The investment landscape for Bitcoin has recently experienced notable developments, particularly with the U.S. approval of various Bitcoin Exchange Traded Funds (ETFs). This has significantly increased demand and price, enabling retail investors to bypass the complexities of blockchain technology and regulatory hurdles, facilitating easy ownership of this leading cryptocurrency.

I have long argued that cryptocurrency is an important inclusion in investment portfolios, with research showing that these can enhance returns and reduce volatility. And, if you focus on the macro trends, this should be no surprise.  Increasing access to technology (especially in countries with low banking penetration), inflationary monetary policy from many governments and a post-Covid sensitivity to the fragility of social cohesion all play to the strengths of cryptocurrency as a store of value.

And there is nothing wrong with (in particular) Bitcoin being treated as an electronic store of value in this context.  It is secure, liquid, low-cost to access and hold, and increasingly well-understood and treated by regulators.  But it is worth remembering that this store of value is secondary to the main reason for its invention – as a medium of exchange in daily transactions.

In 2009, the world was starting its recovery from the Global Financial Crisis (oh happy days…) and (still pseudonymous) Satoshi Nakamoto released the seminal whitepaper “Bitcoin: A Peer-to-peer Electronic Cash System”.  In it, s/he explains “What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party”(my emphasis).

In other words, Bitcoin was invented primarily to serve as an electronic medium of exchange, solving the double-spend problem as well as replacing the authority of federal governments with cryptography.  Yet, right now this purpose has been supplanted by Bitcoin being used as both a store of value and its derivative, a trading tool by speculators.

It is possible for Bitcoin to ‘evolve back’ to its intended use.  I believe that one day, consumers will have the ability, should they choose, to conduct their everyday business in the same way they use credit cards and fiat currency presently (and I am happy to invoice my clients in Bitcoin!)

But this day is still some distance away.  Several steps need to occur for this to become a reality.  Ironically, these will have the possibly contradictory benefit of increasing the value of Bitcoin.  But all of these will provide many benefits for the world’s population and act as an incredible economic stimulus.

Consumer Ecosystem 

First up, the User experience (UX) to use Bitcoin is just hard. To buy Bitcoin, you need to open an account with a Crytoexchange, satisfy KYC/AML then work out how to transfer fiat into the account and place an order.  And, even then, the exchange will most likely lean on you to keep the BTC within your account, where its external usage is very limited.  Try and transfer it out to your wallet (establishing which is itself another not insignificant process of choosing a method, provider, and saving passwords) and you’ll most likely be subject to further interrogation by the exchange who hate to see your assets leave their clutches.  

And that’s just getting ready to be able to spend it!  The benefit of a peer-to-peer system is that there is no ‘middle-man’ but equally, that means you need to be careful that you are sending your Bitcoin to the right address.  There are some early retail systems to make this easy, but they involve (as do most Bitcoin transactions) scanning  QR codes to ensure the recipient address is copied correctly.  Still a long way from Tap and Go, or handing over some cash, that most people use right now.

Which leads to a related problem for mass consumer adoption of Bitcoin:

Speed

If Bitcoin is competing against current payment platforms, the immediate question is, can it compete on price and volumes?  And, right now, the answer is “No”.  The Bitcoin blockchain can handle about 7 transactions per second, compared to Mastercard at 5,000 per second and Visa at up to 24,000 per second.  All that adds up to a lot of standing around for customers, potentially up to an hour for the final transaction to be verified on the blockchain.  This is where Bitcoin’s strength becomes its weakness, as the lack of a central authority means time and computing power to verify and secure – but at the same time making the price for average retail transactions uncompetitive.

There is some good news on the horizon – the development of ‘Layer 2’ networks built on top of the Bitcoin blockchain.  These mini-networks make some short-term technical compromises on security and decentralisation to increase speed and reduce costs.  The Lightning Network is the most prominent example and holds real promise through establishing channels, separate from the blockchain, between Bitcoin users.  These transactions are then grouped and posted, in summary form to the main blockchain together once all transactions between the parties are complete.  The result:  much faster and cheaper processing times.

Price Stability

Bitcoin still lacks one of the most important properties to become a good store of value: price stability.  Ironically, Bitcoin’s success as a speculative investment may retard its ability to act as a medium of exchange.  

After all, why buy your groceries with Bitcoin if you are confident that it will be worth more next week? Why accept Bitcoin as payment if your business has to pay tax in fiat and you aren’t confident it won’t be worth less when it is tax return time?  More than the absolute value of its value, it is the volatility of Bitcoin that also contractions its use as money right now.  

But where does this volatility come from, and how can it be managed?  If price stability is a result of demand being stable relative to its supply, then clearly, in the case of Bitcoin which has a fixed rate of supply, it is the wildly fluctuating demand that has created the volatility.  In other words, for Bitcoin to be used as money, the demand for it needs to be stabilised.

One approach is to adopt the same sort of solutions that fiat currency has used:  create and adopt financial derivatives and credit which is backed by Bitcoin (rather than using Bitcoin itself).  If Layer 2 solutions like the Lightning Network can increase the velocity of Bitcoin, credit  – or even cash money backed by Bitcoin (rather than your federal bank) – could increase the demand and hence bring in price stability.

The Future is Bright if yet to be Created

I was listening to a recent podcast with physicist Stephen Wolfram where he observed that predicting the future of what technological developments will bring was much simpler than guessing when they might happen:  the former is relatively straightforward, but with the latter, it’s easy to be even decades off the mark.

Similarly, I believe that it will be an inevitable consequence of many factors (technological, societal and political amongst them), will see Bitcoin eventually adopted as a quotidian medium of exchange, used by people around the world.  As I have argued, there is still a lot that has to happen for this to occur. But these changes are being discussed and worked on  – and may happen far quicker than we anticipate.  

The exciting part is that we can be part of this change.  Until then, Bitcoin (and other cryptocurrencies) should not be excluded as part of an investment portfolio, and the underlying promise of blockchain to transform our economy be considered as part of your investment decisions. 

I’d love to continue this conversation with you – Contact me and tell me your story!

With the recent approval by the SEC of Bitcoin spot ETPs, there has been increased discussion on how jurisdictions regulate and tax cryptocurrency.  Between the US’s inability to determine whether crypto is a security or a commodity (or both) and China simply outright banning them, the majority of Western countries have, at times, struggled to adapt their existing regimes to this new financial medium.

In my particular area of expertise, assisting investors and expats in Australia and Switzerland, the landscape of cryptocurrency regulation and adoption presents a stark contrast between the two countries. As they both navigate the evolving realm of digital currencies, their distinct approaches offer insights for sophisticated investors experienced in cryptocurrency.

Swiss Embrace of Cryptocurrency

Switzerland, particularly its cantons, has been a frontrunner in embracing cryptocurrency. The Swiss canton of Zug, known as the “Crypto Valley,” is notable for accepting Bitcoin (BTC) and Ethereum (ETH) for tax payments, reflecting the country’s progressive stance towards digital currencies. 

Additionally, the city of Lugano in Switzerland has also announced its readiness to accept tax payments in cryptocurrencies like Bitcoin and Tether (USDT). This initiative is part of Lugano’s broader strategy, known as Plan B, to integrate Bitcoin technology into the city’s financial system.

Indeed, Lugano has positioned itself strongly as a crypto-friendly city, developing its own cryptocurrency and wallet app which is accepted by over 400 businesses throughout the canton. 

The tax treatment of cryptocurrency gains in Switzerland is quite favourable for private investors:

Capital Gains Tax Exemption: For private investors in Switzerland – Capital Gains Tax does not apply to private wealth assets. Capital Gains Tax only applies if you’re a self-employed trader or a business. So, unless you are an active trader in crypto, the value of your assets will be included in the general Wealth Tax and you’ll be taxed according to the specific Canton you reside in.

Wealth Tax: Cryptocurrencies are taxed under the Wealth Tax system. The Swiss Federal Tax Administration (FTA) annually defines the taxation value of the most commonly used cryptocurrencies, which taxpayers need to refer to when declaring their crypto assets​​.

Income Tax: Income Tax may apply in cases where crypto is seen as a form of earnings, such as receiving cryptocurrency as salary or accepting it for services rendered by self-employed individuals​​. The Income Tax rate in Switzerland includes Federal, Canton, and Municipal Income Tax, and is progressive or flat-rate depending on the canton​​.

Other Considerations: Certain crypto transactions like buying, selling, trading, and transferring crypto are tax-free for private investors. However, activities like airdrops are subject to Income Tax​​​​​​. The tax treatment of crypto gifts and donations, mining, margin trading, derivatives, and DeFi activities varies and may depend on the specific circumstances and the canton​​.

Overall, Switzerland’s regulatory approach to cryptocurrency is progressive and investor-friendly, with an emphasis on distinguishing between private investors and professional traders or businesses for tax purposes.

Australian Rigour:  Trade and be Taxed!

Australia’s approach to cryptocurrency regulation is more cautious. The Australian government classifies cryptocurrencies as property, making them subject to Capital Gains Tax (CGT).  Unlike Switzerland, Australia does not permit the use of cryptocurrencies for tax payments, indicating a more conservative stance towards digital currencies.

In Australia, the taxation and regulatory approach to cryptocurrency for individual taxpayers involves several key aspects:

Capital Gains Tax (CGT): Cryptocurrency is subject to Capital Gains Tax when disposed of, which includes selling, trading, spending, or gifting crypto. If held for more than a year, individuals are eligible for a 50% CGT discount​​. For individual Australian taxpayers, disposing of cryptocurrencies is considered a CGT event. This necessitates meticulous record-keeping and accurate reporting of any capital gains or losses.  Unfortunately, the ATO has taken an extremely narrow interpretation of the law, meaning that even routine trading actions such as staking are considered CGT events – spawning a burgeoning tertiary software industry to track crypto transactions.  

Income Tax: Certain crypto transactions, such as receiving a salary in crypto, selling NFTs, or staking, can be treated as income and taxed accordingly.  With staking, the additional coins you receive as a reward are treated as income at the time of receipt – which is a different tax altogether to the CGT applicable on the original staked amount. 

Airdrops: Airdrops are generally considered ordinary income at their fair market value on the date of receipt, except for initial allocation airdrops, which are not considered ordinary income upon receipt​.

Crypto Losses: Losses from crypto can be used to offset capital gains but cannot be deducted from other income​.

Comparison and Actionable Insights for Investors

Both Switzerland and Australia require the declaration of cryptocurrency holdings for tax purposes. However, their approaches differ significantly. Swiss cantons offer flexibility in cryptocurrency taxation, whereas Australia provides a uniform but more rigid framework.

Of course, you can ignore crypto altogether.  I think this would be a mistake – as I’ve previously argued, I think crypto should form a part of every investor’s portfolio.  Aside from the cryptocurrencies themselves, Blockchain technology continues to play an increasingly important role in traditional business operations.

For investors, these differences necessitate tailored strategies:

Navigating Swiss Taxation: Investors in Switzerland must understand the specific tax regulations in each canton, especially if they hold assets in cantons like Zug or Lugano, which have embraced cryptocurrency for tax payments.

Compliance in Australia: Australian investors should maintain accurate records of all cryptocurrency transactions due to the CGT implications and the ATO’s focus on compliance.

Exploring Opportunities: The Swiss model offers unique opportunities in cantons that support cryptocurrency, such as Zug and Lugano. Investors might explore these areas for potential tax advantages and to engage in a burgeoning crypto ecosystem.

Risk Assessment: The flexibility in the Swiss tax system comes with the need for thorough due diligence, especially regarding the tax implications in different cantons.

Strategic Planning: In Australia, investors should incorporate the CGT implications of cryptocurrencies into their long-term investment strategies.

Staying Informed: Regulations in both countries are dynamic. Staying updated with the latest developments is crucial for effective portfolio management and compliance.

Conclusion

An awareness of the differing tax treatments and regulatory regimes is especially useful in times of changing residency, as it allows for any necessary actions to be taken prior to the change.  Equally, the acceptance (or otherwise) by regulators in a given jurisdiction is a strong signal as to where cryptocurrencies are headed within the particular country.  On that front,  while each country has its strengths and weaknesses when it comes to the adaptation and regulation of cryptocurrency, at least we can be thankful for the clarity they each provide – even if some of the approaches are better suited to fiat and real property rather than digital assets.

More specifically, these differences again demonstrate the importance of specific advice for your individual circumstances.  I’d love to hear from you personally to see how my expertise can assist you.  I travel regularly between the two countries and have an extensive range of professional colleagues in the UK, EU, Middle East and the USA.   In Australia, I work with the leading firm The Wealth Designers.  If you would like to arrange a meeting to discuss your specific situation, you can contact me here.

International Investors need to consider the macro-economic environment and jurisdictional factors as critical elements in determining where and how they invest.  The longer the timeframe for investment, the more important this becomes.  

Creating intergenerational wealth is a mission that requires considerations that extend beyond short-term trading.  It means increased consideration for jurisdictional issues, which in turn influences the currencies that one invests in.

A common – and true – statement that fund managers make is ‘past performance is no guarantee of future returns’.  Yet understanding the environmental qualities that foster wealth creation is an excellent way of maximising your opportunities. At the very least, it helps manage risk and, at best, ensures that your capital is in the best place to prosper. 

Simply put, you want your money to be where the action is.  Where entrepreneurs are active, and where capital markets are strong. Where the future is being created.   

The Power Formula

Recently, I was listening to John Mearsheimer, a political scientist, discussing the basis for countries accumulating power. Power is a function of population and wealth. That is, the more people a country has, and the wealthier it is, the more powerful this country will be. Though Mearsheimer was talking in the context of international political relations, (and you can read more about his political realist theories in his excellent book “How States Think”) it got me thinking about how this formula plays out over time, and what the implications are for international investors.

Just as this formula supports political and military power, it also reflects the strength of a national economy. This, in turn, supports the value of that country’s currency and provides an arena to attract and implement capital investments. Thus begins a virtuous circle, which in turn attracts entrepreneurs and early-stage companies, creating a melting pot that, ideally, incubates new companies and creates wealth over time for investors.

Remember too, from my recent posts, that a strong economy is a critical driver of a strong currency, another important consideration for investors. But how can someone assess these aspects?

I’m obviously looking at this from the perspective of Australian and Swiss investors. Home country bias is real and also justified. Not only are there usually tax advantages from investing in your home country (e.g., capital gains discounts for Australians, property concessions in Switzerland), but the geographical proximity results in better knowledge about any given investment compared to one located across the ocean.

Comparing Capital Markets

So, how do Switzerland and Australia stack up? Let’s first have a look at the size of their listed entities over time.

I’ve chosen the 20 years ending in 2019 as a good period for comparison, as it would include the tail-end of the tech crash but also avoid the Covid pandemic. And both countries look good – we can see strong and regular growth in the total market cap of listed entities. This speaks to a strong and growing economy, which would also help support the value of their respective currencies.

On just this metric, both would seem a good place for investors to consider placing their capital. Growing capital markets, indicating a robust and profitable environment for entrepreneurs and a financially literate society.

But though these two countries are relatively competitive, how do they look in an absolute sense? Let’s see how they compare against the largest capitalist economy in the world, the United States.

The two are completely dwarfed by the USA. But it is hardly fair – after all, the USA has a much larger population than either Australia or Switzerland. Is it simply a matter of scale, or is the US actually more productive per person? 

To get an idea, let’s look at the GDP per individual person:

This data surprised me somewhat. I was expecting the USA to have a superior growth rate over the period. Switzerland is clearly the highest (which makes sense given the listed market cap is similar to Australia yet they have a population of only about a third). Importantly, from an investment perspective, all countries show regular positive growth over this extended period of time.

Where the Rubber Hits the Road

So, what does this mean from a practical, coal-face investment perspective?  Let’s start by looking at the Top 10 companies in each domestic market:

Obviously, the US again towers over  Australia and Switzerland.  If BHP, the big Australian, were in the US, it would be ranked around 145!

But what really caught my eye was the age of the companies.  In the USA, 7 of the ten were founded in the last 50 years, and 5 of the Top 10 within the past 30 years.  

Compare that with Switzerland where only 1 (ignoring mergers) – Glencore started in the last 50 years, and Australia which has only 2: Fortescue and Atlassian.

Further, the USA companies have obviously greater exposure to the technology sector, compared to banking, mining, retail and pharmaceuticals in the other countries.  Arguably, this tech sector still has the greater potential for growth.

Investing Takeaways

So what lessons can we take from this?

All three countries are in good shape: Each of these jurisdictions has strong capital markets in proportion to their population.

Individual circumstances hold the trump card: From a strategic asset allocation perspective, your exposure should be influenced by your specific circumstances. For example, Australian shares have a greater emphasis on dividend yield compared to the US. Further, Australian tax residents benefit from dividend imputation. These two benefits may have greater appeal than potential higher capital growth that would be obtained in US equities.

It’s hard to go past the USA for innovation: Let’s face it: the greatest proportion of the world’s innovators go to the US to create and grow their enterprises. You need to be there to participate in this, whether as a VC partner or a simple holder of ETFs.

Finally, if we return to Mearsheimer’s perspective, the USA remains the standout economy for investors. It has the absolute scale and an environment that fosters entrepreneurship. It is the most likely location to incubate the next entities into the world’s largest and successful companies. This, in turn, will support the value of the US dollar. The USA wins the power equation – at least for now.

The good news is, whether you are a sophisticated investor, or just starting out, there are cost-effective ways for you to benefit from this information. Contact me today if you would like to discuss how this can be achieved.

The old show business saying is ‘Never work with animals and children.’ Well, if we adapt that for finance, you can add ‘…or try and predict short-term currency movements.’

After my last blog on why the Aussie is being smashed by the Franc,  I thought the recent increase by the Australian RBA, especially when the US Fed and the Swiss SNB stayed unchanged, would support my explanation and we would see a rise in the Aussie.

However, contrary to expectations, the AUD saw a decline against major currencies like the USD and CHF, falling about 1c against the $US (although it has recovered some of that since).  This counterintuitive scenario in the forex market prompts a perplexing question: “Hey, interest rates went up, yet the Aussie went down? What gives?”

The Short-Term Quirk: A Lesson in Market Complexity

Typically, an interest rate hike is seen as a signal of economic strength, potentially leading to an appreciation in the currency’s value. However, the intricacies of the currency market often defy such linear logic. 

The decline of the AUD, despite rising interest rates, seems perplexing at first glance. Historically, higher interest rates tend to attract foreign capital, seeking higher returns, thus increasing the demand and consequently the value of the domestic currency. So, what gives? Why did the AUD fall?

The answer lies in the complex web of factors that drive currency values. While interest rates are a significant factor, they are not the only one. Other elements such as economic growth forecasts, geopolitical stability, commodity prices, and broader market sentiments play a crucial role. In this instance, the market’s reaction seemed to be reflective of the RBA’s less aggressive stance on future rate hikes​​ (paywall only). The concurrent rise in US Treasury yields that same week also brought further competitive pressure against the Aussie.

The best apparent explanation is that the Aussie fell not because of the actual rise, but because the RBA hinted that the chances of future rises had diminished.  A derivative reaction, in other words.

The Challenge of Short-Term Predictions

This episode serves as a prime example of the difficulties associated with short-term financial forecasting, especially in the forex market. The volatile nature of currencies, influenced by an array of interconnected and sometimes unpredictable factors, makes accurate short-term predictions a challenging feat. 

Or, in more colloquial terms, it can drive you mad!

This is why, as investors and financial strategists, our focus should always lean more towards understanding and adapting to long-term trends, within the context of a health creation strategy, rather than attempting to capitalise on short-term market movements.

The Long-Term Drivers: More Than Just Interest Rates

To fully grasp the dynamics of fiat currency values, we must consider a variety of long-term drivers:

Economic Indicators: Metrics such as GDP growth, unemployment rates, and consumer spending significantly influence currency value.

Interest Rate Differentials: The difference in interest rates between countries can impact currency values more profoundly than the change in absolute rates.

Geopolitical Stability: Political stability and predictability can attract investment, strengthening a currency.

Market Sentiment: Investor sentiment, shaped by global economic news, political developments, and market speculation, plays a crucial role.

This episode serves as a reminder of the challenges in predicting short-term market movements. It underscores the importance of a holistic view of global economic conditions rather than focusing solely on one indicator, such as interest rates. 

As strategic investors, it also encourages us to ignore the noise of daily financial markets and look to the trends – again all within the context of your individual life plan.

Navigating Currency Markets with Expert Guidance

So, for those expats with large Aussie holdings, it looks like the currency pain may continue for a while longer.

The complexities of the currency market present both challenges and opportunities. If you’re grappling with the impact of exchange rates on your global assets, let’s connect. Together, we can optimise your portfolio’s performance and align your investment strategy with your long-term financial objectives.

Every international investor needs to understand the influence that exchange rates have on the return on their investments. Predicting exchange rates, especially over the short term, is notoriously difficult. This is particularly relevant for my fellow Australians living in Switzerland – how we wish this were not the case! Over the last 10 to 12 years we’ve seen the Australian dollar go from around parity with the Franc to being a very sad 58c.  

Still, it’s a double-edged sword.  If you are earning or investing in Francs, this could be a great time to repatriate funds down under (assuming that Australia will again be your future home).

The ebbs and flows of foreign exchange may take us by surprise from time to time.  For those of us with business and life interests in more than one country it’s a good idea to have some sort of benchmark or ‘rule of thumb’ as to what represents a fair value for your home currency. I am often asked by Aussies here in Switzerland whether it is wise to repatriate funds, or invest in Francs or US dollars instead.  Equally, Aussies who are looking to expand overseas, want to get an idea of when they should transfer funds over.  

Whilst trying to specifically predict exchange rate movements can be a heart-breaking game, the path to getting more right than wrong starts with understanding several key factors that affect forex exchange rates:

Interest Rate Differences

Have a look at Chart 1, which shows the Exchange Rate values and Interest Rate differentials between Australia, the US, and Switzerland (currency shown in $AU terms and interest rates as differentials between Australia and the respective country).  Now, imagine you are a global currency manager back in 2011 or 2012, and you are comfortable that the risk of these three countries going broke is small enough to ignore.  By holding $AU as your preferred currency, you could have got an extra 4% on your deposits.  

Which currency would you buy?  Back then, investors could borrow $US, exchange, and deposit it in $AU, getting an additional (almost) risk-free return on their funds.  Even after this carry-trade arbitraged away the valuation difference, the additional yield was a tremendous factor in supporting the value of the Aussie.

Chart 1: AU, US and CH exchange and interest rates

Hence, a virtual circle was created for the Aussie, lifting its value up to parity and beyond with both the $US and the Franc.  As soon as this interest advantage disappeared, so did the strength of the Aussie.

Economic Activity

Another important factor is the level of economic activity in a jurisdiction.  This drives demand for currency because if you want to invest or do business in a country, you must also pay taxes and make your purchases in that currency.  Check out Chart 2, and look at what happens when Australian and US interest rates are the same, as in 2018 and 2020.  Without any extra interest rate differential, the $AU is worth around $US0.72.  

Why?  One big reason is this is the massive differences in economies and equity markets between the two countries.  There is simply more demand for $US which makes them worth more than the $AU.

Chart 2: Au and US exchange and interest rates 

Safe Haven Status

Chart 3 compares the Aussie against the Franc.  Look at how the Aussie has devalued against the Franc during the time in question. Yet, during the past 13 years, the Aussie always had a net positive interest rate differential.  

Australia has a population 3 times the size of Switzerland and, generally, a higher growth rate. The two countries have similar market capitalisations – so Australia more than competes with Switzerland economically. 

Yet, the value of an Aussie has reduced from being above parity to about 58 centimes during this period.

Chart 3:  $AU and Swiss Franc exchange and interest rates

It is not just the Aussie that has been challenged by the appreciation of the Franc.  Chart 4 shows the story of the $US against the Franc over the same period.  Despite the strength of the US economy and the higher interest rates, the Greenback has struggled to keep at 95 centimes.  Look at the two times it has fallen against the Franc recently, the first in early 2020 at COVID and a rapid decrease in interest rate differentials through doubt over the world economy (amongst other things).  More recently though, despite an increasing interest rate differential, the Greenback has fallen around 10% in value.  

Chart 4:  $US and Swiss Franc exchange and interest rates

This trend was material enough for the US government to brand Switzerland a currency manipulator in 2020, a stance they have since rolled back.  I am not sure what Switzerland was supposed to do to avoid US wrath -after all, at the time they had negative interest rates!

Both of these trends illustrate to me the influence of Switzerland’s ‘safe-haven’ status, which has supported the value of the Franc despite the headwinds of Interest Rate differentials and Switzerland’s relatively small economy.  When the world is in a troubled place, the Franc is the ‘go-to’ currency, much like Gold is also seen as a safe-haven commodity.

This isn’t just anecdotal – in 2015 there was research done that concluded that in times of heightened global risk, the Swiss Franc appreciated against the Australian Dollar.

Assessing Fair Value?

Even with a good understanding of these three drivers, trying to predict exchange rate movements is a pursuit that, frankly (pardon the pun), I prefer to leave to others.  There are so many factors outside of an investor’s control that you are wiser to manage your fiat exposure much as you do with other aspects of your portfolio, through diversification and hedging.  

However, if you are an Australian in Switzerland, or have business interests in both countries, there are some tactical measures you can consider to take advantage of what longer-term trends can tell us.  These should be done in the context of your overall financial strategy, and remember that while history may guide us, it doesn’t predict what will happen.

I find it useful to infer a rough ‘fair value’ for the three currencies, based on what they are valued at when other factors are equal.  For example, when there is no interest rate differential (Chart 3, 2018 & 2020), the Aussie is worth around  $USD 0.70 to 0.75.  Similarly, when the US and Switzerland are on the same federal interest rate (Chart 4, 2011 – 2015), the $US ranged from 0.85 to 0.97 Francs.  From this, you can make a simplistic but useful benchmark of what ‘fair value’ is for the Australian dollar.  

Namely, fair value for the Aussie could be considered: 

1 Australian Dollar = 0.70 – 0.75 US Dollars

1 Australian Dollar = 0.60 – 0.65 Swiss Francs

Keeping these benchmarks in mind can help act as a guide when making tactical decisions about your cash allocations and money transfers.

Navigating Choppy Waters?

For Australians currently earning income or holding investments primarily in Swiss Francs, the current valuation exchange rates could present a tactical opportunity to repatriate some of those funds back to Australia at an advantageous rate, if Australia is ultimately where you plan to settle long-term. With Swiss deposit rates hovering just above zero, parking some funds in Australian accounts earning 4%+ interest could be prudent.

On the flip side, Australians who are looking to expand their business or investments overseas may want to consider deferring any major transfers into foreign currency for now, and ideally build up foreign currency reserves slowly when the Aussie dollar eventually appreciates back closer to ‘fair value’. Focusing investments on Australian firms with significant overseas earnings in foreign currencies can also help hedge some of the currency fluctuation risks.

Also, deciding the best tactic is a question that needs to be answered within the context of your strategic financial plan, and you should be talking with your adviser before making these decisions. As always, note that this article is not specific financial advice!  

Remember, although we’ve looked at a fair value for the Aussie based on the past 13 years or so, no rule says that forex values need to revert to the mean.  Always diversify, so that when you need money, you have a smart place to get some from.

The most important takeaway is that foreign exchange levels often overshoot in both directions for extended periods, and sustaining valuation extremes is difficult over the long run. While the ebbs and flows of currency markets are challenging to predict, having a framework to identify when exchange rates look particularly distorted can help investors make smarter decisions on when to transfer funds internationally.

To sum up, the intricacies of currency exchange might appear enigmatic, but they conceal opportunities for the discerning investor. If you’re grappling with the complexities of how exchange rates are affecting your global assets, it’s time we talked. Let me guide you through these financial intricacies to optimise your portfolio’s performance.

References

All historic numbers in the Charts above were amalgamated from the following official sources:

Reserve Bank of Australia

Swiss National Bank (SNB)

FRED St Louis Reserve Bank, USA

Any Aussie who heads overseas for an extended time will tell you it’s a big move, and on the money side, there are many aspects to consider – new jobs, new currencies, new bank accounts, new tax systems.  Eventually, though, the question comes up: ‘I’ve started a new life outside Australia, who knows if and when I may return:  how can I get my superannuation transferred to my new home country?”

Simply put, in most cases, although you might have been able to move, unfortunately, your super must stay put in Australia.  With apologies to Icehouse, Australia remains a Prisoner Island when it comes to the transferability of your carefully saved superannuation funds.  They are locked away, tighter than a snap Covid lockdown.

The strict rules for accessing your super – technically called Conditions of Release – still apply, even if your move overseas is permanent.

For most people, a condition of release is tied to your age and working status. This means being at least 55 and retired, or over 65.  Until then, your Australian superannuation must remain domiciled in Australia, accumulating until you finish working.

If this seems unfair, you have a point (although the first tenet of financial markets is that the concept of fairness is quite a malleable one).  Switzerland for example, will in many cases let you withdraw most, if not all, your retirement savings if you expatriate.

Hidden in the Summer for a Million Years: What Action Should I Take?

It’s not all bad news – just because you must leave your super in Australia, doesn’t mean it should be ignored.  It’s still your money and it should be working hard for your benefit.  This means that your Aussie super should still be part of your overall financial plan.   You can get the best out of it by considering these aspects, all of which can still be done from your new home:

Consolidate accounts: it usually makes sense and saves money and time to have only one superannuation account.

Invest appropriately: Too often I see clients’ super getting left in default portfolios that are not appropriate for their circumstances.  If you are in your 40s and have another 15 years until you reach preservation age, is a Conservative portfolio the right one for you?  

If you are approaching retirement, it is also worth considering the underlying currency in your super investments.  For example, an S&P500 ETF may be denominated in $AU but its performance incorporates the performance of the $US.   

Beneficiary Nomination: There’s one condition of release that few are eager to meet: death.  But who and how you nominate beneficiaries is a critical aspect of estate planning.  The rules for tax on super vary depending on who the money goes to – meaning that with super there is often a ‘de facto’ death tax in Australia.  Funds that end up in the hands of anyone other than your spouse (for example, adult children) can be taxed at up to 15% plus the Medicare Levy. 

Should you still contribute?  In most cases, you can keep saving money in your super fund, but the decision should be made in the context of the savings alternatives in your new home and the tax regime that will apply.  Often, these alternatives are more appropriate and usually have the benefit of easier access should you need it. 

 All of these factors are very simple administratively but do require careful planning, not only for the Australian implications but for what it means in your new home when you are able to access your super.  

A Rainy Day Down on the Harbour: What about my SMSF?

Many Aussies want to have greater control over the management and investments in their super fund and have expressed this by having their own Self-Managed Super Fund (SMSF).  This can be a great idea while you live in Australia, but new problems arise if you leave the country.  

The biggest risk is that your SMSF is categorised as a non-resident fund, which would make it non-complying.   As that phrase suggests, this is not good.  Assessable income gets taxed at the highest marginal rate (right now, 45% versus 15%) and in the first year, the entire assets of the fund are treated as assessable income!

And this risk is very real if you move overseas for a few years.  For the fund to remain resident it needs to satisfy three conditions.  Achieving this for the majority of SMSFs, which are typically one or two-member funds, is in my experience, almost impossible.  Retaining central management and control of the fund, as well as having a majority of members and assets (in simple terms) remaining in Australia is extremely problematic, even if you have a corporate trustee for the fund.  It may be most appropriate to close your SMSF and rollover your benefits to a public regulated fund.

I Hear The Sound of Stranger’s Voices: Retirement Access!

OK, so you have met a condition of release, and can finally get your hands on your super!  Yes, you can withdraw the balance as a lump sum (less any applicable tax) or transfer into the pension phase and take a regular payment from the fund.  The latter method has the advantage that the tax rate on assessable income reduces from 15% to nil.   With some franking credits, the fund may even get a tax refund.

C’est génial, n’est-ce pas? Es ist grossartig, nicht wahr? Not so fast. The planning shouldn’t stop there. Whilst in Australia a lump sum withdrawal and pension payments means little or no tax is payable, as a non-resident you will now need to consider the implications of taxation in the country you reside. 

From a Swiss taxation perspective, the most relevant considerations would be the inclusion of the value of a lump-sum withdrawal in the calculation of wealth tax or the inclusion of all of the (Australian tax-free) pension income in your income. It may be more appropriate to leave the fund in the accumulation stage and make occasional lump sum withdrawals.  

The situation in Switzerland is further complicated by different tax rates in each Canton and of course, determined by your overall financial position.

Looking Everywhere Cause I Had to Find You:  What’s Next

It’s easy for Aussies to put their super in the too-hard basket when you move overseas. Each situation is different and dependent upon the type of super fund, your personal circumstances and the tax regimes of your new home.  Your super fund is likely to be one of your most valuable assets, so it deserves both attention and professional advice, to ensure that your money is working to service the life that you wish.

As a licensed financial adviser in both Switzerland and Australia, I’d be delighted to talk to you further about your own situation.  Contact me here to start the conversation.

Central Bank Digital Currencies (CBDCs) simultaneously represent one of the most exhilarating and menacing investment developments for international investors. They offer the prospect of reducing transactional friction and lending jurisdictional credibility to cryptocurrencies. However, they also pose grave threats to individual privacy, sovereignty, and orthodox capital investments.

The Relevance of CBDCs for International Investors

The quest for understanding the relevance of CBDCs to international investors invites a deeper exploration into the threats and opportunities they present. If these digital currencies proceed on their trajectory, they could significantly impact the established financial system.

In June, the European Union issued a press release that intriguingly covered the spectrum of currency manifestations. It outlined proposals to provide legislative certainty for Central Bank Digital Currencies (CBDC) as well as guarantee the ability for EU citizens to continue to use cash in transactions. 

This caught my eye because, in many circles, CBDCs are seen as antithetical to the use of “the folding stuff”.  A CBDC, in the simplest of terms, is electronic currency, issued by a Sovereign Nation using a private blockchain, carrying equal weight and value as a unit of their traditional fiat currency. Arguably it is the technological evolution of cash money and so in theory the EU’s announcement was akin to ensuring that candles and LEDs had equal legislative prominence.

The Promise of CBDCs

CBDCs promise to combine the strengths of crypto with the benefits of electronic commerce, all with the backing of the nation-state. The goals of CBDCs are predominantly to improve the efficiency and security of domestic and international payments and settlements, enhance financial inclusiveness, enrich monetary policy tools, and combat illegal and criminal behaviour.

The digital dollar has been said to simplify and greatly speed up transactions while permanently keeping the blockchain record of all transactions. The CBDC also allows for much easier cross-border transactions which aren’t as readily available with paper Money.

Not that the motivations are necessarily pure: many posit that the enthusiasm for CBDCs by governments is a way to undermine some of the privacy that comes with using cash. Until recently, the discussion of Central Bank Digital Currency (CBDC) was generally confined to policy wonks and blockchain nerds.  But recently, it has become a political issue in the US, with prospective Republican candidate Ron DeSantis promising to ban them as a threat to personal liberty.   Because the federal government would have direct control over the CBDC and also a record of transactions with the digital dollar, this could be seen as both a breach of individual privacy and substantial government overreach. In the USA, where freedom is often defined as freedom from government, the digital dollar could be an extremely divisive issue and therefore, a risk not worth taking. 

Why does this matter?

Fiat Currency is a very important instrument by which nations exercise their power.  The risk that Fiat might lose strength to alternative means of exchange such as cryptocurrency may not seem a big deal now, but make no mistake, cryptocurrency represents more than an inchoate threat to the structure of the nation-state.  Just look at the billions invested in stablecoins (privately issued crypto designed to track the valuation of a fiat currency, usually the $US), and some of the regulatory heat they have taken.  All the more reason for governments to circumvent this risk and take advantage of crypto’s benefits by issuing a CBDC.

The Money Flower Source: Sampaio & Centenoe

Further, CBDCs exist on a blockchain, which cryptographically protects it and avoids the double-spend problem that has previously plagued electronic money. This is different from how funds transfers currently work, which (simply put) is an electronic representation that is underpinned by traditional fiat currency.  

But, in contrast to well-known blockchains such as Bitcoin or Ethereum (which are public and permissionless), CBDCs would be issued on private blockchains.  This means that the control and administration of this blockchain remain within the control of the relevant central bank/government.  

That is, the details of every transaction of every dollar are permanently and immutably recorded but only the relevant government has access and control of this information.  It also opens up the potential for each CBDC (which essentially would be a piece of computer code) to include within that code elements that could be activated at a later time.  This potentially could give Reserve Banks and governments the power to limit the fungibility of a given dollar or even freeze or terminate it  – all done remotely.

Risks for International Investors

The risk for international investors is that this presents yet another layer of governmental intrusion upon privacy and trade.  Without being alarmist, CBDCs potentially create another leverage point for governments to either surveil tax or interfere in investments or business that is already legal and compliant.  Given the manner in which various governments exercise their powers to limit movement during the recent COVID pandemic, it is prudent for international investors to consider this as a material risk, should CBDCs achieve widespread adoption or become the standard for inter-jurisdictional money movement. 

The CBDC could also pose a huge threat to banking by sparking “bank runs”.  Think about it: in volatile markets or times of financial panic, if account holders can quickly choose a CBDC as means of starring wealth, this could have a contagious effect if people decide to flock in high numbers to exchange their cash for CBDC.  Or large banks with greater reserves, leverage the cost savings they make through CBDCs into higher interest rates for savings.

More broadly, a government-backed cryptocurrency could accelerate the flow of funds across different regimes, exacerbating volatility in valuations.  Typically, the value of a currency has been, in the long term, based primarily on the strength of a country’s economy and their interest rates.  Shifting the emphasis to CBDCs introduces risks of valuations being overly influenced by technical design features, or even different classes or ‘dollar’ depending on how the code is written.

Where does Australia stand with CBDCs?

The Reserve Bank of Australia recently concluded a pilot program into the production and use of an Aussie CBDC.  The design of the project was that the CBDC was a direct liability of the RBA itself, rather than a legislated instrument.  Whilst the project had many learnings. Key was the finding that for a CBDC to be made more widely available, existing regulatory frameworks would need reviewing to address some of the practical implications that arose from the use of a CBDC.  

Overall, this report was very positive for the economic stimulus that a CBDC could provide the Australian economy, seeing the CBDC as a tool to strengthen and support innovation in the economy, provided legal and regulatory frameworks were adopted.

But what about privacy?  In a recent speech on CBDCs in Australia, RBA Assistant Governor Brad Jones acknowledged that law enforcement would need oversight but downplayed privacy concerns based on the RBA not having an incentive to exploit user data for commercial gain. He saw that one of the main benefits of the CBDC was to increase competition and efficiency in the payments system while reducing user costs.  

Cash or CBDC?

The RBA has confirmed (in Assistant Governor Jones’s speech) that while they continue to progress their CBDC research program, Australians can be confident that they will retain access to banknotes issued by the Reserve Bank for as long as they place value on them as a public good.  Presumably, this is a long time.

Coming back to the EU press release, it’s interesting to observe the cultural differences in using cash that exists between Europeans and Australians. Here in Switzerland, they not only have 100 Franc notes but 200 Franc and 1,000 Franc (about $AU1720) notes as well. The EU also has 100, 200 and 500 Euro notes. In Swiss shops, it would be nothing remarkable to use a 100 or 200 Franc bill to make an everyday purchase. More expensive items are happily sold in return for the appropriate number of 1,000 Franc bills.

So, whilst it seems cash is here to stay, CBDC use continues to be increasingly explored and developed by relevant jurisdictions, risk and privacy concerns notwithstanding.  Looking to the future, it is clear that CBDCs will continue to exert an influence on financial markets, albeit widespread use is still some time away.  Nevertheless, it is essential that international investors understand the risks and benefits and factor this into their business decisions and portfolio designs.

Like to discuss with me how CBDCs may impact your own planning?  Contact me and tell me your story!

“I’m not sure it answers a need that people have”

Just over three years ago, the Perth Mint announced that it was creating a new cryptocurrency, which came to be known as the Perth Mint Gold Token.  At the time, Today Tonight did a story and asked me to make some comments.  Frankly, at the time I couldn’t see the market demand for this.  It seemed to me that they had succumbed to the then-current hype around crypto. Creating a purported type of stablecoin that was backed by physical gold was simply creating a solution to a problem that didn’t exist.

Since then I have done a lot more work and study in blockchain technology. Frankly, I had totally forgotten about the PMGT (as it turns out, spoiler alert,  so had most everybody else).  Then I got one of those ‘this happened three years ago’ reminders regarding the story, so I thought I would see what had happened.  

A timely intervention it seems.  Several weeks later the Perth Mint ran into some other problems and subsequently, they announced that the PMGT is now being discontinued.

Regardless of the merits of the project or the manner in which it was implemented, the PMGT turns out to be a microcosm of the lessons that investors need to consider when looking at crypto. 

Investing in cryptocurrency can be a daunting task, especially given the volatility and complexity of this emerging asset class. To make informed investment decisions, investors must assess the merits of any particular cryptocurrency and understand the reasons behind its creation.

Remind me: why Blockchain and Cryptocurrencies?

Check out my earlier posts here and here for more detail on this important topic for sophisticated investors.  In summary, Blockchain technology is designed to create a decentralised, immutable, and scalable system for storing data records.  As such, it has the potential to both create and transform industries in that it reduces the costs of compliance (amongst other things). 

To transact on a blockchain, you need to use cryptocurrencies that are native to that particular blockchain. Ethereum blockchain was innovative in that it developed a standard that allowed different cryptocurrencies to use the same blockchain. 

However, valuing cryptocurrencies can be challenging, resulting in high volatility that makes them difficult to use as a store of value. To address this issue, stablecoins were developed – cryptocurrencies that are backed by an asset such as fiat currency or gold.

So why Perth Mint?

Over three years ago, the Perth Mint announced that they were developing the Perth Mint Gold Token cryptocurrency, designed to track the price of gold. Each PMGT was backed by one ounce of gold. At the time, they promoted it as an innovative solution to the challenge of valuing cryptocurrencies. 

Personally, I felt it was an over-engineered solution to a need that didn’t exist.  There are plenty of other ways to buy gold if that is what you want to do. Physical gold is easy to buy,  there are gold ETFs (also backed by physical gold), and professional traders simply transact based on the price of gold in a derivative fashion. Alternatively, if you are after a stablecoin, why not use a US dollar stablecoin rather than a gold stablecoin, given that the gold price internationally is a derivative of the value of the US dollar?

Unfortunately for the Mint, it seems I had a point.  Three years later, the PMGT is about to be discontinued.  The stats for this aren’t flattering.  Despite the Mint holding billions of dollars worth of gold, the market cap was only ever a couple of million. There were only about 1125 tokens ever issued. This lack of adoption is evident in the low number of addresses with PMGT.  The top wallet holds 67% of the supply, and the Top 10 wallets account for nearly 92% of the tokens that were minted. 

Perhaps more damningly, the PMGT failed to be true to its label.  Despite its 1 to 1 backing with physical gold, its price varied materially from the actual gold price. Chart 1 below shows the daily prices of PMGT and Gold for the past year, revealing material variance between the two. 

Chart 2 highlights the variation as a percentage of the daily gold price.  For a clever trader, there could be a potential opportunity for arbitrage here, though I suspect the limited liquidity in PMGT may have proved difficult.

Sources: 

PMGT prices – https://finance.yahoo.com/quote/PMGT

Gold Prices: www.gold.org

Note: there may be some slippage on daily pricing due to time differences in captured prices however, any effect is consistent across the period illustrated

What is surprising is how much the price of PMGT varied from the actuarial physical gold price – in both directions.  At times it moved over 10% from the asset it was supposed to track.  Although the overall PMGT price trend roughly followed the physical gold price, it significantly lagged behind physical gold for the last 6 months.

Why?  Frankly, I have no idea but I suspect the cause is structural and related to the tight ownership spread, small market cap and low liquidity.  There simply wasn’t sufficient volume for price discovery to operate efficiently.

So what can we learn?

Investors can learn from the PMGT example that it is essential to understand the business model behind a particular cryptocurrency before investing. It may be innovative, new, and exciting technology, but the same rules that apply to ‘bricks and mortar’ businesses need to be used when considering investing in cryptocurrency. 

Part of me admires the quest for innovation that the Mint demonstrated with this product, but equally, I wonder how much market research they did before agreeing to proceed.  This whole exercise would not have been cheap to run and will have cost someone a lot of money.

To me, there is no doubt that Blockchain technology will play an increasingly important role in the future of finance. Cryptocurrencies Investors should consider the use cases, market demand, and systemic risks of each cryptocurrency. In all of this, it pays to invest in professional advice, not only for the specific investment but also in seeing how it fits into your overall investment objectives.

Like to know more about how I work with my international investor clients to achieve their goals?  Contact me and tell me your story!

If you accept – as I do  – that blockchain is an important and transformative technological development, then it makes sense for investors to ask if they should get exposure to this through owning cryptocurrency.  

You don’t have to be a crypto maximalist to take this position.  For all the sceptics and initiates:  regardless of the value of the tech, crypto as a trading asset is here to stay.  There is too much volume, value and usefulness for cryptocurrency in world markets for it to go away (despite arguably the recent best efforts of the SEC in the USA who continue to base their approach on a court ruling from 1946).

But don’t take my word for it: For some good background reading to understand the macro tailwinds for blockchain technology, refer to both The Network State by Balaji Srinivasan and the amazingly prescient The Sovereign Individual by James Davidson and William Rees-Mogg. At the very least, you will get an insight into some of the broader societal changes that support this technology.

However, I am not talking to the traders here – I am looking at the role, if any, crypto should play for investors.  That is, those that build and invest wealth through classic Modern Portfolio Theory portfolios.  Those folk who remember that diversification is the only free lunch the market offers.

It’s in this area that there is some fascinating research. Analysts have shown that adding cryptocurrencies to a portfolio has the effect of both increasing returns and decreasing volatility. Interestingly, this effect plays out whether it is a conservative or aggressive portfolio. 

How Much Cryptocurrency Should You Have in Your Portfolio?

Cryptocurrency in portfolios is like salt in cooking – too little and you still have a healthy, if not somewhat bland, meal – but too much and it can become inedible.  Many articles you will find quote experts that settle on a  figure of 5%, but this seems to me like a compromise with little science behind it (which is ok, just be honest about it). 

Andrianto (2017) suggests that an optimum allocation of crypto should be between 5% and 20% depending on your risk tolerance. Other studies suggest even broader ranges, but these are very academic in nature and assume certain technical aspects of portfolio constructions that rarely translate into the real world (see the Geek Corner for more detail). 

In my experience, unless you are living and breathing crypto as a trader, even the most aggressive investor (remember, investor, not trader) 20% is a level that will cause you to miss sleep at night no matter how much you embrace volatility. Balancing this research with my own experience, I believe a range of between 1% and 5% of your total investable wealth is a more appropriate starting point.

Like other assets, depending on the quantum, your investment can be dollar-cost averaged into the market.  In most situations, these investments should be seen as very long-term exposure to future technology trends.  Of course, in future rebalancing, they can either be topped-up or profit taken depending on the performance within the time frame being reviewed.

What Should I Buy?

The specific crypto purchases need to be determined by your adviser.  But, just like the good old days in Australia when a diversified portfolio was BHP, Rio and the 4 banks; it is hard to go past Bitcoin and Ether:

• Their combined market capitalisation is nearly 3 times larger than the next ten cryptos combined
• They are the most liquid
• Continued technological advancements for both blockchains should act as a tailwind to their acceptance

Alternatively, look at what crypto ETFs are available in your jurisdiction (if any).  These make life much easier but you need to keep an eye on the management fees.

As some final steps, consider what strategies, like ‘staking’ or liquidity pools, you may adopt to enhance your yield and also understand how your particular jurisdiction treats crypto from a tax perspective.

Conclusion

It’s true – the world of cryptocurrency can be both confusing and intimidating when first approached.  The combination of jargon, technological minutiae and poor user interface can make it very easy to put in the ‘too-hard’ basket.  

Don’t let these factors dissuade you.  Do your research, talk to your adviser, and make a decision that is best for your own situation, having regard to your cash flow and need for future access to equity.

Like to know more about how I work with my international investor clients to achieve their goals?  Contact me and tell me your story!

Geek Corner

For all the academics in the room, here’s some further reading on some of the research mentioned in this blog:

Should Investors include Bitcoin in their portfolio?  A Portfolio theory approach. A very interesting summary of a 2020 paper. 

The Value of Bitcoin in Enhancing the Efficiency of an Investor’s Portfolio – looks only at BTC but also includes some helpful background for new investors.

Investing with cryptocurrencies – evaluating the potential of portfolio allocation strategies  A paper from 2018

The Effect of Cryptocurrency on Investment Portfolio Effectiveness  Andrianto and Diputra’s paper referred to above.  It is also back in the distant past of 2018, an eon in crypto terms but interesting reading.

Several years ago, I began researching the hype around blockchain and cryptocurrency. It quickly became clear that the technology was not a mere fad, but I wanted to separate the hype from the substance. There seemed to be much promise for international investors, especially those looking to hedge against sovereign risk.  I had received enough inquiries from clients in both Australia and Switzerland to warrant further investigation.

What I found was a dearth of reliable information available for international and sophisticated investors trying to make sense of how blockchain could add to their wealth. Technology experts struggled to explain their work in layman’s terms and mostly knew nothing about economic fundamentals.  At the same time, the financial expert commentators didn’t really understand anything about the tech. 

Frankly, most of what I could find was 95%, ahem, less than useful. So, I dipped my toes in the water.  I bought and sold crypto, experienced the process as a user, made some trades, used both centralised and decentralised platforms, investigated wallets.

That might not sound like much, but apparently, it is more than the current chair of the SEC has done! Through this practical experience, I learned enough to conclude:

• There really was transformative technology potential in blockchain
• The user experience was light years away from the average person in the street being able to embrace it
• Crypto was a fast-moving chaotic field as everyone from charlatans to regulators tried to get their heads around the opportunity.
• Blockchain was important enough that it could not be ignored or dismissed

I needed to develop some rigour around my understanding. So I decided to spend 12 months doing a Graduate Certificate of Blockchain in Business through the Royal Melbourne Institute of Technology, so that you didn’t have to. 

What exactly is this Blockchain thingy?

Blockchain is simply a way of digitally storing data, but with some very important differences from conventional methods. It is a decentralised ledger system that uses cryptography to secure data entries and prevent tampering. 

Put another way: Blockchains can store any digital data, in the order that it happens, in a way that cannot be altered.

The key feature of blockchain is that it is immutable; no one can modify the data without everyone else being aware of it.  This makes it incredibly secure. Because all transactions are permanently stored on the blockchain, exactly as they happened, in the order that they happen, you don’t need to trust the other participant. This has made blockchain technology attractive for many different industries, from finance to healthcare.

By contrast, consider a database: say, for example, a company’s customer records. These are stored in one central location, with any number of operators having access and editing control over the data. This has advantages, but it also introduces vulnerabilities. Blockchain prevents all this because it synchronises any changes across multiple copies, in different locations, using cryptography to ensure that they can’t be altered.

A study in 2010 estimated that fully 35% of US employee time was spent on various forms of compliance. Blockchain promises to eliminate much of this expense through its cryptographic advances, at significantly less cost. This is a promise that businesses cannot afford to ignore.

But I Keep Hearing About Crypto!?

Most of the hype in the media has focussed on the price – and crazy volatility – of cryptocurrency prices. But what is crypto anyway? 

Blockchain networks don’t operate for free. Keeping them running and maintaining all these copies and security has a price.  That price is denominated in the particular cryptocurrency of the specific blockchain.

Think of it this way: Blockchain networks can be likened to countries, with the cryptocurrency token being its native currency.  For example, Ethereum has Ether just as Switzerland has the Franc. Solana has Sol the way Australia has the dollar. Trick answer: Bitcoin has, well, Bitcoin. As the first serious Blockchain, they didn’t give the token a separate name.

The problem arises when trying to put a value on each of these. Blockchain is so new, most of its applications are within the crypto universe, rather than extending anywhere to what is known as RWA – Real World Applications. And when they do, the poor User Experience and price volatility work against consumer adoption (not to mention various jurisdictions’ tax departments).

The result is that most cryptocurrency valuations are speculative, or at best, self-referential. They don’t have any underlying business model to support a valuation. Or, unlike fiat, they don’t have the backing of a national government and long history of yields. Where yields are offered, they are usually in the form of the same or another token, rather than fiat (which, if you talk to a libertarian, is actually the point). I am not saying this is necessarily a bad thing, just another point to understand when you next read of some lucrative yield-farming opportunity.

See the chart below for an example of this regarding Bitcoin. It makes the case that Bitcoin is cheap because it is cheap in relation to itself, and in the past when this ratio was this low, people started buying again. To me, this mixes causation with coincidence, and I am reminded that the market can stay ‘cheap’ a lot longer than most people can stay liquid.

Bitcoin price relative to Total Bitcoin Market Capitalisation

However, focusing only on the prices of crypto is fine for speculators, but this misses the bigger picture for investors. In the long term, cryptocurrency valuations are largely driven by the long-term demand for the underlying blockchain. Look at cryptocurrencies, not as an investment in and of themselves; but as a way to create exposure to the technology that powers them.

Limitations of Blockchain

When I first started my journey of understanding, it seemed that perhaps Blockchain was the cure for many ills, based on some of the claims of its proponents. But like most things, Blockchain is not a perfect solution.  There are compromises that have to be made when constructing a blockchain architecture. 

These compromises are known as the trilemma of blockchain architecture and must be taken into consideration when evaluating a blockchain’s suitability for a particular task. The trilemma consists of three components: security, scalability, and decentralisation. In order to maintain a high level of security, blockchains must sacrifice scalability or decentralisation; this means that either the network can only process a certain number of transactions per second or it must rely on trusted central authorities for validation.

Blockchain developers are obviously working on minimising these issues and blockchain performance – and hence applicability – will continue to improve exponentially. Any business considering using blockchain needs to seriously consider whether it is the right solution before they spend a mountain of cash to discover that maybe a good old-fashioned database is a better answer. Australian Stock Exchange yes, I am looking at you.

Opportunities for International Investors

Real gains can be made when existing businesses are able to use blockchain technology to improve their profitability and productivity. For example, businesses can use smart contracts to automate payments or enable peer-to-peer trading without the need for intermediaries. It is important to identify which businesses are integrating blockchain technology into their processes and how transformative this can be to their bottom line. International investors should also keep an eye on developments in the regulatory space, as regulators are beginning to create frameworks for governing cryptocurrency transactions.

For example, leading businesses such as Microsoft, Amazon and Walmart have all integrated blockchain into their business processes to improve back-office performance. IBM has sponsored an entire blockchain – Hyperledger – as a platform to assist their clients to implement blockchain applications in a private environment.

What Next?

The lesson here is to look through the hype and distraction that various actors and their agendas have put onto blockchain and cryptocurrencies, and consider how this incredible technological advance will transform existing legacy businesses. Scandals such as FTX and Terra/Luna are examples of human frailty set in within the theatre of new technology, not a refutation of the technology itself.

Blockchain is a transformative technology that will, over time, completely change the face of how companies do business with each other. As an international investor, don’t ignore this or put it in the too-hard basket. Understand the basics of how it works and look to see how companies are intending on using it to improve their results.

Want to know more?  Contact me here for an initial discussion to explore how we might work together.

Further Reading – Geek Corner

Want to really sink your teeth into some extra reading?  This short but sweet selection will give you a great start:

Bitcoin: a Peer-to-peer Electronic Cash System the original whitepaper that launched it all, from the pseudonymous Satoshi Nakamoto

Ethereum Whitepaper by Vitalek Buterin, one of the co-founders of Ethereum.  Ethereum is the leading blockchain for business applications.

Messari Crypto Theses Every year, Messari publishes a whopping insight into all things crypto.  It is a rollicking read and the 2023 edition is no different.