Why BlackRock Is Correct In Predicting Complete Losses For (Most) Crypto Investors

Summary

• BlackRock's assessment on cryptos was misconstrued and misunderstood.
• The data and arguments presented in the report points toward a cautious approach towards investing in cryptocurrencies, rather than being dismissive of them.
• The cryptocurrency market is still in its infancy and will take a lot of time to mature. During that period, there will be a lot of crash and burns.
• A regulatory framework is necessary for the survival of the cryptocurrency ecosystem.

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On February 26 BlackRock (NYSE:BLK) published its Global Weekly Commentary in which its global chief investment strategist, Richard Turnill, shared his views on cryptocurrencies and came to the conclusion:

We see cryptocurrencies potentially becoming more widely used in the future as the markets mature. Yet for now we believe they should only be considered by those who can stomach potentially complete losses. Similarly, blockchain needs to overcome significant hurdles to reach its promising future.

Ever since this commentary was published and picked up by media outlets, it has generated the usual fierce debate between critics and believers of cryptocurrencies. While crypto-related websites and bloggers only took the positive from Mr. Turnill's statements ('We see cryptocurrencies potentially becoming more widely used in the future as the markets mature'), the critics latched on to the latter part. However, there is more to it than meets the eye. No one paid attention to what exactly Mr. Turnill said and in what context. The critics and the believers just took home the side of story that suited them, without digging deep into Mr. Turnill's assessment and the implication of investing in cryptocurrencies at this stage that he was referring to. In this post, I will like to do the opposite of that.

Before beginning, I would also like to disclose that I am not advocating for or against bitcoins (or any other cryptocurrency).

The Size and Nature of the Market

In the weekly commentary, Mr. Turnill presented some key data points and facts of the cryptocurrency market, which I am highlighting here:

1. The combined market capitalization of all cryptocurrencies has reached $500 billion after the rally they witnessed in 2017.
2. The annualized volatility of major cryptocurrencies has been significantly high compared to any other conventional asset class.

_{Source: BlackRock Website}

3. 'There are over 1,500 cryptocurrencies. Spot trading of these "coins" takes place on more than 400 online exchanges around the world - with no central order book.'

To anyone who tracks the cryptocurrency market, these facts and figures are irrefutable. Mr. Turnill is not making his assessment based on whims and fancies but on authentic data. Yes, the crypto market has ballooned in size in the past few quarters, yes the annual volatility of most coins has been dangerously high and yes there are far too many coins and far too many exchanges on which they are traded.

The Drawbacks

After providing the data to back his claims, Mr. Turnill proceeds to the drawbacks, as he sees it, of investing in the crypto market at present. The drawbacks he mentioned were: 1) Extreme volatility, 2) Weak regulations, 3) Security flaws at cryptocurrency exchanges and 4) Valuation being difficult. Now, let us analyze each of the drawbacks that he has mentioned in detail and see if they actually make investing in cryptocurrencies dangerous.

Extreme Volatility - Although Mr. Turnill presented the chart which compares the annualized volatility of major cryptocurrencies vis-à-vis other assets, it wasn't actually needed. To anyone who trades or just tracks cryptocurrencies, it is evident that they are extremely volatile and no, I am not talking about a specific coin, but a majority of them. Everyone knows that volatility is enemy number one for most investors. It is what destroys performance, makes one take rash decisions, and puts people off from investing. Most investors want consistent returns, without a major drawdown and they are ready to let go of opportunities and assets that can grow their money faster for relatively safe (read- less volatile) assets. The volatility exhibited by a major of cryptocurrency has been outright crazy. A 40% up or down move in a month -that is enough to make you lose your savings or lead you to clinical depression.

Weak Regulations - One of the hallmarks of cryptocurrency that is touted often is that they aren't regulated by any institution or governments. Yes, fiat currency has its disadvantages, but a currency that is not regulated by anyone has its equal, or probably more, share of disadvantages as well. Forget billion-dollar speculators, anyone with a sizeable bank account can manipulate or inflate a digital currency, something that has been witnessed often. Remember Coinbase? Not only that, weak regulations ensures that if your digital currency is stolen or lost due to any of the innumerable reasons (hack attacks, exchange malfunctions etc.) you can do nothing to get it back. Moreover, who is going to check if the cryptocurrency is being used for legitimate transactions or for laundering dirty money? Ask any law enforcement officer, how many white collar crimes are solved because they left a money trail. You will be surprised to know the answer.

Security Flaw In Cryptocurrency Exchanges - Ok, I don't need to delve deep into this drawback. The number of cases of attacks, manipulations, shady practices that we have seen in the last one year speaks for itself.

Valuation Being Difficult - Now, this is an interesting point. Whenever I have raised the question about valuation to a cryptocurrency proponent or expert, I have never got an answer, rather they ask me a counter question in return - How do you value fiat currency? Fair point. Yes, deciding the intrinsic value of a fiat currency is difficult, but how many people 'invest' in currencies for returns? Fiat currencies are traded not invested in, and even when people buy fiat currencies of other countries to keep, they do it mostly for safety i.e. they don't trust the currency of their native country enough as a store of value because of inflation, devaluation or geopolitical tensions.

As one can see, each of the drawbacks that Mr. Turnill mentions for his skepticism regarding cryptocurrencies is logical and valid. He hasn't drawn them out of thin air, but from facts that are evident. Having analyzed where he is coming from, now let's dissect his assessment about cryptocurrencies and try to understand what he really meant.

Not Against Bitcoin (or Any Other Specific Crypto)

Only after providing the facts and figures and enlisting the drawbacks, Mr. Turnill proceeded to present his current view on the cryptocurrency market, which was:

The nature of cryptocurrencies makes them tricky investment targets. On top of dramatic price swings, cryptocurrencies face major challenges such as weak regulation and security flaws at cryptocurrency exchanges and other end points. Valuation is difficult, as cryptoassets have no cash flow, earnings or interest rate. Their uses vary from a speculative bet to payment medium. The market is evolving, however.

From what he said, it is clear that he wasn't dismissive of the cryptocurrency market. If anything, he just voiced his skepticism regarding the way the cryptocurrency market, as a whole, functions right now. He doesn't see cryptocurrencies as outright Ponzi schemes, which many critics have said in the past; rather he ends his assessment on a positive note.

In the whole commentary, he only mentions Bitcoins twice. The first time is when he is talking about the bitcoin futures launched by CBOE last year and the second time when he is talking about the present consensus among policymakers about the cryptocurrency space, which is 'Cautious on Bitcoin and bullish on the underlying blockchain technology.' He doesn't talk about any other crypto or altcoin in the whole commentary, or how good or bad they are. The only thing he does is provide his broader view on the whole market.

Before concluding the commentary, Mr. Turnill briefly talks about the technology that drives cryptocurrencies - blockchain/DLT. Even when he is doing that he doesn't take sides and mentions both the 'disruptive potential' it has and the challenges in implementing it on a wider scale.

What BlackRock Really Wanted To Communicate

The whole section on cryptocurrencies in the weekly commentary ends with Mr. Turin's (and BlackRock's) present view on the cryptocurrency market, which is:

We see cryptocurrencies potentially becoming more widely used in the future as the markets mature. Yet for now we believe they should only be considered by those who can stomach potentially complete losses. Similarly, blockchain needs to overcome significant hurdles to reach its promising future.

Again, it is evident that the tone is cautiously optimistic rather than dismissive. Yes, he warns investors of 'complete losses' if they invest in cryptocurrencies at present, but he is not talking about a specific crypto (Bitcoin, Ethereum, Ripple etc.) or advocating that every cryptocurrency investor will lose his shirt.

The point that Mr.Turnill and BlackRock are trying to make can be summed up in two parts -

1. The cryptocurrency market is still in its infancy and like any other new technology, it will take time to mature. During that transition, there will be several obstacles and crashes. We can draw parallels here with the internet boom of the late 90's, which saw several dot-com ventures raising truckloads of money, only to eventually crash and burn. However, that didn't destroy the Internet ecosystem; instead, it made it stronger and resilient. The tech behemoths that we see today rose from the ashes and became what they are because Internet and e-commerce had potential. So does blockchain and DLT.
2. Just because the technology has potential that doesn't mean that every individual coin will succeed. He clearly mentions that there are 1500 coins in the market today and 400 exchanges. Almost every week we see a new ICO or a lesser-known company announcing that it's getting into blockchains. Very few, if any of them, will actually succeed, just like very few companies from the dot-com era have managed to survive. For a normal investor, choosing a cryptocurrency today is just like choosing an internet company in the 90's - too many options, very little value. A lot of people from the previous generation burned their fingers by investing in random tech stocks in the 90s and the same thing can happen with millennials. So, it is better to either stay away from the crypto market completely or invest only a small amount, which one can afford to lose, in a crypto and 'hope' it turns out to the Google, Facebook or Netflix of the crypto market.

A Word on Regulations

Without regulations or any regulatory oversight, individual cryptocurrencies and even the whole ecosystem can be easily manipulated, taken for a ride by hackers, scamsters, and other bad actors. Regulations can bring the necessary stability in the cryptocurrency market, which continues to go through wild swings. This extreme volatility in cryptocurrency prices is preventing businesses and people to use them for everyday transactions, thus ensuring that the very reason why they exist - to be used as a currency - is invalidated. So, in essence, the debate about regulating cryptocurrency has ended up in a cycle and sooner or later this cycle will have to break. Either, there will be a cryptocurrency that is properly regulated, thus ensuring that it is relatively stable and can be widely used as a currency or this cryptocurrency movement will die a slow, but extremely painful death.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.