin initially with smaller, incremental investments over time, always keeping within your own personal limits of affordability. As your knowledge, understanding and experience of cryptotrading grows, you can make larger and more significant trades.
The likelihood of all 1 000 cryptocurrencies that are in existence today, surviving into the future is slim. However many observers believe that this genie is not going to be put back into the bottle. That said, before you rush out and set up a crypto portfolio, here are a few salutary words of caution.
“It is ridiculously risky”
The first crypto-currencies appeared on the dark net (essentially the anonymous internet) in early 2008 and have since gone mainstream, with the price of bitcoin in particular exploding in 2017.
“There are many great stories of people who have made fortunes, who have started businesses or paid for university studies with the profits. However past price performance is no indication of future price performance,” says Co-Pierre Georg, associate Professor and the course convener of MPhil in Financial Technology at UCT.
“Crypto-currencies are popular in the underworld and it’s a matter of time before regulators come down hard. I would strongly recommend you sell everything right away. This is a bubble – in fact it is the mother of all bubbles.”
He says there are other alarm bells:
The environment lacks transparency and trading is anonymous. “A few people dominate ownership of every currency. Take bitcoin, less than a 1 000 people own over 40% of mined bitcoins. They can co-ordinate with each other to manipulate the market and there is nothing anyone can do about it,” he says.
Correlation between the currencies is another concern. “Coins are issued with different underlying business cases, so there is no fundamental reason why they should be so correlated – no asset class has ever moved like this.”
Extreme volatility is another concern. “The volatility is several times that of the Rand. No ordinary investor would go near this.”
He does not dismiss the importance of blockchain – the technology that underpins crypto-currencies. “Blockchain is equal in importance to the development of the internet. Remember though, that while the internet changed the world,
pets.com failed.” ■