Deciphering Cryptocurrency

Chip Rutan watched in recent weeks as the value of cryptocurrencies plummeted. To him, it was all part of the up and down cycles he has witnessed since he first bought cryptocurrencies about four years ago.

“This is kind of the pattern that it always has been,” said Rutan, owner of Rutan Productions in New Cumberland. “You watch. It will rebound…probably this year. But it is risky.”

His interest in cryptocurrencies is more of a hobby than a financial plan.

“I am not banking my retirement on it,” he said. “It moves all over the place and that is not me. But it is fun.”

As cryptocurrencies such as Bitcoin have become a household name, more people have bought into them, which pushed prices to new highs this year, before falling sharply and then rebounding some in June. While the skeptics are numerous, national and international banks, financial institutions and governments have been paying closer attention and seeing how they might be able to use the underlying blockchain technology, if not the cryptocurrencies themselves.

“Access has become more prevalent,” Rutan said, adding that few, if any, places would take cryptocurrencies as payment 10 years ago. “It was off the radar completely. Now, the adoption rate is as high as it’s ever been.”

Sheetz, for example, recently announced plans to start accepting cryptocurrencies later this year. The Altoona-based convenience store chain will join other companies, such as Microsoft, that accept such payments. Elon Musk, the billionaire owner of the Tesla, made headlines by saying he would accept cryptocurrency payments for his cars before backing off.

A flurry of developments this spring has led to numerous news articles, columns and explainers from major publications such as the New York Times and Wall Street Journal. On June 14, American Banker wrote about how banks are catching up after being forced to pay closer attention. Large investment firms have been tracking the issues, as well, often writing articles on their websites or in newsletters to provide updates for clients, while discussing why they aren’t jumping in.

“Bitcoin and other cryptocurrencies have been getting a lot of attention lately. Investors hear news about overnight Bitcoin millionaires who lose their fortunes just as quickly,” said a June 14 newsletter by the Schwab Center for Financial Research. “…Understandably, investors have questions.”

The idea for Bitcoin, which is considered the most established cryptocurrency, was conceived in 2008 as a theory on how transactions could be handled worldwide securely and swiftly without the need of a central bank or intermediary. Bitcoin was valued at a fraction of a cent in early 2010, according to Coinbase, an information resource and cryptocurrency exchange. Coinbase provides detailed tips and histories of cryptocurrencies for those still learning, as well as for those who want the latest investment guidance. In April, Bitcoin’s value was placed at nearly $65,000 before being cut in half within weeks. By June 14, it was rebounding to around $40,000, according to Coinbase. But it has fallen steadily since, sitting at just under $30,000 earlier this week.

The obvious appeal is that someone who bought low and sold high made a fortune. However, the opposite is true, too, and anyone who bought at the peak might have to wait a long time to recoup losses—if they recoup them at all—and that makes some skeptics compare cryptocurrencies to Ponzi schemes.

Even with widespread information available today, it can be difficult to get people in the traditional financial services industry to talk about the trends. Several years ago, Rutan was trying to find people to openly talk about cryptocurrencies, so he created the now defunct Bitcoin Navigators, a free forum where people could ask questions and chat about their experiences. (The Central Penn Business Journal wrote an article about the group after it was formed in 2017.)

“When I talked to some financial planners in the area who I knew, they wouldn’t touch it,” he said about his experience at the time, which was a reason he created the forum that has since closed. “I understand why: What happens if something goes wrong?”

Experts in the financial services industry still are reluctant.

Lon Jury, president of the Financial Planners Association of Central Pennsylvania, said in an email that he was not in a position to discuss cryptocurrencies. Brian Fields, a former president of the trade group, also said he couldn’t comment, point out that most full-service investment companies don’t invest in cryptocurrencies because of the volatility and lack of regulation. Fields referenced a Bank of America Securities newsletter that outlined general advice and cautions. One segment is titled “The new money: Bitcoin has many downsides, few upsides.”

The Schwab newsletter calls Bitcoin and other crypto currencies speculative.

“Bitcoin doesn’t fit within traditional asset allocation models, as it is neither a traditional commodity, such as gold, nor a traditional currency. Bitcoin’s dramatic volatility is driven primarily by supply and demand, not inherent value,” the research center wrote. “Bitcoin doesn’t have earnings or revenues. It doesn’t have a price-to-earnings ratio, price-to-sales ratio, or book value. Traditional value metrics don’t apply, so there are no methods for assessing its value that we endorse or find persuasive beyond the trading value.”

The newsletter acknowledges that the cryptocurrency market has evolved since it was formed in 2008, creating “a new, unique and sizable asset class.”

“Several institutional investors and corporations have begun to invest in Bitcoin, and some traditional capital-market participants have introduced crypto-market infrastructure services to make it more accessible,” it also said before guiding customers on how to access cryptocurrency markets.

The skeptics have reasons to be cautious. The prices of some of the thousands of various cryptocurrencies now on the market—such as Dogecoin that started out as a joke — have soared in value, only to fall again, adding to both the allure and the skepticism.

Rutan understands the caution but suggests an educated buyer can sort through what are the best bets and what is flimsy, although that can be difficult.

“I know people who did well with it. But others lost because they bought when they did,” Rutan said. “You have to know what you’re doing, and you have to have patience for when it goes back up.”

Value in blockchain technology

Perhaps the biggest appeal is the underlying blockchain technology. Essentially, a record—or block—is chronologically stamped on a computer code after transactions, creating a string of code—or chain. Once established, the block cannot be altered, leaving a digital fingerprint of all transactions along the chain.

The Schwab article discusses the merits of blockchain but cautions that an investment in Bitcoin is not an investment in the actual technology.

In the case of Bitcoin, no actual coin exists. Instead, the coins are unique computer code. If the code is lost or stolen, so is the investment. Otherwise, transactions are considered secure, said Judith Herron, a member of PICPA, which is based in Harrisburg and is the trade association for certified public accountants in Pennsylvania. While cryptocurrencies have become notorious because some criminal organizations use them to conduct illegal activities, companies have been getting more involved because they see the flexibility and security.

“Legitimate organizations have reasons why they might want a transaction to be properly recorded—but private—and nothing does that better than something you do on a blockchain,” Herron said.  “You can tell this transaction happened, so this person that you don’t know on the other end, and you don’t trust, it doesn’t matter. Because the blockchain is going to show it happened.”

Part of the security is because, unlike traditional transfers of money through a middleman company like PayPal or a bank, Bitcoin does not require a user to enter sensitive personal information. The technology underpinning the coded coin provides the validation, which is why transactions are private, as well.

She began studying the trends about 10 years ago in the early days of cryptocurrencies when she started getting questions from clients. Around that time, Mt. Gox, a Bitcoin exchange in Tokyo, had been created and was operating for a few years before it collapsed in 2014 after a number of Bitcoin codes were stolen.

“In the beginning, I really didn’t know anything about it, but I thought I’m going to educate myself about this because it’s likely to have some tax consequences,” Herron said, adding that she personally doesn’t own cryptocurrencies. “A lot of clients were viewing cryptocurrencies like money. But from an accounting perspective, they needed to think about it like a stock, where, if it is sold after a gain, the proceeds are taxable.”

Her typical clients investing in cryptocurrencies are entrepreneurs who are young men with disposable income.

“Whether it’s through a contractor business or a software engineering business, it’s definitely people thinking about how to make money,” Herron said. Real estate might be out of reach for them in the current market, and the stock market might have peaked. “They see this as ‘maybe this is the thing that’s in my lifetime going to create that big financial bump I need to get to the next level.’”

And they understand the risks.

“The people that I see who are most intense about purchasing cryptocurrency really do see it as something that is valuable to them as an investment, even though there’s a risk factor,” Herron said. “Most of the people that I deal with know it’s a roller coaster and, if you don’t know that, don’t buy it.”

Other uses for blockchain

Herron and others point out that blockchain technology is exciting because it can be used for other applications, such as with executing contracts, monitoring supply chains or offering financial services, all of which are gaining wider appeal. Over time, blockchain technology could revolutionize numerous operations and services. For example, governments would be interested in the details of how transactions flow through their economies.

Governments, such as the U.S. and China, also are monitoring the trends closely, with the idea of at least tapping the underlying technologies.

“It gives them an opportunity to really see where money is going,” Herron said.

Meanwhile, the IRS is taking an increasing interest, moving a question about cryptocurrencies to a more prominent position on tax forms so that they can better capture revenues. Someday, blockchain technology also would help organizations like the IRS monitor the various steps of transactions, which could help with oversight and enforcement.

More to learn

But a lot still needs to be understood.

For example, the melding of data security with blockchain technology still isn’t clear and is being followed closely by Jordan Fischer, an attorney who is co-chair of the cybersecurity and data privacy committee of the Pennsylvania Bar Association based in Harrisburg.

Her work centers on cybersecurity and privacy issues and how blockchain technology can be effectively used. Governments here and in Europe increasingly look at consumer privacy concerns, requiring companies to take proactive steps to protect consumers’ data, said Fischer, who is an attorney based near Philadelphia and a professor at Drexel University’s law school. Because information cannot be deleted from a blockchain, that might bump up against data privacy rules.

“Inherently, in the blockchain, you can’t change a node once it has been placed in the blockchain environment. So, if I conduct a transaction with a cryptocurrency, it is always going to be there in a way that I can look back and validate the transaction. But the problem also is that you can’t change it,” she explains. “That means that, if I later have a privacy concern with that information, I do not have the capability to change or delete that transaction.”

In the larger context, Fischer suggested, cryptocurrencies are a secondary concern to the overall use and effectiveness of blockchain technology, which she said will prove extremely valuable to many industries. To her, cryptocurrency is merely a “buzzword” that is the way most people understand how blockchains work. But because the underlying technology has tremendous potential, it is important to think through the ramifications of how it is used. The question of whether cryptocurrencies will replace paper money is not as important.

“We’ve lived in a world of dollars and cents and euros etc., and I don’t know if that is going to go away,” she said. “There is a lot to be understood with digital currencies and a lot of potential downfalls. But I personally think that a lot of good can come from blockchain, generally. I just don’t know if in the cryptocurrency space it is going to become the end all, be all.”

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