Your Quarterly E-Zine
Edition 11 • December 2019

This website contains the latest edition of Forsyth Barr Focus, a quarterly on-line magazine written by senior members of Forsyth Barr's investment team.

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THE KRYPTOS CODE

The Greek word “kryptos” describes things which are hidden, concealed or secret. As the etymological root of the word cryptocurrency, kryptos can evoke equal amounts of suspicion (from global authorities looking to expose illegal transactions undertaken on the so-called “dark-web”), or praise (from those seeking to disintermediate and democratise the world of finance entirely).

For investors, the allure of cryptocurrencies has been fuelled by the stratospheric rise in the value of electronic-exchange-tokens such as Bitcoin in recent years, although the equally prominent slide in cryptocurrency values in recent times has left many wondering if the promise of a “new world of money”, is in fact just another financial mania.

As cryptocurrencies are not regulated (and are not overseen) by any country or authority, their use escapes legal scrutiny and offers no legal safeguards. Recently, New Zealand has experienced its cryptocurrency crisis, with Christchurch-based digital currency exchange “Cryptopia” experiencing “a security breach which resulted in significant losses", estimated by the media to be worth tens of millions of dollars.

Cryptocurrencies use cryptography (or complex algorithmic codes) to facilitate secure transactions between different parties, instantly, anywhere in the world. Transactions are undertaken using a new technology called “block-chain”, which permanently records a single transaction across many different computers, meaning that the record of the deal is unable to be altered, once completed.

For this article, we’ll use Bitcoin as a cryptocurrency example. (There are many other look-a-like cryptocurrencies to Bitcoin such as Ethereum, Ripple, Stellar Lumens, EOS, Litecoin and Cardano, but they all essentially function similarly).

There are three generic ways that someone can participate in the world of Bitcoin: as a “miner”; as an “investor”; or, as a “user” (or consumer). You can find (or “mine”) new bitcoins by becoming part of the global computer network which validates transactions submitted through the block-chain, or you can trade (buy and sell) existing Bitcoin (as a speculator or investor), or you can use Bitcoin to transact (buy and sell) products and services online. Let’s look at each of these opportunities in turn.

A Bitcoin is created electronically as a reward when someone (known as a “miner”) uses their computing power to assist in the completion (verification) of a transaction. For Bitcoin miners, the challenge today is that the computational calculations to generate new bitcoin have become so complex, the cost of powering standard computers exceeds the potential value of the bitcoin reward. Specialist companies now provide most Bitcoin computing power, so the opportunities for amateur miners to find new bitcoin are limited (and are most likely unprofitable).

Of course, the aspect of Bitcoin which has received most publicity has been its remarkable rise (and subsequent slide) in value. The value of a single bitcoin, (the supply of which is capped at 21 million), increased from around NZ$500 four years ago, to as much as NZ$28,000 in 2017, before plummeting in value to around NZ$5,000 late last year.

Those who inherently believe that Bitcoin (and other cryptocurrencies) represent the future of money and financial transactions, may consider buying bitcoin as an investment with future growth potential. (Equally, many have speculated on its short-term increase in value in an attempt to achieve windfall gains). On the flip-side, unlike real money (notes and coins), Bitcoin has no intrinsic value (i.e. it is not backed by anything of tangible value).

Simply put, as a non-fiat currency, there is nothing to prevent the value of a bitcoin from falling to zero. Whereas physical cash is the liability of a government, (with a Central Bank, like the Reserve Bank of New Zealand controlling its value), Bitcoin is a liability of nobody.

Finally, you can use bitcoin to transact online (for example, gift cards, travel, software, music, some professional services), but it is not universally usable in any transactional setting. Where on-line transactions are undertaken in Bitcoin, the value of a single bitcoin is derived from the number of bitcoins in circulation and the demand for them, at that moment in time. Some Bitcoin users see an advantage in cutting-out the costs of the middle-men who collect fees for processing transactions through the traditional banking system, while the anonymity which accompanies Bitcoin transactions more attracts others.

For most, the security offered by the fiat currencies of the traditional banking system against fraud, theft or loss, probably provides greater peace of mind compared to the risks associated with cryptocurrencies. In the case of “Cryptopia”, it’s still uncertain as to what has happened to the rumoured NZ$5 million of “ether” (the second most popular cryptocurrency globally) which is reported to be missing. It appears to have just disappeared into thin air, rather like the mythological substance breathed by deities after which it is named.

Overall, it seems that the unregulated and unorthodox way in which crypto-currencies function, which creates the most fear for interested but unconvinced users. Alert to the threat of hackers, Gerald Cotton the founder of Canadian crypto-currency exchange “QuadrigaCX”, took security so seriously that he kept users’ electronic accounts (totalling around C$190 million) off-line on his encrypted laptop. Unfortunately Cotton recently died, and he was the only one who had the password. Despite frantic searching, his widow has been unable to find it. A somewhat unexpected twist to the old truism that, “you can’t take it with you”.

Gordon Noble-Campbell
Director, Private Client Services

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