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.