Cryptocurrencies: Bitcoin’s long and winding journey

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on December 30, 2019 - January 05, 2020.
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Bitcoin (and cryptocurrencies in general) has come a long way. What started as a concept on a white paper written by one Satoshi Nakamoto in 2008 has become a thriving technology-backed digital currency that has disrupted many sectors.

As at Dec 18, cryptocurrencies had a market capitalisation of about US$178 billion (according to data provided by CoinGecko, which tracks 6,412 coins). Bitcoin’s market capitalisation alone stood at US$120 billion.

For context, the current market capitalisation of Netflix and Facebook — two of the world’s biggest tech stocks — are US$138 billion and US$565 billion respectively, according to Bloomberg data. Meanwhile, the market size of various gold sectors (including bars, coins, jewellery and exchange-traded funds) stood at US$7.886 trillion as at February, according to the World Gold Council.

Kenrick Drijkoningen, founding partner at LuneX, a fund that invests in blockchain assets globally, says it took a long time for investors to fully recognise bitcoin as a viable asset class. In 2009, when the cryptocurrency was introduced, it was almost worthless. The price only increased to less than half a US cent the following year.  

In 2010, a year before bitcoin reached US$1 apiece, the first real-world transaction happened. A bitcoin miner in Florida bought two pizzas for 10,000 bitcoins. This translated to about US$30 at the time.

In the early days, most of bitcoin’s adopters were tech geeks or those with strong libertarian beliefs, says Bobby Ong, co-founder of CoinGecko. He adds that back then, many of the early adopters had a strong belief that bitcoin would become significant and could even go as far as becoming the single unified currency for the world.

“That said, many of the early adopters knew that bitcoin was an experiment in defining a new monetary system for the world and there was a non-trivial probability that it would fail and the value would plummet to zero,” says Ong.

Along the way, bitcoin’s reputation was damaged due to its use as a method of payment in dark markets such as Silk Road, a digital marketplace that connected vendors of illegal drugs with potential buyers. In a 2011 exposé, it was revealed that bitcoin was the only method of payment accepted on the now-defunct platform. Credit cards or payment accounts such as PayPal were not allowed on the platform to retain the anonymity of those involved in the transactions.

However, while the identities of bitcoin owners may be anonymous, their transactions are traceable, having been recorded on a public ledger. Law enforcement agencies could use sophisticated network analysis to decipher the transaction flow and track down individual bitcoin users. In fact, on Oct 16, the US and South Korean authorities announced that they had broken up one of the world’s largest child pornography sites, “Welcome to Video”, by following a bitcoin trail.

Henri Arslanian, PwC’s fintech and crypto lead for Asia, says several catalysts may have drawn people’s attention to bitcoin and changed their perception towards it, the most prominent being a rally that started in October 2017. Two months later, the price of bitcoin reached an all-time high of almost US$20,000 before crashing to US$7,000 in April 2018.

Not a single catalyst was said to have caused the crash. However, there was negative newsflow during the period, including rumours of South Korean authorities banning cryptocurrency trading, the hacking of Japan’s largest over-the-counter cryptocurrency market Coincheck and the initial coin offering (ICO) advertising ban on all major social media platforms.

The rally, coupled with the ICO boom that took place around the same time, attracted a lot of attention from the public that bitcoin could potentially be a lucrative asset class, says Ong.


The rise and fall of bitcoin

Over the past decade, the price of bitcoin has been on a roller-coaster ride. The first notable rally happened in 2013. At the beginning of that year, the cryptocurrency began trading at about US$13.50 apiece. By early April, it had risen to US$220, before falling to about US$70 in the next few weeks.

In October that year, the price of bitcoin went from US$100 to US$195. Thanks to several factors, including miners from China entering the marketplace, bitcoin rose to US$1,120 each the following month.

At this point, bitcoin experienced a bear market and bottomed at US$152 on Jan 14, 2015, having lost about 87% of its value from an all-time high two years ago. Throughout 2016, bitcoin rose steadily and moved above the US$1,000 mark early the following year.

The upward trend did not stop in 2017. In October of that year, bitcoin reached US$5,000 apiece before doubling the following month. In December, the price surged to almost US$20,000.

Last year was not a good one for bitcoin. According to CoinGecko data, the price plunged about 70%. Bitcoin was trading at about US$13,000 in June but by Dec 14, the price had dropped to US$7,076.

Drijkoningen says the bitcoin community is looking forward to a major event next May, when the cryptocurrency will be halved. Once every four years, the issuance rate of the entire bitcoin network is reduced by 50%, which reduces the amount of new bitcoins entering circulation every day and increases mining costs to secure the network.

Historically, this event can be seen as one of the driving factors behind bitcoin’s previous bull runs. Next year, bitcoin’s block reward will be halved from 12.5 BTC to 6.25 BTC per block.

Will investors see another bull run like the one in 2017? “Some people think it will be tough for us to see another bull run like the one in 2017, when the bitcoin price increased almost 20 times that year. That was a once-in-a-lifetime opportunity as most people were hearing about bitcoin and blockchain technology for the first time. Today, almost every educated person has heard about blockchain technology,” says Ong.

“That said, I think there is a [slim] chance that a repeat of 2017 may happen again in the future. Most of the wealth in the world is still in traditional asset classes such as fiat currencies, real estate, stocks and commodities. Under perfect conditions, such as the erosion of trust in national governments like in Venezuela, we may see people move money into cryptocurrencies at a rapid pace and we could see another huge price increase. When or if it will happen is, of course, a tough thing to predict.”


The ICO boom and repercussions

In the early 2010s, bitcoin was the only cryptocurrency in the market. Today, there are more than 6,000 digital coins. The growth of these altcoins, or digital currencies other than bitcoin, can be largely attributed to the initial coin offering (ICO) boom in 2017.

An ICO is a type of crowdfunding exercise, where a company creates a digital coin to raise money for its projects or operations. The coins may represent a stake in the company or project, or can be utilised to acquire its products and services. Despite emerging in 2013, ICOs really took off in 2017, when the software for these offerings was standardised in the market.

“At the time, companies were raising a lot of money, which caught the attention of businesspeople, who started to consider ICOs as a new avenue for fundraising. For investors, the ICO boom led people to believe that these offerings democratise venture capital funding and that good deals were now democratised and available to the average person, with potentially high returns,” says CoinGecko co-founder Bobby Ong.

Henri Arslanian, PwC’s fintech and crypto lead for Asia, says the ICO boom and the rally in bitcoin prices have prompted regulators around the world to look deeper into cryptocurrencies. “A few years ago, anyone could publish a white paper to raise funds and even set up a digital asset exchange without applying for a special licence. Today, however, regulators all over the world have come out with their own guidelines and frameworks for ICOs and digital asset exchanges.

“I think the regulators have done a very good job of understanding and regulating the space. In my personal experience, the average regulator knows more about this space than the average financial services professional.”

In Asia, cryptocurrency-related regulations vary in their stringency. The Securities Commission Malaysia (SC), for one, has amended its guidelines on recognised markets to introduce requirements for digital asset exchanges. The amended guidelines come after the implementation of the Capital Markets and Services (Prescription of Securities) (Digital Currency and Digital Token) Order 2019 on Jan 15.

On March 6, the SC published a consultation paper to seek public feedback on the framework for ICOs. In July, Deputy Finance Minister Datuk Amirudin Hamzah said the SC would be finalising the regulatory requirements in the second half of this year.

Meanwhile, the Monetary Authority of Singapore issued a guide to digital token offerings, most recently updated in November 2018. The regulator is also exploring plans to allow payment token derivatives to be traded on the local exchange and for such activities to be regulated.

Japan recognises bitcoin as legal tender and has established the Japan Virtual Currency Exchange Association, a self-regulating body that operates in collaboration with the 16 registered digital asset exchanges.

China has banned all ICOs and cracked down on trading platforms, by not only banning national cryptocurrency exchanges but also restricting access to these platforms in other countries. Similarly, South Korea prohibited all domestic companies and start-ups from participating in ICOs in 2017.

Is stricter regulations the way forward for the cryptocurrency industry? Definitely, says Arslanian. “I think the regulators are moving in the right direction. With more regulatory clarity, institutional players have more comfort to come on board, which leads to greater mass adoption.”

Ong concurs. “Regulations are indeed needed to stop the bad actors from swindling the public of their hard-earned money. Regulations need to be progressive and supportive of the growth of the industry. Too strict a regulation will result in either the industry going underground or entrepreneurs moving their operations offshore,” he says.

“I am pro-regulations to weed out the bad actors in the industry. We have seen too many scams in this industry and regulations will play a big role in cleaning things up. A progressive regulator will contribute a lot to the development of this industry. Thankfully, the SC has a very progressive attitude towards the development of the industry in Malaysia.”

Fraud prevention is one of the reasons stricter regulations are welcomed by the cryptocurrency industry, especially in the light of infamous incidents such as the Mt Gox hack, which caused some investors to lose millions of dollars in bitcoin. Mt Gox CEO Mark Karpelés was arrested in Japan in August 2015 and charged with fraud and embezzlement (although none of these charges were directly related to the theft).

Another case that received a lot of attention involved QuadrigaCX, previously the largest cryptocurrency exchange in Canada. Last December, it announced that the CEO — supposedly the only person with access to the US$190 million in customer funds — had died. Later, it was revealed that the exchange had gone into financial difficulties and most of the investor money was missing.

In a June 19 report, global accounting firm EY said QuadrigaCX’s CEO had transferred millions of dollars worth of cryptocurrencies out of customer accounts and into other exchanges. He had also used the money to fund his trading habits and personal lifestyle.

While these cases may have caused some investors to be wary of cryptocurrencies as an asset class, LuneX founding partner Kenrick Drijkoningen asserts that the amount of money being laundered in the cryptocurrency space is actually insignificant when compared with the cases in the conventional financial industry.

The United Nations Office on Drugs and Crime estimates that the amount of money laundered globally a year is 2% to 5% of the global GDP, or US$800 billion to US$2 trillion. Meanwhile, cryptocurrencies worth about US$1.7 billion were stolen from exchanges or investors in 2018, according to a Jan 28 report by US-based cybersecurity firm CipherTrace.

“Banks regularly get fined for money laundering-related cases. In fact, they expect these kinds of cases so they actually budget for it. The fines they get are many times over the current market capitalisation of bitcoin. Putting that into perspective, it does not even compare,” says Drijkoningen.

“That said, like many other industries and asset classes, there are Ponzi schemes in the cryptocurrency space. It is nothing new. These schemes happen with fiat money as well. Those in the cryptocurrency space attract more attention because it is a new technology. Over time, as people start to understand the technology, they will be able to avoid being taken for a ride by these schemes.”