Crypto has had all the hall marks of a classic financial bubble, with a phenomenal amount of hype coupled with unrealistic levels of hope and unresponsive regulators that have left a lot of shadows for the unscrupulous to operate in. Kay Rieck Dubai
Crypto has had all the hall marks of a classic financial bubble, with a phenomenal amount of hype coupled with unrealistic levels of hope and unresponsive regulators that have left a lot of shadows for the unscrupulous to operate in. After months of rising prices, the sector has collapsed into what many are calling the second crypto winter. While it doesn“t help the investors that have lost their shirts as a result of the sector“s many scams and over blown pipedreams, fundamentally, the underlying technology continues to show promise, suggests Kay Rieck, an experienced market observer and investor.
Those of us that have been involved in the financial markets down the years have been following the developments in the crypto sector with a certain a certain amount of trepidation.
On the one hand there appears to be a great deal of potential in the blockchain technology. Implemented well, it could help enhance the speed of information processing and create new efficiencies that would augment a range of industries from the financial services right the way through to the fine wine sector.
On the other hand, you would struggle to find a market that was more obviously overheated if you tried to make a trade in a sauna in the middle of the Sahara Desert in a heatwave at the height of summer. Any market where Dogecoin (pronounced dodgy), let alone PooCoin, gains traction is a market that most experienced investors would know is worth staying away from.
#TheEmperor“sNewClothesCoin
Several factors have played into the rise and fall of the crypto market. From a retail perspective, the global pandemic was a significant factor in the bull market that took the price of bitcoin, the best known of the cryptocurrencies, from US$7,220 at the start of 2020 to US$29,260 at the start of 2021 to US$46,309 at the start of 2022, basking in a peak of around US$64,084 in November 2021. Lockdowns suddenly created a swathe of people that had a lot of time on their hands. They weren“t really able to spend very much and some even had some excess disposable income as a result of the world“s various furlough schemes. At the same time, interest rates on traditional savings accounts were virtually at zero.
The crypto markets looked like an opportunity. Fear of missing out took hold. They all started investing, perhaps in some cases without doing their due diligence, which inflated prices, some people invested heavily and had an interest in keeping prices high so the internet was awash with evangelical articles breathlessly explaining the opportunity. Crypto was going to the moon.
Taking these factors together made the price rises self-perpetuating, inflating what is known in economic textbooks as a bubble. And what the economic textbooks will tell you about bubbles is that they tend to burst. Sometimes spectacularly. In the case of Bitcoin, the price currently sits at just over US$20,000, more than two thirds off its peaks.
To be fair to bitcoin, this does mean that if you entered the market at the start of 2020 you“d have done okay off the investment. Unfortunately that is not what many retail investors have had to endure. Life savings have been squandered on random coins with glossy websites, founders have gone on the run, pension pots have dwindled to nothing.
Meanwhile, at the bank
There is also a financial services story to be told. The financial services sector was very early to adopt electronic systems, and it has continued to invest over the last four decades, enhancing efficiency, reducing headcount and saving a great deal of money along the way. It“s got to the point where the CEO of Bank of America is quite comfortable describing themselves as the head of a tech firm rather than simply a bank.
The problem is that the systems that they designed were built in silos, often for individual institutions and even individual departments within those institutions. This meant that they required extensive tinkering at the back end to be able to interoperate. But the tinkering was necessary because over the last few years regulators have been expecting more and more detailed reports about risk and exposure. Investing in the systems to fulfil that need has meant that the institutions have been relatively slow to update some of the back-end systems because they have focused on patching them to make sure that they can respond to the regulators“ requests before they become demands.
There has also been a lot of focus on making trading algorithms as efficient as possible, which has also required a good amount of developer time and research and development money, so in some quarters there is an inherent bias against investigating new technologies such as the blockchain that potentially requires that institutions tear down their systems and start again.
The thing is though, this has made the financial services system as ripe for disruption as any on the planet.
Blank slate state
If you were to start with a blank piece of paper and armed with the knowledge of what a system needs to achieve, the current global financial system is not what you would design. There are quicker, more efficient, cheaper ways of doing things.
If you were lucky enough to be starting with a blank sheet of paper, you might well design something that resembles a form of blockchain, the technology that underpins cryptocurrencies.
Blockchains offer a way to move information between global systems quickly and ensure that it has not been tampered with as it moves because (at a massive simplification) pieces of the data is verified by several independent sources. These verification sources are rewarded for the service they provide, usually though a proportion of a cryptocurrency.
This creates several benefits, not least of which is that when implemented correctly, it is possible to track a piece of information through the system, so not only can you see that it has been verified, you can also see where it has been and, if it has been tampered with, where in the process the tampering took place. It is built on trust and also the computational reality that it would be prohibitively expensive and time consuming to spoof the system. It is an approach that would have benefits for the buy-side, the sell-side, and regulators and governments who in theory would be able to track fraud and recover funds more easily.
Crypto also has the potential to offer a new, more efficient way of enabling investment in small innovative companies that in the past might have struggled to attract investment. Rather than go through the process of issuing stocks, small companies with big ideas have more recently been issuing crypto shares. It“s an approach that offers significant levels of automation and simplifies things like lock-in periods to offer a level of investment stability that has eluded many small companies in the past.
#Everything“sRuined
Unfortunately, the sector has blossomed too quickly, grabbing headlines and attracting investors around the world before regulators and governments could develop an appropriate response.
Investors piled into crypto projects that aren“t necessarily backed by anything in particular, they are often simply coins for coins sake, rather than nascent companies looking for investment. Like the dot.com boom twenty years ago, many of the investments have turned out to be vapourware, based on little more than hype, hope and unfounded optimism, which is dangerous in an unregulated market where there are plenty of people willing and able to tell a fantastic story in order to part an investor from their cash.
Regulators and governments are very rarely particularly impressive at delivering appropriate responses quickly, particularly where innovative technologies with the potential to disrupt intricately developed global systems are involved. You tend to have a choice between three responses: they do nothing, they do something quickly but badly, or they do something appropriate eventually.
Take care when changing a delicate, intricate system
To be fair, it“s one thing to disrupt taxi hailing services, the bed and breakfast sector, or fast-food deliveries. Every city or state may have its nuances within local labour laws or such as working hours and holiday pay, but the global banking system requires a little more thought. And quite a lot more delicacy. We all rely on it every day so change needs to be incremental.
At the same time, cynics and crypto evangelists might suggest that the global financial institutions could see the disruption that crypto has the potential to represent and took steps to slow its progress wherever they could. Whether there is much truth in this suggestion is difficult to say, senior leadership roles at many crypto companies are often filled with former denizens of Wall Street, The City or Central.
So where does this leave us?
To be honest, it leaves us pretty much where you would expect. There are several hundred investors of all sizes that have won and lost fortunes as a result of the bull market. Unfortunately because they were active in a pretty much unregulated market that regulators were vocally uncertain about, those that have seen their fortunes evaporate are likely to struggle to recoup anything that they have lost, even if it is the result of activity that is proven to be fraudulent.
For the rest of us, we have a technology that still needs a little finessing perhaps but has proven itself to be pretty much robust. Only time will tell if it is adopted more widely beyond the community of early adopters and evangelists. Ultimately, we are exactly where we were even before the bear market reared its ugly head: in possession of a technology that has a lot of potential and may or may not develop to become something useful.
The last crypto winter lasted 18 months. It will be fascinating to see when, or even if, the first green shoots of spring start to emerge this time around.
About the author
Kay Rieck has been active on the investment side of the oil and gas sector for more than two decades. Starting his career as a financial adviser and stockbroker on the New York Stock Exchange, he quickly developed an interest in natural resources and associated assets building his expertise with investment banking and asset management roles at the New York Board of Trade and the Chicago Board of Trade. Utilising his exceptional network of global contacts, he started his first exploration and production company in the US in 2008, selecting investments across the Haynesville Shale, Permian basin, Eagle Ford shale, Dimmit county and elsewhere that offered exceptional prospective returns.
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