Why is the SEC striving for cryptocurrencies

10 questions about investing in cryptocurrencies

FundResearch: Dr. Giese, let's start with a very "simple" question: Do crypto currencies count as currencies?

Philipp Giese: In short: no. A currency is a state-recognized and regulated means of payment. These are neither Bitcoin nor the tons of other cryptocurrencies or tokens. Nevertheless, a distinction has to be made between regulatory status and the functions inherent in cryptocurrencies. Thus, cryptocurrencies can very well fulfill the same functions as fiat currencies, but without being assigned the status of a currency. The term cryptocurrency is often misleading because very few of the more than 1,500 "cryptocurrencies" represent a digital currency, but can rather be described as tokens that fulfill a function within a network.

FundResearch: What are the advantages of investors who invest in digital currencies?

Philipp Giese: The asset class of cryptocurrencies shows hardly any correlation to other asset classes. As a countercyclical investment, however, they offer interesting diversification and hedging opportunities, for example as a safe haven or digital gold. In addition, under certain conditions it can be lucrative to invest in alternative investment methods offered by the crypto ecosystem. Mention should be made here of mining, staking or hosting a masternode. These are various methods that help secure the network and process transactions.

FundResearch: Which risks do you have to be prepared for?

Philipp Giese: Of course, the volatility cannot be dismissed out of hand. Fluctuations of five percent in a day are commonplace and ten percent are not uncommon. The so-called Initial Coin Offerings (ICOs), i.e. crypto IPOs, involve very high risks, as there are a lot of black sheep here. Due to a lack of regulation, it is easy to get caught up in fraud.

If you entrust your investments to an exchange, there is also the risk that the exchange will close or that coins in which you have invested will be delisted or something similar. With MtGox, Cryptsy and recently Coincheck or Bitgrail there are several examples that this can happen. Accordingly, every investor is advised not to simply leave the crypto assets on an exchange.

But there are also risks when using a wallet. If you should enter the private key, so to speak the pin for the wallet, in an online source, someone could intercept it. It must be clear to everyone that with the private key or the seed everyone has access to their own funds. Accordingly, these are to be stored safely.

FundResearch: What investment horizon should investors realistically enter the market with?

Philipp Giese: After the correction this year, you should have a medium to long-term investment horizon. A cost-average strategy is a good option. Here you can learn from the past: Someone who invested in Bitcoin at the then all-time high at the beginning of 2014 and reinvested in Bitcoin every month was up 25 percent in 2016, long before the all-time high in early 2018.

FundResearch: We hear about digital theft again and again. How well do you think crypto-coins are protected?

Philipp Giese: The classic cryptocurrencies are in principle extremely well protected. The connection between the publicly visible public key - if you will, the account number of a wallet - and the private key, i.e. the associated PIN, is almost impossible to crack according to the current state of the art. Even taking into account the possibilities offered by quantum computers, this connection, contrary to statements to the contrary, cannot be broken.

The difficulty is partly due to the interfaces to the real world, i.e. the exchanges and partly also the wallets. As mentioned above, it is extremely important to protect the private key or the seed. The private key must be kept safe and must not fall into the wrong hands. In the latest crypto compass, our stock market letter focused on crypto currencies, we have put together a special for the secure storage of crypto currencies.

FundResearch: Bitcoin has recently made massive corrections. Will the downward slide continue?

Philipp Giese: If I only knew ... Personally, I think less of the constant speculation as to whether the price will rise or fall again. If we take the downward slide after the then all-time high in 2015 as a basis, exchange rates of up to US $ 3,500 are theoretically possible. However, it is doubtful whether this comparison is so useful. Of course, the SEC's upcoming ETF ruling will have an impact on the price. The development of the Bitcoin price in 2017 showed, for example, that an SEC ban only depresses the price temporarily.

I therefore find it more important to emphasize that Bitcoin still has incredible potential from a technological point of view. The so-called scaling solutions, such as the Lightning Network, which are supposed to make Bitcoin faster and cheaper, are still at the beginning and will only be able to show their full potential in a few months.

FundResearch: One disadvantage of cryptocurrencies is that they are purely demand-based. What guarantees are there against total losses?

Philipp Giese: No. As with all other forms of investment, a total loss is always possible. Even if the coins do not disappear, their price can go to 0 if there is no longer any demand.

FundResearch: How do I, as an investor in an unregulated market, recognize reputable providers?

Philipp Giese: That is a complex question. Is it about cryptocurrencies, token sales, exchanges, wallet providers or other service providers? In the case of exchanges, one can now see whether the companies are following KYC / AML regulations or whether they are taking measures against wash trading or spoofing. I expect from a wallet that the user has complete sovereignty over the stored funds, i.e. that he is in possession and knowledge of the private keys.

Furthermore, the alarm bells should ring when providers advertise with excessive profits. Strongly centralized projects that claim to be decentralized should also be viewed critically.

The whitepaper is a good guide to differentiating between serious and dubious projects. When reading whitepapers, I always use my experience as a reviewer at a project management agency as a guide. At that time, I decided whether funding applications would be approved or rejected. Good projects could transparently present the initial situation, the solution approach, the risks, the competence of the team and the usage strategy. In the case of whitepapers that are published as part of ICOs, I also look at the token behind the project. What kind of token distribution is the project aiming for? If a significant part of the issued tokens stay in the team, I consider that to be a red flag. What should be achieved with the token? Does it have a real function in the envisaged project - and thus an added value beyond speculation?

FundResearch: Which regulation do you expect in Europe / USA / worldwide in the near future?

Philipp Giese: In Europe, the relationship between the GDPR and a public blockchain will have to be clarified. Strictly speaking, a public, transparent blockchain strongly contradicts the right to erasure or the right to be forgotten.
In the USA in particular, the question of what counts as security and what is not will have to be clarified. For classic cryptocurrencies like Bitcoin, the question has already been clarified, but what it looks like for other projects is still unclear. A clear regulation is needed here. The SEC decision regarding a Bitcoin ETF, which is now expected, is of course important with regard to regulation in the USA. I think that this decision will be made before the much more diffuse question regarding the classification of different crypto assets.

Not that I expect a quick decision here, but what is necessary on a global level is a clear decision on the regulation of token sales. The current situation, that there are states with a crypto-hostile attitude and others with a tolerant attitude, makes the global growth of this sector difficult.

FundResearch: We are currently experiencing a concentration movement of mining capacities in the hands of a few companies. How will mining change in the future?

Philipp Giese: This development is very worrying. Less because of any 51% attacks than because this would stand in the way of the original idea of ​​the crypto currencies - the construction of a decentralized system.

However, a few things should be noted about this legitimate concern. First, the developers are not sleeping here. There are proposals to put mining back on a more decentralized foundation. In addition to Bitcoin, there are other cryptocurrencies whose mining algorithm is much more decentralized. Second - and much more important in my opinion - it is a mistake to claim that the miners had Bitcoin completely in their hands. Even before the miners, it is the node hosters who manage the blockchain. The User Activated Soft Fork last year showed the power of the node hosters: Those node hosters who accepted the soft fork would not accept blocks from miners who oppose it.

The relationship between node hosters and miners is therefore a symbiotic one: the miners are needed to generate new blocks, but the nodes are needed to manage the blockchain. Therefore, the miners alone do not have as much power as one might think.

FundResearch: What are the consequences for investors? Do you have to prepare for 51% attacks?

Philipp Giese: No. With the larger crypto currencies, the costs of such an attack are extremely high, it would simply be unprofitable.

Should there be a 51% attack, that would certainly mean that the consensus mechanism would have to be adjusted. However, that is not impossible.

Finally, one should also consider what could actually be achieved via a 51% attack. The attacker would receive all mining rewards. This may be unfair for other miners, but it is not a problem for the individual user. In principle, he could censor transactions. To do this, however, he would not only have to have a sufficiently large hash rate for the 51% attack, but also be able to associate the relevant public keys with the people to be censored, which is not entirely trivial. Finally, an entity executing a 51% attack can double-spend. That would be immediately apparent, however. You would not only see that there was a 51% attack, but also which miner was responsible.

FundResearch: Does the future belong to the largest in the market (Bitcoin), the most institutional (Ripple) or a coin that doesn't even exist today?

Philipp Giese: If you look at the various use cases of cryptocurrencies (medium of exchange, store of value, decentralized application, supply chain management, social network, etc.), you can see that many can and will exist side by side. Also with regard to the payment aspect, I think that the future will not belong to one cryptocurrency alone; There are already different use cases for Bitcoin, Monero and Bitcoin Cash - to name three examples.

But with regard to the three options: I am convinced that the future belongs to Bitcoin rather than XRP. XRP, the cryptocurrency of the company Ripple, is in terms of technology significantly more decentralized than its reputation, but the use cases and the distribution of capital are extremely centralized. The majority of all XRP tokens are in the hands of the Ripple company, albeit secured in a complex escrow mechanism.

A cryptocurrency that does not yet exist is of course difficult or impossible to assess, but from the current status it can be said that the second wave of cryptocurrencies with Cardano, Tron or EOS are much more centralized than Bitcoin or Litecoin. If you look at the origin of Bitcoin and the original community, you can see that the price of Bitcoin was not in the foreground at the time. The situation today is fundamentally different. Accordingly, I would also be more likely to bet on Bitcoin.

Column cryptocurrencies: FitBitcoin in classic portfolios