FORECASTS & TRENDS E-LETTER
by Spencer Wright
April 16, 2024

Decoding Crypto

IN THIS ISSUE:

1. What are Cryptocurrencies?

2. What is the Blockchain?

3. What is a Crypto Wallet?

4. Bitcoins are Mined?

5. Fad, Fortune or Mania? The Dangers and the Rewards

6. Crypto Isn’t Going Anywhere… For Now

What are Cryptocurrencies?

Today’s newsletter is intended to provide a basic understanding of cryptocurrencies; my explanations and examples are by no means exhaustive as this is a complex subject. In the interest of full disclosure, I am what is known as a crypto skeptic, meaning I do not believe that there is long term viability for cryptocurrencies.

 A cryptocurrency is a form of digital asset based on a network that is distributed across many computers, secured by cryptography. These decentralized structures allow cryptocurrencies to exist outside the control of governments and central authorities.

Everyone is familiar with Bitcoin, the progenitor of the crypto space, but do you know how many cryptocurrencies there are? As of 2023 there are over 9,000 of them. That is nearly three times the number of stocks listed on the NASDAQ. However, 90% of the total value in crypto is concentrated in the top 20 names.  Here are the current top ten, of course always subject to change, Bitcoin, Ethereum, Tether, Binance Coin, Cardano, Dogecoin, USD Coin, Polkadot, and Uniswap. In this installment we will focus on the largest cryptocurrency by far, Bitcoin.

Of course, cryptocurrencies can’t function without the blockchain.

What is the Blockchain?

The blockchain is a technology that is central to the functionality of cryptocurrencies. A blockchain is a set of connected “blocks” of information on an online “ledger.” Each block contains a set of transactions that have been independently verified by each validator on a network. The contents of the online ledger must be agreed upon by a network of individual nodes (computers that maintain the ledger). This makes it almost impossible to forge transaction histories. Blockchain is what makes up the crypto portion of cryptocurrency and it is a self-policing, self-regulating system. Consider this infographic.

What you are probably imagining right now is far more sophisticated than the actual blockchain. As revealed in the FTX scandal, the blockchain is a massive spreadsheet that is continuously updated to reflect buying and selling.

What is a Crypto Wallet?

Contrary to what you may think, a crypto wallet is not where your Bitcoin is stored. Instead, the wallet stores two keys: a public key and a private key. The public key is somewhat analogous to a bank account number and the private key to the PIN. Wallets use 256-bit encryption, generating very long strings of random characters. Wallets can be either software wallets or hardware wallets. A software wallet is stored online while a hardware wallet is stored offline on a discrete device like a flash drive. Hardware wallets are considered more secure but require very careful handling. If you misplace the storage device or it becomes corrupted somehow, you are in trouble. You can check out some crypto wallet horror stories here: Crypto horrors: Tales of lost Bitcoin wallets.

Bitcoins Are Mined?

You may have heard that Bitcoins are “mined” and that there are very elaborate, very large operations that specialize in Bitcoin mining. Again, like many aspects of the cryptocurrency world, this is not, at all, what it sounds like.

Start by considering the following infographic:

As you can see it is quite a process. The mining occurs on high powered computers that are programmed to complete very complex mathematical operations. The answers generated actually create the data that comprise the blockchain. As the blockchain grows larger, it takes exponentially longer to complete the operations and add data to it.

It can take professional mining operations several days to complete a block and secure one bitcoin award. This is an extremely expensive enterprise, requiring rows of the most up-to-date hardware and massive loads of power. Individuals participating in crypto mining are usually relegated to mining pools which can take a very long time to yield only a fractional Bitcoin to the participant.

An important update to the above is the current award is not 25 Bitcoins, but  only 6.25, and that may be cut in half again this year.

Fad, Fortune or Mania? The Dangers and the Rewards

This needs to be said: Bitcoin is not a currency. Period. Yes, you can spend Bitcoins at Starbucks and a few other places. But I know Bitcoin isn’t a currency because the Federal Reserve says so, as does every sovereign central bank on the planet with the exception of El Salvador.

Investment fads come and go. (Beanie Babies anyone?) But is Bitcoin a fad investment? Not entirely. Bitcoin is a tradeable security with no need for the individual investor to fiddle with crypto exchanges or wallets or mining or any of the many barriers to entry for most. All of this is thanks to the SEC, which has recently approved spot Bitcoin ETFs for trading.

Spot Bitcoin ETFs hold large amounts of Bitcoin directly. Like a spot gold ETF which holds physical gold bullion on behalf of its shareholders, retail investors can participate in Bitcoin through the purchase of the ETF. The value of the ETF rises and falls with the value of Bitcoin. Easy.

So easy in fact that tens of billions of dollars have already flooded into these spot ETFs. And just this week spot Bitcoin ETFs have been cleared to trade on the Hong Kong exchange. This opens the door to billions more in assets that will be placed in Bitcoin ETFs.

It is undeniable that a Bitcoin investor could have done very well. Consider this chart:

This chart shows the percentage gain of Bitcoin vs. the S&P 500 over the past 10 years. Stunning, isn’t it? Equally stunning are the incredible drawdowns (losing periods) that Bitcoin is prone to. Bitcoin is extremely volatile. And despite the implicit head nod from the SEC, it remains a type of black box investment. Still, the result is beyond impressive.

For good or ill, many retail investors, advisors and turn-key platforms will be allocating funds to these spot ETFs in the future.

But is Bitcoin a mania? Not in the truest sense. In general retail Bitcoin investors spent what they could afford, that is they didn’t borrow money to buy Bitcoin. Many Bitcoin investors took the time to do their research and had at least some understanding of how the realm of crypto worked.

And you didn’t have to be wealthy to participate in cryptocurrencies. A true mania is when the wealthy borrow to participate in a market they don’t understand. The Dutch Tulip Mania of 1634 remains the gold standard of manias to this day.

Crypto Isn’t Going Anywhere… For Now

Cryptocurrencies have definitely attracted a fanatic following. With the advent of spot Bitcoin ETFs, crypto investing is estimated to exceed $1.7 trillion. Considering astronomical numbers like that, digital assets aren’t going anywhere. Keep in mind that along with the potential for great gains come substantial volatility and speculative risks. These risks include regulatory changes, market manipulation, bugs in the software, theft and loss by a crypto exchange.

I already mentioned that I am a crypto skeptic. It turns out JP Morgan Chief  Jamie Dimon is an even bigger crypto skeptic than I am. Finally, Warren Buffett considers cryptocurrencies “rat poison” and warns, “I can say with almost certainty that they will come to a bad ending.” Of course, time will tell.

If you have an interest in educating yourself more about cryptocurrency and the FTX scandal in particular, I highly recommend the book Number Go Up by Zeke Faux.

Thanks for reading,

 

 

Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc., a Registered Investment Adviser under the Investment Advisers Act of 1940. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of the named author and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific advice. Readers are urged to check with their financial counselors before making any decisions. This does not constitute an offer of sale of any securities. Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have their own money in markets or programs mentioned herein. Past results are not necessarily indicative of future results. All investments have a risk of loss. Be sure to read all offering materials and disclosures before making a decision to invest. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.