Tag Archives: Risks
You know we are at the top of the hype cycle on blockchain and cryptocurrencies when examples of peak crypto include glistening fleets of Lamborghinis as a reflection of price spikes and talk of crypto-utopia with no central governments. Nonetheless, there are a number of key risks that plague this asset class and stand in the way of broader market adoption and stability. While there is no doubt cryptocurrencies, digital tokens and blockchain-based business models are here to stay, understanding how risk interplays with this emerging market and their underlying technologies will not only help protect investors, it will also give regulators a steady hand and, hopefully, guide how entrepreneurs are approaching risk management in their projects, which is not easily done after the fact. One unique facet that blockchain-based projects bring to the market is that unlike the analog economy, which hopes to code good conduct in people who have the care, custody and control of our savings and assets, is that “good conduct” can be coded at the technology layer and in an unalterable and transparent manner. In short, a machine is not naturally greedy or prone to moral hazard (risk taking without bearing the consequences).
What follows are 10 examples of key risks that imperil cryptocurrencies and stand in the way of market progress.
Wide Entrance, Narrow Exit – It is true that the advent of bitcoin and its ilk of cryptocurrencies, of which there are more than 1,600 and counting that have been digitally minted, has democratized many aspects of finance. This lowered barrier to entry creates a wide entrance and a very narrow exit, which as is prone to happen in the real world during Black Friday shopping frenzies for example, can lead to collateral damage as people rush to get out. The exit can be barred due to technological constraints, currency inconvertibility and few counterparties with whom to trade. While the asset class is generally uncorrelated to the traditional economy, it is all correlated to itself, which can create market panics and runs.
Intangible, Illiquid, Uninsured – The true miracle of blockchain-based cryptocurrencies, such as bitcoin, is that the issue of double counting is resolved without any intermediary, such as a bank or banker. This feature captured by the notion of digital singularity, where there can only be one instance of an asset is powerful and one of the primary reasons this asset class has blossomed. However, the intangible and illiquid nature of cryptocurrencies (combined with the point above about narrow exits) hampers their convertibility and insurability. Indeed, despite reports of growing insurer interest in the segment, the majority of crypto-assets and crypto companies are either under-insured or uninsurable by today’s standards. There is no deposit insurance “floor” for this asset class, which can help broaden appeal and investor security.
Mark To Market – As crypto holders seek to exit the intangible asset class returning to fiat currencies or other assets, which are often loathed by many crypto purists, their flight to safety or liquidity most often takes them to the greenback or U.S. While the price pegs work well on the way in to cryptocurrencies as investors informed by their “animal spirits” who want in on a speculative wave have a willingness to pay at a stated value or peg. On the way out, however, this mark to market feature sees many investors subjected to downward price pressure, which highlights the adverse effects of illiquidity, narrow exits and narrow participation in the asset class. These types of issues are being remedied as more institutional investors enter the space and more markets and trading platforms open. In the meantime, market participants would be wise in minding currency inconvertibility and the implied volatility of cryptocurrencies, which would make high-frequency traders flinch. To truly understanding blockchain’s potential requires the suspension of disbelief. To truly capture the investment thesis of cryptocurrencies requires the suspension of the traditional economy yardstick.
From Extortion To Manipulation – While no investor should part ways with money they are not prepared to lose, no matter how nominal the amount, cryptocurrencies are particularly prone to social engineering and misinformation risks. The naïve, as with the analog economy, can become easy prey to cyber extortion, market manipulation, fraud and other investor risks. The U.S. Securities and Exchange Commission, SEC, has gone as far as creating a fake initial coin offering (ICO) website as a way of alerting would-be crypto investors to “shinny object” threats. Indeed, emerging regulatory clarity on what constitutes a truly decentralized asset, such as bitcoin or ethereum, which is beyond the control of any one party, versus company-issued cryptocurrencies or tokens is a growing area of securities attention.
Care, Custody And Control – Despite the intangible and unseen nature of cryptocurrencies and digital assets more generally, one of the single biggest issues plaguing the market is care, custody and control. Not unlike the perennial challenges of cyber and physical security of the traditional banking sector, there is a veritable standards war taking place among crypto custodians on who is providing the highest standards of investor protection and asset security. The number of high profile and high value crypto heists suggests that this playbook of best security practices is still being written. The wealthiest crypto investors are going to great lengths to protect their intangible hoard by using cold storage devices placed in physical (offline / airtight) vaults and bunkers. Not every crypto investor can afford this level of security no more than every crypto investor is a target, but all are subject to the emerging nature of care, custody and control standards. Here too, the absence of a basic “floor” in terms of security and capital guarantees, like a cyber Federal Deposit Insurance Corporate, FDIC, means that investors are exposed on a first-loss basis.
Cyber Risks On All Sides – As is true with cyber threats, which evolve according to Moore’s law, the space between the keyboard and the chair (or the smart phone and the digital wallet) is as important as the cyber hygiene and defenses of the crypto custodian. While in principle the bitcoin blockchain has proven to be among the most cyber resilient innovations thus far, the firms that plug into it, like other cryptocurrencies, are often new entrants with lax cybersecurity standards and wherewithal. By this measure, not all cryptocurrencies are created equal in term of their traceability, transaction ledgering and levels of trust or fiduciary responsibility. For this, risks as simple as “mysterious disappearance” and as complex as ransomware attacks and AI-powered bots scouring the Internet for weak links and easy prey are complex and fast-moving perils.
Human Error (And Forgetfulness) – Given the intangible nature of the asset class, human error and something as confounding as password amnesia can spell total loss of a crypto fortune. Not everyone is as lucky as 50 Cent, who forgot he accepted bitcoin for an album release and discovered an $ 8 million bitcoin bounty. The prospect of being locked out, losing hardware or facing “geophysical risks,” such as spilled coffee is often enough to create losses – not to mention the ever present risk of buyer’s remorse given cryptocurrency price volatility. At the crypto whale end of the market, the high-profile nature and public quality of large asset holders may expose people to direct physical security threats, such as kidnaping, ransom and extortion. A fleet of lambos will not add to the needed discretion of not becoming a potential target.
(Un)Safe Havens – Another key risk with cryptocurrencies and this asset class more generally is the lack of coordination and clarity on regulatory, financial, tax and legal treatment. This is unsurprising given the relatively new nature of this market and the often slow moving and lagging quality of “regulatory catch up.” Indeed, most regulators around the world did not begin to form an opinion about cryptocurrencies until their rise to prominence with bitcoin’s meteoric appreciation in 2017. Suddenly, countries and jurisdictions around the world have entered a crypto land grab by seeking to become destinations of choice for prospective investors and projects. Like the global financial system, coordination and coherence can go a long way in eschewing risks of the systemic and mundane variety while improving overall market stability.
Technological Risks – There have been many reports about the computational complexity and energy consumption of bitcoin mining, as one example of some of the technological limitations of cryptocurrencies. This computational complexity may also work in the inverse and pose potential risks to the asset class under the premise that complex systems fail in complex ways. It is true that the decentralized feature of true blockchain structures gives then an inherent disaster and risk-proofing that is not enjoyed by centralized databases (which are veritable honey pots as evidenced by Equifax’s massive breach). Yet not all cryptocurrencies or tokens are riding on similar rails. For this, investors should beware of the technological risks and false promises of decentralization that are being made in many projects, for not all blockchains are created equal.
Civil Wars With Forks – Last, but certainly not least, while much crypto wealth is concentrated in the hands of people who are thinking long term about the positive change this asset class can have on the world, there is nevertheless the constant specter of civil wars and forks, which can bifurcate the consensus on cryptocurrencies, thus eroding market share, valuation and adoption. This standards war continues to flare up, including most recently with the advent of Bitcoin Cash. It is also notable that despite the talk amongst crypto-utopians of a world ruled by blind scalable trust and no centralized authorities, that councils of large crypto holders, much like a papal conclave or the Bank for International Settlements (BIS), can set a course on the market influencing outcomes and price fluctuations. As with the real movement of whales, smaller fry can either get gobbled up or caught in the wake.
Precisely because there are risks in the cryptocurrency market there are rewards. Countless new entrants, from large traditional enterprises who have awoken to blockchain’s promise, or startup teams bent on creating a new democratized future challenging status quo, all realize that a new technology driven wave of value creation is upon us. Understanding the potential perils of diving into this wave can help improve the long-term prospects of cryptocurrencies and broaden their adoption beyond risk-seeking first movers.
LONDON (Reuters) – Dozens of stallholders, pitching anything from a happy retirement to commercial property to the future of electronics, set up shop in central London last weekend to pitch their wares.
The companies and their salesmen were not there to part ways with the actual product, however. They just wanted to encourage buying into the digital coin craze that is raising billions of dollars.
At what organizers claimed to be Britain’s first large-scale “Crypto Investor Show”, attendees were looking to get in on the next initial coin offering (ICO).
The talk of Silicon Valley, ICOs are a mostly unregulated funding mechanism for start-ups to raise capital by creating and then issuing their own virtual coins or tokens. Last year, they raised a record sum as interest in cryptocurrencies like bitcoin surged.
“I came here to learn about ICOs. You have to do your research, but I would invest, it’s the upcoming thing,” said 30-year-old Shahzad Anwar, who installs electric charging points and had traveled down from the central England town of Solihull with his brother to attend.
“To me, stocks and shares and bonds are over, they are done,” he said, as attendees listened to a pitch at a nearby stall for an ICO wanting to raise tens of millions of dollars to build and race a supercar. Another promised to build a network of rest homes for the elderly.
Regulators say ICOs are highly speculative and investors should be prepared to lose everything. Unlike stocks, most ICOs do not confer ownership rights in the underlying business, just the possibility that the tokens will be worth more in future.
Supporters say ICOs are revolutionizing the capital-raising industry, a crowdfunding alternative that gives ordinary people the chance to invest in start-ups, normally the preserve of the venture capitalist elite.
From circulating on tiny online chatrooms a few years ago, cryptocurrencies and ICOs have moved to the mainstream, with public advertising common.
Some companies have pushed back, however. Facebook said it would ban all crypto adverts because of the risks to investors. Twitter said it was taking measures to prevent cryptocurrency-related accounts from running scams on its platform.
London regularly hosts conferences on blockchain, the technology underpinning cryptocurrencies, where tech wizards exchange ideas, but the London show was geared towards the general public as well as experts.
The crowds arrived, some families for a day out, touring the stalls and listening to panelists. As well as marketing, there were sessions that discussed the risks.
Several attendees who worked in the industry said they were disappointed with the ICOs on offer, with staff hired for the day to hand out flyers and with little understanding of blockchain technology, or if it was even relevant to their idea.
“Don’t fall for some of the marketing out there … [You have to ask] is it actually solving a problem or is it just making one up?” said Linda Leaney at Globcoin, which claims to be a stable cryptocurrency backed by global currencies and gold.
One Leeds-based company, offering a token backed by commercial property, crypto trading and the founder’s online discount shopping platform, said it had raised $ 4 million in seed investment, and was targeting $ 10 million, with bonus tokens and referral awards for attendees that emailed their details.
Nearby, one programmer and salesman after another took to a small stage to explain their business. No company promised anyone a specific financial return, and aside from the price of each token and early-bird discounts, they stuck to talking up their product.
Sam Smit, a 34-year-old electronics engineer from Horsham in southern England, is a self-styled “dirty flipper” – someone who buys a token at the pre-ICO stage before token sales are opened to the general public, then sells them when they begin trading on an exchange.
“Have you seen `Wolf of Wall Street’? This is the same, pump and dump!” he said, referring to the 2013 film about the stock broker and convicted fraudster Jordan Belfort.
“People here are illiterate idiots. Often after the pre-ICO stage, it’s already too late to buy,” he said – while admitting that he had lost around $ 400,000 in January when cryptocurrency prices slumped.
Editing by Sujata Rao, Larry King
The most powerful threat to greatness isn’t evil. It’s mediocrity.
Of all the colorful ways to articulate that truth, one of the best is what Elon Musk told Chris Anderson of Wired magazine, back in 2012.
They were talking about Musk’s space exploration company, SpaceX, which grew out of Musk’s “crazy idea to spur the national will” to travel to Mars–by first sending a private rocket to the red planet.
He tried to to slash the cost of his quixotic dream by buying Cold War Russian missiles to turn into interplanetary rockets. While negotiating that deal, he realized that it wasn’t lack of “national will” that held the U.S. back from exploring space.
Instead, it was a lack of affordable technology–and the high cost, he told Anderson, was the result of some “pretty silly things” in the aerospace industry, like using legacy rocket technology from the 1960s.
Anderson: I’ve heard that the attitude is essentially that you can’t fly a component that hasn’t already flown.
Musk: Right, which is obviously a catch-22, right? There should be a Groucho Marx joke about that. So, yeah, there’s a tremendous bias against taking risks. Everyone is trying to optimize their ass-covering.
That’s the quote that I liked so much, especially those last six words: a “bias against risk,” because everyone is “trying to optimize their ass-covering.”
It’s funny–but also poignant. And, of course, it applies to a lot more than space exploration.
It applies to the vast majority of successful companies that get stuck producing legacy products–because they can’t risk that innovation might upset their own profit models.
It applies to the service providers that make a mockery of the word “service” (say for example, big airlines and utility companies)–because cost-cutting with crappy service maximizes shareholder value.
It applies also to temptations in our personal lives, and in the lives of those around us.
Think of the colleagues you know who hold onto uninspiring jobs for fear of going after the careers or entrepreneurial dreams they really want.
Or think of the friend you might have (I think most of us do), who stays in a lousy relationship because he or she is more afraid of being alone than of living with less than they deserve.
We’re all a little bit afraid of risk. Yet, each day represents a new chance and a new beginning. At the start of the year, that sense is especially acute.
And sometimes we need a little inspiration to take the leap.
Whatever is the thing you’re afraid of trying–a new business, a new adventure, a new relationship–maybe now is the time to give it a try.
Cast aside your risk aversion. Be uncomfortable for a while as you try something new. Accept the chance that you’ll fail.
Don’t optimize your ass-covering. Instead, optimize your opportunities. And find your own mission to Mars.
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