New Kids on the Blockchain

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It is hard to predict when bubbles will pop, especially when they are nested within each other. It helps to keep this image in mind when considering one of the biggest surges in asset values of recent years: The market value of all the world’s crypto-currencies has trebled since the beginning of the year, and is now worth more than $60 billion.

Attendees visit the Bitcoin stand, January 6, 2015, at the Consumer Electronics Show in Las Vegas, Nevada.

Bitcoin is the best known of these currencies, especially after this week, when hackers instructed victims to pay ransoms in the anonymous digital cash in order to get their computer files decrypted. Not that many bitcoins exist: There are about 16.3 million of them, with only 1,800 new ones “minted” every day. However, growing demand has pushed bitcoin’s price to a record recent high of about $1,830, up from $450 a year ago.

Problems abide. Earlier this year some of the biggest exchanges, such as Bitfinex, experienced problems with their correspondent banks and were unable to pay out real-world currencies to account-holders. To get their money out, they had to buy bitcoin and exchange them elsewhere.

The market is becoming more mature, however. Institutional investors, from family offices to hedge funds, have become more comfortable with crypto-currencies, said Mike Komaransky of Cumberland Mining, which arranges over-the-counter trades. Other factors driving demand include fluctuations of China’s yuan, the French elections and, in a small way, the ransomware attack: When this story went to press, only about $80,000 had been sent to the bitcoin accounts held by the hackers.

Counter-intuitively, bitcoin’s biggest weakness—the system’s limited capacity—also has increased demand for crypto-currencies. Its developers have argued for years about how to expand the system, which can handle only seven transactions per second, compared with thousands on conventional payment services.

Even before worries surfaced that the currency could split in two over the disagreement, bitcoin holders had started to diversify into some of the many other crypto-currencies, or “alt.coins,” to emerge in recent years. Coinmarketcap.com, a website, lists more than 800, from Arcticcoin, an obscure Russian currency, to Zcoin, which boasts added privacy. The latest beneficiary is Ripple, which saw its market value explode from $2 billion early this month to more than $13 billion. Ethereum, which issues “ether,” has jumped from $700 million in January to $8.6 billion in May.

Ethereum’s surge in turn helped inflate another bubble. Feeling richer, holders of ether started investing in what have come to be called initial coin offerings. Startups sell “tokens,” sub-currencies of sorts, which exist on top of Ethereum. A total of 38 such I.C.O.s already have been launched this year, raising more than $150 million, according to Smith & Crown, a research company. This has lured even more money into crypto-currencies. Some of the gains have found their way back into bitcoin and alt.coins: Trading between crypto-currencies has grown tenfold, to $2 billion on average a day, said Erik Voorhees, the founder of Shape Shift, a crypto-to-crypto exchange.

The question is not if the market will turn, but when. Even crypto-aficionados may run for the exits should bitcoin bifurcate or if one of the ICOs, which are completely unregulated, goes badly wrong—if, for example, issuers abscond with the money. Prices will also suffer if regulators start clamping down on such offerings.

On the other hand, although it is now easy to buy crypto-currencies for real cash, selling big amounts can be hard, as the woes of Bitfinex and others show. This makes sudden outflows unlikely.

The price surges also have shown that the crypto-currency system is no longer about bitcoin alone. Although it is still the biggest kid on the blockchain and functions, in effect, as a crypto-reserve currency, it now makes up less than half the combined market capitalization of all crypto-currencies. Come a crash, they may not all fall.

 

© 2017 Economist Newspaper Ltd., London (May 20). All rights reserved. Reprinted with permission.

 

Image Credits: Philippe Lopez/Agence France-Presse/Getty Images, Robyn Beck/Agence France-Presse/Getty Images



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