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The State of Digital Currency Investing

The State of Digital Currency Investing

Digital currency exploded into the public consciousness in 2017, thanks in part to the extraordinary investment returns offered by coins and tokens such as Bitcoin and Ether.

While investor fervor eventually cooled as the market retreated from its stratospheric heights, the state of the digital currency market remains decidedly optimistic. With enterprise adoption of tokenized blockchains increasing -- and institutional investors poised to enter the space in force -- the conditions for sustained growth are ripe.

To help investors better understand the nature of this opportunity, this paper will explore:

By illuminating these issues, we hope this paper will give investors a basic knowledge framework to begin evaluating the opportunities offered by this innovative and exciting new asset class.

The Birth of Digital Currency

The story of modern digital currency begins with one of the more enigmatic figures in recent times: Satoshi Nakamoto, inventor of Bitcoin. Nakamoto's identity has never been revealed; in fact, the name "Satoshi Nakamoto" is simply a pseudonym used by the creator (or creators) of Bitcoin.

Though the idea of digital currency had existed before the creation of Bitcoin, early attempts to create a cryptographically secure and commercially popular digital currency failed. Companies such as Digicash and Cybercash sought to integrate digital currency into the existing financial system by partnering with banks and using technology that would link consumer identification with strong cryptographic protection.

Bitcoin took a radically different approach to digital currency, one that was decentralized and pegged to a transformational new technology called blockchain. This technology can be visualized as an ever-expanding list of records (or blocks) that are linked (or chained) together and secured by powerful cryptography. These blocks contain transaction data -- one person sending Bitcoin to another, the amount of Bitcoin sent, the time sent etc. This data is immutable (meaning it cannot be altered) and is publicly viewable by anyone.

The technological foundation of blockchain allowed Nakamoto to create a secure method for recording Bitcoin transactions. Rather than relying on third parties (such as a bank) to validate a Bitcoin transaction, network participants achieve consensus on the validity of transactions via a process called mining. After a Bitcoin transaction is initiated, miners compete to validate transactions by using computing power to work out complex equations, and receive new (or mined) cryptocurrency as a reward.

Along with acting as a decentralized currency, Bitcoin also derives value from scarcity. Unlike government-issued (or fiat) currency, the total number of Bitcoins is capped at 21 million. As the years go on, the difficulty of mining Bitcoin increases, meaning Bitcoin will still be mined well into the next century.

Though the invention of Bitcoin was little noticed (except among cryptographers) at first, it soon captured the public's attention. Worth only fractions of a cent when created in 2009, the value of a single Bitcoin increased to $1,127 by 2013. Then, after an explosion of interest in 2017, Bitcoin saw another exponential rise in value, topping out at nearly $20,000 per coin.

Yet the creation of Bitcoin, revolutionary as it was, represented only the first step toward the use of blockchain as a global business solution, and cryptocurrency as a major asset class.

The Development of Altcoins and the Emergence of Cryptocurrency as an Asset Class

Though Satoshi Nakamoto abruptly dropped off the public radar in 2010 (leaving behind an untouched wallet of roughly one million Bitcoins), blockchain and cryptocurrency development continued at a rapid pace.

The first wave of altcoins (or alternative, non-Bitcoin coins) included many projects that were similar to Bitcoin from a technological standpoint. Litecoin, a popular altcoin created in 2011, proposed to increase speed through faster block generation times but was otherwise nearly identical to Bitcoin.

Soon, however, new approaches were applied to the idea of cryptocurrency. Ripple, a real-time financial settlement, remittance and currency exchange system released its digital asset (XRP) in 2012. Ripple, which focused on adoption by the financial services sector, aimed to use its XRP token to help these institutions move and settle funds faster than would normally be possible.

Though Bitcoin is often criticized for enabling people to move assets anonymously, the opposite is true: All Bitcoin transactions are immutable and publicly viewable. In 2012, developers created a new, privacy-focused approach to cryptocurrency transactions called CryptoNote. Monero, today's most popular privacy-focused altcoin, is derived from this approach.

Perhaps the most significant leap forward in altcoin development came with the creation of Ethereum. First proposed by programmer Vitalik Buterin in 2013, Ether, a blockchain-based cryptocurrency on the Ethereum blockchain, was the result of Buterin's desire to modify Bitcoin by adding the possibility of application development through a more expansive scripting language.

This innovation allowed Ethereum to introduce "smart contracts," which are self-executing contracts that enable the exchange of money, property or almost any asset without the help of an intermediary. Whereas Bitcoin could only enable the transfer of currency, a smart contract allowed almost anything of value to be exchanged.

Smart contracts also served as a bridge of sorts between conventional applications and blockchain. Now, developers could create decentralized applications (or dapps) on top of the Ethereum network through the use of smart contracts. The first popular example was "CryptoKitties," an Ethereum-based game that allowed users to collect digital kittens.

With this development, the idea of a blockchain-based decentralized Internet -- powered by the spending of digital coins and tokens -- began to form. These events were soon to be followed by the emergence of cryptocurrency as a modern asset class -- and one of the greatest bull runs in history.

The First Wave of Adoption

While digital currency and blockchain technology continued to grow at a frenetic pace, investment opportunities in the early years were somewhat limited. In the beginning, no market infrastructure existed to accommodate investors. Most people had to either mine Bitcoin or engage in risky peer-to-peer purchases.

Things began to change with the emergence of the first large-scale digital currency exchanges. However, early exchanges were plagued with security and performance issues. Most were undercapitalized or operated by people from within the early digital currency community.

By 2012 and 2013, however, exchanges began to professionalize, as well-funded companies with expertise in digital assets entered the space. By 2017, the process of buying and selling digital currency had become much more secure and user friendly.

Greater access to digital assets coincided with a significant spike in consumer interest. Bitcoin and Ether, which were valued at around $1,000 and $10 respectively in January, 2017, began to surge in value. Within one year, they had increased to nearly $20,000 and $1,400 -- staggering (albeit unsustainable) returns that were reflective of the excitement surrounding this new asset class.

Bitcoin and Ether were hardly alone in experiencing extraordinary growth. The market cap for crypto as a whole grew by an astonishing 5,000-percent in 2017. Along with public awareness and enthusiasm, this growth was partially fueled by two things of which early Bitcoin hobbyists could have only dreamed: The prospect of institutional money, and looming enterprise adoption of tokenized blockchains.

Current Market Opportunities and Developments

Though Bitcoin was being used as currency almost immediately following its release, few outside of the digital currency community believed it would one day become a massive global interest. In fact, few in the community could envision a day when a single Bitcoin was valued at $1 -- let alone $20,000 .

That view began to change, however, as Bitcoin use began to grow and early adopters sensed the transformational potential offered by digital currency. The value of Bitcoin began its journey along a parabolic growth curve, as retail investors began entering the market in large numbers. By 2017, these retail investors sparked one of the most memorable bull runs in investment history.

Institutional investors, however, remained on the sidelines -- for a multitude of reasons. First, there was natural skepticism toward the viability of digital currency and blockchain. Though blockchain and digital currency were often touted and billed as world-changing technological advances, both also remained in the very earliest stages of development. As with any new and ambitious technology, hiccups occurred and progress unfolded in fits and starts.

While retail investment was surging, many in traditional finance remained unconvinced. Jamie Dimon, CEO of J.P. Morgan Chase, famously said he "didn't care" about Bitcoin and urged everyone to "beware" -- a sentiment that was not uncommon among financial services leaders at the time.

Some institutional investors also perceived decentralized currency as a potential threat to the existing financial order -- though that threat has been mitigated to some degree by the fact that so many digital currency projects are now working with or attempting to serve the financial services sector. Finally, the financial sector is highly regulated, and government regulation moves at a something of a glacial pace.

Despite these factors, many of those who once expressed skepticism toward digital currencies have since changed their tune -- including Dimon, whose J.P. Morgan Chase recently implemented a new digital currency strategy.

Dimon's firm isn't alone. Goldman Sachs is exploring crypto derivatives and has begun investing in digital currency startups. BlackRock, the world's largest asset management firm, is exploring digital currencies and blockchain. These are just two of the many examples of the world's largest banks, hedge funds and other financial firms dipping their toes in the crypto market.

Regulatory clarity is also looming. In early 2018, the first Bitcoin futures markets were approved, allowing institutional investors to enter the market and allowing digital currencies to take a giant step toward becoming a mainstream financial asset. The next step is the pending approval of the first Bitcoin ETF. Should this meet with U.S. Securities and Exchange Commission approval, institutional investors will have even more access to digital currency markets.

These developments could facilitate the mass entry of institutional money into the digital currency market. Given the development of secure and professional cryptocurrency industry exchanges such as Bitvo, the financial infrastructure is already in place to support the next wave of exponential growth.

Benefits for investors

Investing in an emerging asset class isn't as easy as simply choosing an index fund or buying a favorite tech stock. The digital currency market is more volatile, and not quite as user-friendly, as the equities markets. Yet those are also two of the reasons why the potential benefits are much greater.

Much has been made of the recent performance of FANG (Facebook, Amazon, Netflix, Google) tech stocks. Amazon, for example, gained 56-percent in 2017 -- a remarkable return for stock market investors. Ether, however, gained 14,000-percent over roughly the same time period. Ether was hardly alone; hundreds of cryptocurrencies experienced exponential value gains as investors moved into the space for the first time.

Investors (some of whom earned $1 million returns on $1,000 investments ) reaped the benefit of being ahead of the curve. Non-Bitcoin digital currencies remained obscure to the general public, and were often difficult to trade, as exchange options were limited. These conditions -- and the bleeding edge nature of the technology -- created extraordinary volatility and price appreciation.

What happened next is a familiar tale: Parabolic growth reversed, and values declined. Astronomical growth on that level is generally not sustainable. Yet this reversal presents still another opportunity for investors. While Bitcoin and other digital currencies may have receded slightly from the public's imagination, the technology continues to mature at a rapid pace.

The first wave of enterprise adoption of tokenized blockchains is underway -- global corporations such as BMW, Volkswagen and Bosch have partnered with digital currency projects such as IOTA and VeChain to integrate their tokens into blockchain-optimized solutions. Digital currency will be used to reduce fraud in supply chains and enable machine-to-machine micropayments (imagine a driverless car refueling and paying for it with IoT-enabled digital currency).

Ripple is partnering with banks and remittance providers to lower costs and reduce settlement times. Another popular digital currency project, Stellar, has forged a strategic partnership with IBM to transform how cross-border payments are made and facilitate enterprise adoption of blockchain.

Enterprise adoption is unfolding in parallel with institutional investment and adoption. Both now are in the early stages. Yet it's not hard to envision a time in the near-term future when digital currencies and blockchains are an indispensable global business tool; a time when investment banks and hedge funds are major players in the digital currency investment markets and a time when decentralized applications have become refined enough to offer a viable alternative to the Internet.

Most digital currency investors (let alone average people) are still unfamiliar with this narrative -- and that creates enormous potential for early adopters and investors. As remarkable as the 2017 bull market may have been, it occurred largely through media-fueled retail investment. The next bull run will likely be fueled through enterprise adoption and institutional investment -- making the potential returns for today's investors even greater.

Key Considerations

The case for digital currency investment is a strong one, built on a foundation of deeply innovative technology, looming enterprise adoption and institutional investment. Yet no investment comes without concerns, and investors should do their due diligence before proceeding.

As witnessed by historical price data. the digital currency market is highly volatile. This is natural for an emerging asset class based on bleeding-edge technology, yet it still needs to be considered. Though Bitcoin reached nearly $20,000 in 2017, it fell to roughly $5,800 in early 2018. Today, it has rebounded to around $8,000 -- still an 800-percent return from January, 2017.

Altcoins with smaller market caps are typically far more volatile than Bitcoin and Ether -- it's not unusual to see swings of 20-percent in value in a single 24 hour period. Investors should proceed with caution and understand the volatility inherent to the space.

Investors should also understand that digital currencies are both an emerging asset class and an early-stage technology. Some of the historical issues associated with digital currencies and blockchains (their ability to scale, for example) remain untested or unsolved. Although developers are working daily to navigate these challenges, there is no certainty as to when they will be solved.

Also, because the asset class is so new, digital currency investing has wrinkles not seen in equities markets. The value of altcoins, for example, is closely correlated with Bitcoin. Until Bitcoin value decouples from the value of altcoins, the movement of all coins and tokens will remain somewhat synchronized.

Valuing digital currencies is often more difficult than valuing stocks, as many of them are either decentralized, developer-led community projects or startups that provide limited information to investors. Evaluating fundamentals is more difficult, and as such, the market tends to be more easily influenced by news events, rumor or even outright manipulation.

While all of these considerations are to be expected in a lightly regulated developing market, all investors should take note. As digital currencies mature, we can expect more regulation, lower volatility and more transparency.

In short, with the possibility of great reward comes risk, so investors should take the appropriate steps to mitigate downside exposure. Trading through trusted exchanges such as Canadian based Bitvo helps mitigate some of these challenges including greater security and transparency, a same day guarantee on account registration, funding and withdrawal transactions in addition to 24/7 customer support.

In Conclusion

In less than a decade of existence, digital currencies have taken the world by storm, culminating in one of history's greatest bull markets in 2017. Yet we still remain in the very earliest stages of blockchain and digital currency development.

As the technology continues to mature (and enterprise adoption and institutional investment grow) digital currency markets are poised to experience sustained and possibly exponential growth.

For today's investors, this creates a rare opportunity to become an early investor in paradigm-shifting technology.


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