194. What do Birkenstock, eBay, recycling and litigation all have in common?
Lucy Isles, co-manager of Baillie Gifford High Yield Bond fund, discusses her investments in the...
If you Googled cryptocurrency a few years ago, information about Bitcoin would have been the main result. Today you get a list of top stories including “Do I owe tax on my cryptocurrency?”, “How Stablecoins can help crypto investors” and “India says it will launch digital rupee as soon as this year”. Cryptocurrencies are on the rise and their uses are growing. In this podcast, we go back to basics, discussing their humble beginnings, before exploring how they could impact our futures.
3 February 2022 (pre-recorded 2 February 2022)
Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.
Staci West (SW): Welcome back to the Investing on the go podcast. It’s almost impossible to avoid a discussion about cryptocurrency today. Once just a Bitcoin story, crypto’s continued growth means it is creeping into other areas of our lives and is now much more than just a currency.
In this episode, Sam Slator, communications director for FundCalibre, discusses this very topical area with managing director Darius McDermott and senior research analyst James Yardley to find out more about cryptocurrencies and whether they can truly be viewed as an investment.
Sam Slator (SS): So let’s start with, what are cryptocurrencies?
James Yardley (JY): So cryptocurrencies started with Bitcoin, which was basically a project to create digital cash, whereby anybody could send money to anybody else in the world. And the key part of Bitcoin is that it’s decentralised, there’s no single point of failure, so you can’t shut it down. Even a government can’t, is not supposed to be able to shut it down. And as a reward for securing this network, you receive more Bitcoin in the form of the Bitcoin token called BTC. And there’s a capped supply of Bitcoin. Meaning that, you know, it doesn’t have the same inflation as you can get with some fiat currencies, which some people believe means it can be a better store of value.
Now, cryptocurrency has actually evolved a lot more since Bitcoin. And I think one of the mistakes people make is to just assume that crypto is Bitcoin, and actually it’s changed a lot now. Most of the innovation in the space is happening away from Bitcoin. So, so after Bitcoin, we got this thing called Ethereum and Ethereum is very interesting because it had the idea of decentralising not just money, but decentralising anything essentially. And you can build decentralszed applications on top of Ethereum.
And this in turn also has sprouted a whole load of other tokens because one of the other features of Ethereum is you can create tokens on top of it. So now we have this huge broad base of lots of different types of cryptocurrencies. And what that really means is that we can, you can have applications where you, you can do things between individuals, trade things where you don’t need a centralised third party, as you do at the moment.
Darius McDermott (DM): That’s one of the key things, isn’t it James, each crypto has a slightly different use, as you say, Bitcoin was set up for sort of payments. And you’ve just touched on Ethereum, and you know, all the different coins and tokens have slightly different uses. And I think before one ever bought any of them, one should at least try and get their heads around what each of them are trying to achieve, and whether you can make a judgment on whether that is achievable.
SS: I was gonna say, why do we need things to be decentralised? What’s the benefit of that?
JY: Well, the benefit of it is of course it’s a lot more efficient potentially, I mean…
DM: And cheaper. I think trading costs are deemed to be lower, moving something in a decentralised way. It’s when, in a regulated way, there’s always associated costs, isn’t there?
JY: Yeah. I mean, I go back to the Michael Gambon quote in the film Layer Cake, when his character Eddie Temple says “the art of good business is being a good middleman” and the point of the idea of decentralisation is to destroy the middleman. And that has potentially huge implications for our society and for economics and for finance. If this vision actually comes true, because if you think at the moment, what if you could build an eBay or an Uber or all of these central, where at the moment you have these centralised platforms, what if we could build a decentralised alternative where I don’t need to go through an Uber to order a taxi, I just go straight to the driver. And then you can even go even further than that and say, well, what actually, if rather than Uber owning the platform, what if the users own the platform and what if the drivers own the platform? And what if we all then got a reward for owning the platform? So this is a potentially a lot bigger than tulip bubbles and JPEGs as people sometimes tend to dismiss it as, in my, in my view at least.
Whether this is actually possible, whether that ultimate vision is actually possible, you know, is very much up for debate. And whether you can actually have these decentralised applications, I don’t know.
But just coming back to the original thing of what are cryptocurrencies, that has actually become a very broad spectrum now, because so after Ethereum, what Ethereum also allowed was for these own, your own tokens, basically to be created on top of Ethereum. And so this allowed for everyone to create their own projects. And this led to the first sort of huge speculative run up we had in 2017 and the ultimate crash because, you know, a lot of these things were, had a lot of promises, but nothing had been built yet. And some of these tokens, which are being built are a bit more like traditional shares and things that we have at the moment, compared to something like Bitcoin, which is really quite removed. So it’s, that’s why it’s quite, it’s quite tricky because they, it is actually quite a broad spectrum now. We also have things like stablecoins and things which are designed to say, track the US dollar, which is another example of a token you can have.
DM: Do you think of them as investments? Cause I don’t, I mean, I’m a bit older than James and a bit more of a traditionist maybe, but you know, when I think about investments, we look at trying to find either an intrinsic value or discounted cashflow, there appears to be no traditional way of valuing them. And certainly, the original coins didn’t have any dividends. Now I think that has matured with some of these token-type investments or token-type purchases, but they appear super complex and super volatile. And I know investors have, some people have made a lot of money, which is why they’ve become popular. You know, there was that run up in 2017 to sort of $20,000 per Bitcoin, but, you know, then between sort of 2020 and sort of, you know, April 2021, and then again in November 2021 were massive price rises. But it also comes with volatility and you know, as we know anything that you can make money in a short period of time, the opposite is that you can lose a lot of money in a short period of time. So yeah, I still don’t categorise them as an investment per se.
JY: Yeah. I think it very much depends on the individual project or token or coin. I mean, you have to remember this, the space is really the Wild West at the moment, right? There’s no regulation or anything really. So there are scams out there, there are sort of semi scam sort of lots of pyramid schemes, sort of tokens of things. And then there are actually the really genuine projects with, you know, real proper VC [venture capital] funding behind them which are actually building serious projects. So it’s all kind of in a mix together and it’s, you know, it’s very much the responsibility of the individual to kind of work out what is actually a real investment. And then what is maybe a scam or not even a scam necessarily. I mean, sometimes just, you know, something which just becomes popular for the sake of it. And you know, you really have to do your own research on a lot of these things and it’s not easy.
DM: Definitely there has been potential for fraud. And I like your description of the Wild West – I had in my head I was going to say a lawless environment. And you know, there has been fraud and theft, numerous documented occasions since launch. So, you know, I think potential buyers of these things do need to bear those added risks in mind.
JY: Absolutely. This is not sort of the space for the fainthearted. And I think before anybody really invests in anything, I mean, what I always encourage people to do is to just actually go and use the networks a bit or experience it a bit with a very small bit of money. And actually do a lot of research before you start getting involved with it because there are, yeah, there are lots of scams and things out there.
I mean, Ethereum and Bitcoin though have been very successful in that they haven’t gone down at all and they’ve never actually been hacked. Although there are lots of, sort of hacks around the side into various other protocols. They themselves have never been hacked. And that is one of the reasons why they’ve continued to gain adoption and gain in price as the longer they’ve gone on the more confidence people have had in them.
SS: But it sounds to me as though the word cryptocurrency is a bit of a misnomer then, because you’re kind of saying that on the one hand, there are some that are like currency, like Bitcoin, but then there’s these other projects going on with platforms in the background. So can you kind of almost spit it into buckets now and separate it out?
JY: Yeah, exactly. That’s the way you should really think about it. So really you should think about it in terms of what I would say are coins and tokens. So really there you get those coins, which we call basically are layer ones. So those are actually the blockchain, which secures the network. So that is things like Bitcoin, Ethereum, or there are also now lots of competitors to Ethereum, like, you know, Solana or Avalanche or Phantom. And then below that you get the tokens which are being I guess, to some of the things which are on top of these networks, you also have other things as well, like layer twos, which are sort of side chains attached to the networks. But, you know, I wouldn’t worry about that for the moment.
SS: So when you’re talking about side chains and platforms, can you kind of dumb it down for this old brain here? Cause I still struggle to get my head around all of this, I have to say. It’s, you know, we are talking about, so how…
DM: That’s the point, Sam though, it isn’t straightforward. And I suppose one could argue that any type of investment, understanding what makes a share go up and down, isn’t straightforward. But to my mind, this does add an additional layer of complication for your standard retail investor/punter. You know, we’ve discussed this as we with many of our industry friends and, you know, because James has a good understanding, he tends to be a fountain [of knowledge] of ‘how do I make money out this Bitcoin and stuff that everybody’s getting involved in’? And I also think there is a huge amount of FOMO, fear of missing out, people say, well, you know, you’ve done really well with this or that. My neighbor’s done really well with that. And this is why they are, this is why we’re even having this conversation because there are a decent population that have made an awful lot of money out of crypto, Bitcoin or whatever. But you, you tend to hear less of the stories where people have lost a lot of money.
And just to put it into context, you know, on the middle part of November  Bitcoin was at $64,000 and on the 21st of January , it’s $34,000. So it’s almost halved so, you know, by all means play, but do be prepared to either a) ride that volatility out in the belief that long term these things are winners. So I can understand that type of investment thought, you know, the demand for these things are going to push it up, but then the likes of the Chinese government ban them, that causes massive volatility in the price. You’ve seen Elon Musk at Tesla. He talked about allowing Bitcoins to be able to use Bitcoin to pay for the cars and invested in them at the same time. Then when it was pointed out to him that the cost from a green perspective of the electricity to mine these coins, he had to change his mind. And of course that led to a massively down in the price.
So it, it, I think James said, it’s not for the fainthearted, these types of whether you wanna call them investment or not, or punt. But I think there are characteristics around long termism that hold true. You know, you wouldn’t buy, well, I don’t think you should, you wouldn’t buy the US Index for six weeks. You know, if you were making an investment in US shares, you’re probably thinking 5, 10, 15, 20 years. And I think that type of behaviour probably is a good idea. Maybe not trying to put all your investments in, let’s just pick on Bitcoin, cause it is the most prominent of these, you know, if you wanted to make an investment for £10,000, maybe not doing it, as James said all £10,000 in one go, you know, buy £2,000, see what you think about it, maybe add in, but you know, that sort of, that sounds a bit like pound cost averaging which we talk about in investing a lot. So I think there are characteristics that could be followed through from investments, but…
JY: Yeah, I think you made very good point about not wanting to FOMO in, I mean, I think before people even think about investing, as I say, I think they should do research and actually try and use some of these networks. Cause I mean, you can actually use them now for various things.
DM: What sort of things can you use them for today?
JY: Well, I think this is one of the things which is a bit different from in 2017 when we just had hype, a lot of hype, and not very much you could do, whereas what’s happened now I mean, we went through this huge bear market for crypto and everyone sort of forgot about it until the last year or so. And a lot of the projects which started building in 2017 are now starting to come to fruition. So you have, for example, things like decentralised exchanges, Uniswap is the biggest one. So rather than using a centralised exchange, like Coinbase, a lot of people choose to use something like Uniswap instead now which has, you know, it’s decentralised, it’s supposed to have no central point of failure.
You’ve also got things like lending platforms, like Aave and Compound. So people sort of lend out their cryptocurrency and that this has been a big attraction for people because you can get a much higher interest rate on your US dollars potentially than you can in the bank. And that’s, what’s driven a lot of the adoption recently. And then we’ve also, we’ve also got other things like NFTs [non fungible tokens], which have come along, which approved very, very popular recently which we can get into if you want. We’ve also got GameFi now – gaming and crypto emerging together – and then other things like the metaverse, so everything is sort of starting to come together a bit now. And that’s why it’s starting to gain traction.
SS: So how’s that working in gaming then? Cause that’s something that most people will be able to think about in sort of their everyday lives. How does crypto get into gaming then and the metaverse?
JY: Yeah. So one of the big problem with traditional games is as a gamer, you’ve never actually been able to own your in-game assets. It’s all kind of sort of pretend, right? So things like FIFA or Fortnite, I mean, they, they make millions of pounds or millions of dollars, selling digital skins and digital cards and assets. But as the gamer, you don’t actually own them really. You can’t take them and sell them to somebody else. And, you know, eventually when the game shuts down, that all goes away and it doesn’t really mean anything. Now…
DM: There’s no sort of reward or loyalty system is there, which is where the tokens maybe come in. Is that about right?
JY: Well, so now we have non fungible tokens. So basically you can take those things and verify the ownership of who actually owns them. And that, and that’s actually a game changer for these games. Because now I can actually, maybe I’ve got a really valuable, powerful item in a game and I can sell that to another player who wants it. And furthermore, maybe I can even take that item out and go and use it in a different game, or maybe somebody else develops a new game for that item. So it is potentially a game changer for games.
I mean, quite a lot of controversy among gamers. A lot of gamers are worried about where it’s going. I think that’s that thing is not going away. We’ve also had this thing called play to earn in games you can sort of earn or mine cryptocurrencies by playing the game or winning the game in some way, and that’s proven very popular, although that’s, that’s a bit more controversial and you know, there are question marks about that and it’s sustainability. That’s sort of an introduction to it, but yeah the, the things that this as well, which allows it allows for proper in-game economies, which we’ve never really had before.
SS: So is that a threat to gaming companies or is that a good thing for them to embrace? Because if it was kind of me who owned, I don’t know, FIFA ‘22 or Fortnite or something, I’d be like, okay, well I can actually allow my players to do this if they want to, would they start doing that themselves? Or is it something that’s completely out of their control? Or does it actually matter to them?
JY: It’s a very good question as to whether it’s a threat or an opportunity, it’s probably a bit of both and they, and the game companies also have a difficult path to navigate cause they don’t want to upset their existing audiences. Many of whom are actually quite against crypto. Another reason why gamers generally dislike crypto is because a lot of the graphics cards and things which gamers like to buy, they’ve all been bought up by the cryptocurrency miners, which has caused a massive surge prices. So there’s kind of a natural dislike of crypto to start with from gamers.
I mean they do, they can’t just stand still in this space, cause this is, I think this is definitely a case where there was a real problem in gaming. I mean, one of the criticisms of crypto is it’s just a solution looking for a problem. This is where crypto’s really found a problem, which actually is a big deal. If you’ve got a card game or if you’ve got a collectible game, it makes a lot of sense to actually have these where, you know, the player really owns them. They’ve gotta be able to adapt and navigate that balance.
I mean, the other thing we’re also seeing is though is with crypto, you are going the full way now that people are actually sort of, you can almost creating their own game studios and allowing them to be owned by the players. So that’s another dynamic at play.
DM: So it sounds like to me that like a lot of investing, that you do need to do your reading, your research, try and understand what it is that each of these things are trying to achieve. And to my mind, definitely be prepared for volatility in the prices of these assets.
DM: I think that, you know, there is evidence in their reasonably short life, that they go up quite violently and can come back quite violently.
JY: I guess coming back to, I dunno if I said it before, but to your discount cashflow point, I mean the other point I would just make with some of these protocol, some of these platforms, like Uniswap for example, they are generating real amounts of revenue now. So you can sort of start to think about putting a valuation on them in a traditional metric, in a traditional way rather, whereas you can’t really do that for Bitcoin. So I think that’s one of the things where me as sort of an analyst, I start to get more interested, cause I can start to see potentially what some of these things might be worth.
SS: Why do some governments like them some hate them? Is it just that some governments want more control and others…
DM: The large central banks, like the Fed and the ECB or Bank of England, one of their functions is to control the flow of money. And they do that on behalf of governments. I think this ability to make transfers between assets and coins or whatever it might be, beyond their reach, I think is a threat to central banks. And maybe they, as James said about the gaming companies need to adapt and find a way of, if not regulating it, controlling it.
But we talked a lot about policy at the moment and the US rate rises that are coming. That is done to try and control economies, unemployment, inflation, and if there is this mechanism for money moving or money assets moving, without them being able to control them, then I think that is a threat. That would be my, again, very basic way of looking at it. But, you know, that’s where I see it could be a threat is the central functions of these banks could be distorted and again, maybe too early to say to what level or to what impact. Yeah,, that’s what it appears to me. And I don’t know what the central banks feel, but James, you got anything to add or is that not…
JY: Yeah, I mean generally, I mean, governments hate crypto because it’s, it’s taking power and control away from them, right. I mean, particularly a currency is one of the things which makes a state a State. So if you take that away, you remove a lot of government’s power. I mean, this is particularly relevant in emerging markets. And the IMF is basically in a state of panic at the moment because it’s easy for us, you know, living in the UK where we don’t have to worry too much about the currency collapsing every few minutes, but if you are living in Argentina or if you’re in Venezuela or if you’re in Turkey at the moment, you know, crypto offers you a way out to save your savings. And a lot of people are potentially taking that, even if you are just transferring it into a US stable coin or something. So the, yeah, I mean, the IMF is, as I say, almost in a state of panic at the moment, because it doesn’t quite know how to deal with this. I mean, this is potentially a game changer. I think ultimately it is actually a good thing that people can save their savings and that governments can’t just, you know, inflate their currencies away to nothing. At the expense of…
DM: That’s another tool that central banks have, don’t they, when they raise interest rates or lower interest rates or, you know, is to partially sometimes manipulate their currency, because as we know, currencies can get overvalued and cheap as well. And you know, if you are wherever, either emerging or developed markets, if you want your currencies to go up and down…
SS: Do you think like eventually you could have like bonds issued in hard currency, local currency in crypto currency?
JY: I think we already have some bonds which have been issued on the Ethereum platform. I think the, I can’t remember who did it exactly, but I’m sure that’s already, that has already happened.
DM: It’s definitely a fast-maturing environment. The both of the two of us on this call, I know James has invested in cryptos. I haven’t, primarily because I haven’t fully understood them and at least if I have a bet on the 3:30 at Kenton, I know there’s an eight in nine chance I’m actually going to lose my money, but that’s more of sport and fun. But I’m interested in learning more about the subject, but it would never be more than a small percent of my portfolio, I think, but primarily because of the volatile nature of those assets.
SW: Digital currencies are probably here to stay and could maybe even replace some current forms of payment. So, if you are going to back crypto, it must be for the long-term. However, before you jump on the bandwagon, make sure you know what you’re getting into and don’t invest any money you can’t afford to lose. Diversification is key.
Please remember this podcast is not intended as a substitute for investment advice and mention of specific assets or platforms but should not be viewed as a recommendation to buy or sell.
Please also note that members of the FundCalibre team own some of the cryptocurrencies and platforms mentioned in today’s podcast in their personal portfolios.
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