Risk vs Reward: Navigating the risky world of cryptocurrencies

Bitcoin was the first big cryptocurrency

There are few areas of finance at the moment that are generating as much hype as cryptocurrencies. Bitcoin is the most popular, but it also fields its fair share of criticism. Earlier this year, Jamie Dimon, chief executive and chairman of JP Morgan, called it a scam and announced he’d fire any employee caught trading the digital currency.

To crypto-enthusiasts, this seemed to signal that the old world of finance is feeling threatened by the new. And from an investment perspective, they have a point.

As of December, the price of one bitcoin crossed the US$11,000 (HK$90,552) threshold. Compare that to the start of this year, when a bitcoin was worth less than US$1,000. Looking further back, for a lot of 2010 its value fluctuated between six and seven cents. Prescient people who bought bitcoin back in 2010 and held them until now would have seen their investment grow by 10 million per cent. Not a return to be sniffed at.

How to choose between different cryptocurrencies

Ether, the second most popular cryptocurrency, looks like it is at an earlier stage of the same process. After its creation in 2014, the price saw little growth for a couple of years, and one ether was worth less than US$1 at the start of 2016. It rose, however, and in December 2017 the price floated around the US$460 mark. Again, solid returns for the early enthusiasts.

Looking beyond the big two, things get a little more complicated. There are now thousands of cryptocurrencies. Some – Ripple, for example – have been around for a while, but more are arriving. Genesis Block, a crypto exchange in Hong Kong, now allows traders to buy and sell over a thousand different cryptocurrencies over the counter. Since there are only about 180 traditional currencies in the world, some of which are barely traded, life for the normal investor in the crypto world is not going to be easy.

Another exchange in Hong Kong, OKex, will soon launch trading in bitcoin derivatives, with plans to offer derivatives of other cryptocurrencies in the future. If you fancy speculating on what the price of an ether will be in six months’ time, there’s the place to do it.  

Picking the right cryptocurrency may yield large returns

With the crypto ecosystem clearly growing, how should a normal investor take advantage of it? At their simplest, cryptocurrencies are digital tokens underscored by distributed ledger technology, or blockchain. Whatever happens to cryptocurrencies, blockchain is going to be part of the future. It is turning up in everything from the world of financial services to shopping. Over on the mainland, US retail giant Walmart is experimenting with blockchain technology to track its produce.

In some ways, blockchain could be seen as many giant excel spreadsheets, linked in such a way that if one is updated, all the others are simultaneously updated. In the age of pre-blockchain internet, one of the problems that prevented a digital currency takeover was figuring out whether an asset was the original or a duplicate. If you can copy your digital token and pay two different people with the same coin, it doesn’t work. Blockchain technology has changed that, and alas, bitcoin was born.

Blockchain technology caused the rise of cryptocurrencies

While many of the new tokens use the bitcoin blockchain to operate, others use the Ethereum blockchain, which underscores ether. Yet many fall into neither camp and are off doing their own weird thing.  

Investors are advised to stick to cryptocurrencies that use an established blockchain. There are already enough variables to worry about when investing in crypto without throwing another into the mix.

If you understand what a token is used for and why, and it seems sensible, then maybe it’s worth a punt. If you really like an idea and want to get in on the action from the start, then a token sale, or ICO (initial coin offering), allows you to do just that.

Investing in cryptocurrencies are risky but rewarding

Developers looking to create a project using cryptocurrencies hold a token sale to raise funds and distribute their tokens. They don’t normally cost a lot to invest in, and they may even offer high returns.

Many are getting excited. So far, nearly US$2.3 billion has been raised in ICOs, mostly in the first half of 2017. Be careful, though – even experts in the crypto world are exercising caution. “There are so many ways to scam people with an ICO,” Leonhard Weese, president of the Hong Kong Bitcoin Association, told the South China Morning Post.

“Investors beautifully admit that most of these start-ups will fail, so all you need to do is raise a few million, appear busy on social media for a few years and then say you ran out of money and blame it on competition, developers or bitcoin. Alternatively, you could ‘hack yourself’ and retire immediately.”

Text: Emrys Gould

Investment Tips: Where should investors put their money?

Where should we be putting our money during this period of record highs? Gafencu’s investment advisor Emrys Gould gives his two cents’ worth

Equity markets around the world are at record highs. The Hang Seng index is poised break the 29 000 barrier, and is at its highest in 10 years.  If we look east from Hong Kong, the Nikkei is pushing 21 year highs and the S&P is continuing to flirt with record highs. If we look west, the FTSE in the UK and the Dax in Germany are also at record highs.

What should investors do? At times like this many of us start getting a little edgy, “what goes up must come down” and all of that.

A fall’s going to come, they always do, the only question is when. The indications are it might be soon(ish). Central banks are starting to unwind the quantitative easing which pushed markets to such highs, the Fed is reasonably likely to hike rates again in December, and, linked to all of this the US dollar is set to start rising again. As it does, liquidity would be likely to flow out of emerging markets and back to the US, hurting valuations.

The big question of course, is when is this going to happen. The Fed has been raising rates all year, and we’ve not seen a correction yet.

If you know the answer, then what to do with your money is fairly easy. Hold plenty of cash, and if you really back yourself, then in Hong Kong since March of this year there have been a few reverse ETFs in the marketplace. These offer returns inverse to the performance of the Hang Seng index, so buy them just before the market plunges, and you’re in the money.

However, knowing when a market has reached its peak is notoriously near impossible to predict.  Even if you’re absolutely convinced you’re right, the old saw attributed to John Maynard Keynes comes to mind: “the market can remain irrational for a lot longer than you can remain solvent.”

So what do you do if you’ve just received a lump of cash and want to invest it? There is no point putting it in a bank when interest rates are as they are, and equity markets probably still have a few months more ooomf in them which you wouldn’t want to miss. There are some bond funds out there which should do OK when big investors start getting risk averse, but no one would describe them as exciting. Gold? Well maybe, but it’s not that big a jump from buying a sizeable chunk of gold, to buying tinned food and fortifying a shed in the woods, and we’re not there yet.

The answer is probably to keep buying equities. It’s a cliché, but in the US, if you invested in the S&P 500 at its peak in 2008, and held on to everything you owned, you’d be back in profit by 2013, and well ahead by now. The same isn’t quite as true in Hong Kong, and since we’re not quite at a peak yet, then the thing to do is to keep buying. The question is what.

If you’re Warren Buffet, then keep doing what you’ve been doing: finding companies whose strong fundamentals aren’t reflected in their price, and investing in them for the long term. But for those of us who have had less success at picking individual stocks, it is rather more a case of finding sectors or areas that might outperform the market as it peaks. 

There are a few options. One thing to consider if you think that rising interest rates are going to put an end to a stock market boom are those few sectors that do well in a rising rate environment.

Banks would be one option, as when rates go up, they can get higher returns on any deposits they have sitting around in savings accounts that they haven’t been able to lend out more profitably. This is particularly true for the big Hong Kong banks. HSBC and Bank of China Hong Kong have vast lazy balance sheets, and higher interest rates go straight to their bottom line. The case is different for those mid and small sized mainland banks who have invested more than 100 per cent of their deposits in whatever bit of the Chinese shadow banking system is in fashion at the moment, but a peaking market isn’t the only reason to steer clear of those.

What about the stocks to avoid? Research by China Constriction Bank International Securities found that tech companies in Asia like Japan have fallen by an average of 25 per cent in the six month period either side of a market peak. The big Hong Kong listed tech companies (really we mean Tencent) might be all right with most analysts still saying buy, but the handful of smaller Chinese tech firms that Charles Li and the Hong Kong exchange managed to lure to Hong Kong rather than the Nasdaq are worth steering clear of.

Other poor performers by CCBIS’ analysis were materials and industrials, which also dropped by high single digits. The best performers, along with financials were energy and real estate stocks.

Energy certainly sounds like a reasonable bet at the moment when it comes to companies listed in Hong Kong with the Belt and Road Initiative likely to provide long term support for both new and old mainland energy firms. The Chinese authorities’ hope to be a green energy superpower continues to be a secular boost for newer forms of energy.

CCBIS’ advice seems sensible. Holding financials, energy and real estate as the market peaks looks like a reasonable thing to do.

Text: Emrys Gould

For the full article, please check out Gafencu’s November issue or the Gafencu app. Download the app from the Google Play Store or Apple App Store