10 January, 2018

Cryptocurrency Investing and Peer to Peer Lending

Cryptocurrency Investing and Peer to Peer Lending

We are raising investment into our own business and during a recent conversation with a potential investor I was faced with the following rejection regarding cryptocurrency:

‘I am going to pass because of the impact of Blockchain on the market’

It’s an interesting response which caught my attention. The impact of blockchain technology on the peer to peer lending market will inevitably be positive once the technology matures to an extent where it can be implemented within the peer to peer lending (P2P) platforms. Cryptocurrency investing, where assets are built using blockchain technology, has, however, had an impact on the wider investment market, not just specifically P2P.

I’m fascinated by the dramatic rise of cryptocurrencies in the past year. It’s taken Nutmeg, the UK’s leading robo-adviser 5 years and substantial marketing spend to reach 50,000 users. At the start of the month, Binance, one of the major cryptocurrency exchanges announced that it on-boarded 250,000 new users in a single day. These large new investor numbers are common across all exchanges and not unique to a single day or exchange. It’s worth caveating this point by stating that cryptocurrency investors reside globally while Nutmeg investors are UK-based only.

Before we draw comparisons to P2P investments, it’s worth noting what is going on in the cryptocurrency market currently. A lot of people have made a lot of money over the past year with the emergence of this asset class which now has a market cap of $700 billion (Jan 10th).

It’s hard to argue with the results. The price of Bitcoin rose from $964 on the 1st of January 2017 to $13,414 on the 1st of January 2018, a 1200% rise. An actual slow growth rate in comparison to others: Ethereum which now has a market cap of $125 billion grew 8800% and Ripple, with a market cap of $74 billion, grew by 39700%. Large swings in prices are still common with no clear sight of stability.

Figure 1: Top 10 Cryptocurrencies by market cap (10th January 2018, https://coinmarketcap.com/)

A bubble exists when assets are traded far in excess of their intrinsic value. The principal technology, ‘Blockchain’, is widely accepted as a game changer but how it will be used is still up for debate. This creates significant speculation as it is impossible to evaluate the intrinsic value without using traditional methods. Cryptocurrencies can be divided into three categories: Platform-based, Currency-based and Application-based. This can be useful when trying to estimate the intrinsic value.

Platform-based cryptocurrencies such as Ethereum, NEO or EOS are full blockchain technologies that have their own protocols and allow for other applications to be developed onto of them. In theory, if the applications increase in value, the underlying technology should also increase in value. It’s not clear, however, how this value will be transferred.

Currency-based cryptocurrencies such as Bitcoin are stores of value that facilitate transactions. They are often compared against commodities such as gold as the number of Bitcoins, for example, in circulation are limited by a technological algorithm. They will never generate cash or profits and could be used to transfer wealth. If the price of Bitcoin was stable it could be useful in countries with high corruption levels and an unstable local currency.

Application-based cryptocurrencies are blockchain solutions/ start-ups/projects which solve problems. They could earn cash or additional coins through the provision of services sold and can be valued similar to that of a company.

All three cryptocurrency types are very different and difficult to value. This has increased speculation in the market which has increased prices dramatically. Cryptocurrencies are launched to the market to raise funds to finance the aims of the blockchain initiative. This is done through an initial coin offering (ICO).

If we take TRON as an example, the 12th largest cryptocurrency with a market cap of $7.5 billion – which was actually the 9th largest with a $11bn market cap two days ago – we can find on the TRON website that the project aims to construct a worldwide free content entertainment system. The technology allows for each user to freely publish, store and own data.*  The application-based cryptocurrency came to the market in September 2017 and has yet to launch its actual product. It simply has an idea with a team of developers. With no product, the intrinsic value of $7.5 billion feels somewhat overstretched. By comparison, Funding Circle is expected to IPO later this year with a proposed market cap of £1 billion ($1.35 billion). So, on paper TRON is currently valued at 5x Funding circle or, by Monday’s value, roughly the same size as Hargreaves Lansdown.

*Interesting drill-down into TRON can be found here: ‘Tron Cryptocurrency: 30 Burning Questions Answered

Let’s assume that a bubble does exist, one key question is when will this bubble burst and is there still an opportunity to make money. This is purely my own view and should not be considered financial advice, but I believe we are not at the peak of the bubble. There are now large institutional investors in the market and the number of new investors the exchanges are on-boarding demonstrates that demand is still growing. An opportunity may still exist to make short-term money.

Making a move is, however, extremely risky as you can see by the large swing in TRON in the past two days. If the fundamentals of blockchain technology are strong enough, winners may emerge in the future. Drawing comparisons to the DOTCOM bubble, is there a way to predict the next Amazon or Microsoft? Unfortunately, it is impossible to say with any confidence which coins will be the winners, the extent of the bubble, when it will burst and, if it does, how long it will take for the winners to recover. It took Amazon 10 years for its stock price to reach the same price as it was at the height of the DOTCOM boom. If you invested in CISCO at the height of the bubble you would still be holding at a loss. Remember, these are only the winners who survived the DOTCOM bubble, many didn’t.

Figure 2: CISCO Stock Price

If you’re considering taking the plunge, I would add further caution. It is actually difficult to first invest in cryptocurrencies, but more importantly it is difficult to get money out of the market. Coinbase, one of the main exchanges which converts pounds sterling into a number of leading cryptocurrencies will not send money back in pounds sterling. Investors need to set up a Euro account with providers such as Revolut and even this takes time. It’s not clear why this process is so difficult, however there have been murmurings that the UK GBP banks are not accepting funds from cryptocurrency exchanges because of anti money laundering reasons. I can imagine if a large number of users tried to withdraw all at once this withdrawal issue would be multiplied dramatically.

Does all this affect the P2P market?

It takes the spotlight off the P2P market for sure, but it does not change the fundamentals of P2P. They are completely different investments. Our Chairman proposed yesterday that an opportunity may exist for the P2P platforms to capture cryptocurrency investors who have made a lot of money in 2017. Perhaps these people still want exposure to alternatives offering steady, reasonable returns without the same risk or volatility of cryptocurrency investing. Both asset classes are classified as alternative investing, based on innovative technologies after all.

The profile of a cryptocurrency investor is really interesting. Both robo-advisers and the P2P lending market have in the past tried and to a large extent failed to capture the millennial investor market. With the hope of a quick win, this younger investor group has been drawn to the cryptocurrency market. Perhaps this will be their first step into investing and will open up a new group of investors to the P2P sector.