Capital markets: Investors must be cautious of bitcoin appeal

Virtual currencies are under the spotlight.
Virtual currencies are under the spotlight.
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HARDLY a day goes by at the moment without a headline referring to bitcoin and so-called crypto-currencies.

The technical detail on how the technology works is complex but what really matters is whether it is an investable asset or is likely to become one.

Bitcoins have performed well, but do all investors truly understand the pricing mechanics of this market? A dazzling performance but it could blow up in your face!

It should be remembered that investors sit up and make enquiries when something they haven’t got exposure to starts to make a lot of money – the so-called investor greed factor.

The temptation to get involved based solely on past performance is very strong despite understanding very little about it.

This has been a common feature with all historic bubbles, all of which ended in disaster, although some investors made a fortune along the way.

It is very easy to take the intellectual high ground, scoff and discount crypto-currencies as a passing fad but some did that with the internet before Amazon was born.

It is also similarly very easy to get consumed by greed and influenced by others who have profited and climb aboard.

Keeping the facts simple, bitcoin is a virtual currency, a little like gold, where intermediaries play a very limited role and central banks and governments none at all.

The ledger of who owns what is encrypted and uses ‘blockchain’ technology which is basically an ever expanding database comprising a series of blocks of data which are linked.

This feature, where banks and governments are bypassed is probably the single biggest reason why it is unlikely to succeed. At the moment, any transactions involving a crypto-currency cannot be monitored and completely bypass any regulations or security and exclude banks.

Controlling the money supply is a key part of the role of the Bank of England as we have seen with quantitative easing.

Prevention of money laundering and cybercrime is an increasing concern for the regulatory authorities and we have a plethora of regulation being implemented at the moment and next year which seeks to address this.

Crypto-currencies such as bitcoin cut straight through all this regulation and control and this is why they are currently the preserve of illicit trade such as drug trafficking.

For the time being, we are watching closely but currently have no plans to consider crypto-currencies as part of our investment universe.

It is possible it could become outlawed by the authorities.

Some investors in bitcoin may also not be aware that there are tax implications.

Just because something is unregulated it does not mean you don’t pay tax.

This may make investors reluctant to sell their holding in bitcoin because they are sitting on healthy profits and don’t want to be stung with capital gains tax.

This is the mistake that many made back in the dotcom bubble, and rather than realising taxable gains they got hung, drawn and quartered when it collapsed.

The golden rule of investment is to understand what you are buying.

Investors should be very cautious until we can sufficiently analyse crypto-currencies and the underlying technology to an acceptable level.

Guy Stephens is the technical investment director at Rowan Dartington.