Why investors need to start paying more attention to cryptocurrencies

David Garrity is the CEO of GVA Research.

Cryptocurrencies are essentially “New Money,” backed by independently operated computers and user faith in an open source algorithm, that runs on blockchain technology. According to MIT Technology Review, “A blockchain is a shared, permanent, encrypted dataset, created by a network of computers according to a set of software rules.” Understanding the operation of blockchain technology and cryptocurrencies (e.g. bitcoin) can be daunting. Yet, they have become central to the discussion of investing and technology, so it’s time to dive in.

Here are five reasons why cryptocurrencies are significant:

1) In Bitcoin, Millennials Trust

As of April 2016, the Millennials surpassed the Baby Boomers in size in the U.S., with 76mm Boomers and 77mm Millennials. Much as the Boomers before them drove the global economy and created from their tastes and preferences investment opportunities for decades, Millennials are having a growing effect that cannot and must not be ignored. When it comes to finance, Millennial experience is shaped by the dot.com bubble burst of the early 2000s and financial crisis of the late 2000s. When it comes to the financial system, Millennials have had to suffer from the mistakes and greed of their elders. However, while Millennials may not trust financial advisors, they do trust technology as the first generation to come of age with computers, smartphones, social media and as such a healthy admiration of creative entrepreneurship.

Millennials are tech-centric and are comfortable investing in an asset class such as bitcoin which depends upon technology. Cryptocurrencies help Millennials bypass fears about the traditional financial industry by serving as a decentralized asset class in which to invest. Based on recent surveys, 87% of respondents aged 18-24 know of bitcoin vs. 76% of those aged 55+. While respondents aged 25-34 are most likely to invest in bitcoin as an asset for the future or to consider using bitcoin for purchases, older respondents have already made up their minds to not get involved with bitcoin.

As Millennials increasingly drive the global economy, expect bitcoin to be more and more how they pay for the ride. Already we can see that digital payments are displacing older payment forms as the market capitalization of PayPal (ticker: PYPL, market cap: $87bn) has surpassed that of American Express (ticker: AXP, market cap: $83bn). Bitcoin is a currency with a future as Millennials put their trust in it.

2) When It Comes To Laundering, Digital Outperforms Physical

BlackRock CEO Larry Fink has said that bitcoin is an index of money laundering. However, note that currently the $100 bill issued by the U.S. Treasury is the currency of money laundering the world over. There are more than $1.1 trillion worth of US$100 bills in circulation globally, a number that has doubled over the past decade. If Fink is right, then bitcoin has ample room to rise from its current value of $7,300 (implied value of $153bn for the maximum 21mm bitcoins possible) as it displaces US$100 bills.

To be realistic, money laundering is an activity generally frowned upon by governments and one that they have sought to control through the introduction of anti-money laundering (AML) regulations. However, to be equally realistic, one should note that given how the rich and powerful like to keep their money clean, one shouldn’t expect to see regulation over cryptocurrency proceed in a way that diminishes their wealth by excessive regulation or outright bans. To the extent bitcoin is more secure and cleaner than $100 bills, expect to see more of it.

3) Bitcoin Is Driving A Fresh Investment Cycle In Highly Scalable Technologies

Let’s be honest, the US$100 bill enjoys its status because the U.S. Dollar is the global reserve currency, a status enjoyed since the end of WWII when the USA was the strongest economy left standing in a world bombed flat by war. By having the global reserve currency, the USA is able to set monetary policy and interest rates that drive the global economy. With benefits like that, who wouldn’t want to have the opportunity to create a new global reserve currency? However, given the current likely undesirable outcomes from global scale nuclear conflict, it is not likely war will be the means by which the U.S. Dollar will be displaced from its global reserve currency status. Cryptocurrencies such as bitcoin do offer the opportunity to compete.

As the worldwide opportunity in creating such new money dwarfs the combined market capitalization of the FANG stocks, it is likely this point is not lost on policymakers in Beijing and Moscow, along with other countries. Consider the total addressable market for a new currency as there are over $5 trillion in physical Dollars, Euros, Yen and Yuan in circulation globally with multiples of that in total money supply across the economies where those currencies trade. On a relative basis, total cryptocurrency valuations of approximately $170bn appear almost immaterial.

4) Bitcoin Will Be Accepted By More Retailers

There is significant disruptive structural change unfolding in the retailing sector centered in large part around Amazon.com (AMZN) which is at a point where it is accelerating the pace at which grows by now acquiring established retail outlets such as WholeFoods. With its large customer list and the competitive edge provided by its stellar technological capabilities, note with interest that Amazon has just recently registered three domains: amazoncryptocurrencies.com, amazoncrypotocurrency.com, and amazonethereum.com.

With Millennials inclined to use bitcoin to pay for purchases, Amazon is most likely posing consumers the question: “How do you plan to pay for all those Xmas gifts?”

5) Bitcoin – A Powerhouse

An index from cryptocurrency analyst Alex de Vries, aka Digiconomist, estimates that with bitcoin trading over $7,000, it would be profitable for bitcoin miners to burn through over 24 terawatt-hours of electricity annually as they compete to solve increasingly difficult cryptographic puzzles to “mine” more bitcoins. That’s about as much electricity as Nigeria, a country of 186mm, consumes annually. Since the average American household consumes 901 KWh per month, each bitcoin transfer represents enough energy to run a comfortable house, and everything in it, for nearly a week. On a larger scale, De Vries’ index shows that bitcoin miners worldwide could be using enough electricity to at any given time to power about 2.26 million American homes. As such, if bitcoin mining were a separate U.S. state, it would fall between Maryland (#20 with 2.2mm households) and Wisconsin (#19 with 2.33mm households). Terrapins, Badgers and bitcoin, oh my!

To update Winston Churchill’s statement on Russia and its national policy prior to the outbreak of WWII, namely “it is a riddle wrapped in a mystery inside an enigma”, one might say of cryptocurrencies that they are “money wrapped within a cryptographic puzzle inside the enigma of 21st century technology”. While the key to understanding Russia was its national interest, there is no such unifying theme to consider with cryptocurrencies, only the rising tide of technological innovation washing away the foundational assumptions of established paradigms. We live in interesting times.

David Garrity has over 25 years’ experience in the financial services industry, he has held senior roles including CFO and board of director positions for both publicly held and private companies, and has extensive experience in several disciplines including operating, advisory and research, and is CEO of GVA Research. David currently serves on the Board of Directors of BTCS Inc., a publicly-held U.S. company involved with Digital Assets and Blockchain technology development and application, and the Advisory Board of Venture.co.