Cryptocurrency 2018 Outlook

In 2017, digital assets broke through as a mainstream phenomenon for the first time. The world outside the crypto community finally began to appreciate the numerous upsides of decentralization and blockchain technology. The result has been exponential returns for early adopters. For example, Bitcoin’s value increased over 1600% in 2017 and many of the larger alt coins, such as Ripple and Ether, are up significantly more. The craziest part about this growth? The majority of it has been driven by retail investors. Coinbase, the largest U.S. crypto exchange, started the year with less than 6 million users and has since more than doubled, while even temporarily achieving the top slot in the Apple Appstore.

2018 has the potential to be an even bigger year. Here’s my thoughts on a few of the larger macro factors in the crypto space –

Institutional Players

Cryptocurrencies are the world’s first bankerless boom — retail investors have driven the majority of the growth in the space while institutions have been sitting on the sidelines pending clarity on technological applications, the regulatory environment, and custody before investing. Only recently have traditional financial institutions begun to acknowledge the explosion of cryptocurrency growth and the potential applications of blockchain technology in their own businesses. They are now starting to invest more heavily in the space, enriching the early adopters. This redistribution of wealth typically happens in the inverse — institutions invest in private start-ups and then reap the rewards upon the Initial Public Offering (IPO) when the retail investors pour in.

It is clear 2018 will see more institutional players coming into the cryptocurrency space, especially with the introduction of additional investment vehicles such as futures, options, and ETFs. Big banks such as Goldman Sachs are launching their own cryptocurrency trading desks, and many others will probably follow suit. Furthermore, about 100 crypto focused funds have been created in 2017, many of which are launching at the beginning of 2018. These funds are aggressively meeting with high net worth individuals and institutions, educating and convincing them to invest in this space. This could result in short-term inflows and price appreciation early in the year for the crypto market.

Speculation

In 2017, the emergence of smart contract blockchain technology and Initial Coin Offerings (ICOs) revolutionized the ability for startups to raise capital.

ICOs provide startups with access to decentralized crowdfunding from any geographical location, removing the need for expensive middlemen such as traditional venture capitalists. ICO funding in 2017 grew to over $4 Billion and surpassed early stage venture capital (VC) funding.

Unfortunately, in 2017, excitement about ICOs got out of hand very quickly, and millions of dollars were raised in minutes for projects that had nothing more than a 5-page whitepaper. Moreover, ICOs without a working product actually performed better than those with a functioning product, illustrating the irrationality in the market.

Wild speculation continues to persist across the entire cryptocurrency asset class and is a definite risk for investors. Many coins in the space are not yet being used for any practical, real-world function, but they have market caps larger than companies with millions of dollars in cash flow. Furthermore, many coins are simply fraudulent.

Bitconnect Affiliate Program

For example, BitConnect, one of the largest cryptocurrencies with a market cap of over $2.5 billion, is an obvious ponzi scheme. The chart on the left from BitConnect’s website lays out their “affiliate program” and is literally in the shape of a pyramid. Another example is Tether, a coin created as a digital asset pegged to the U.S. Dollar. However, there is substantial evidence that a large portion of Tethers were “printed” and not actually backed by an equal amount in USD. Thus, there could be up to $1 billion of fake Tether in the cryptocurrency system.

In the next couple of years, I believe that some cryptocurrencies currently in circulation will fail or be exposed as scams, and there will be higher volatility as the market consolidates. At the same time, I expect that in 2018 we will start to see higher quality coins with legitimate, real-world use cases emerge from the rest of the group. The increased participation in the space from institutional investors may also accelerate this process, as they will have more robust due diligence processes before investing in various coins.

Regulation

Although decentralized technologies are difficult to regulate by definition, regulators have been drawn to the crypto space because of exponential growth and, in some cases, fraudulent ICO activity.

In 2017, China disallowed ICOs and closed crypto exchanges. General market consensus is that Chinese regulators will likely unban ICOs and allow trading in 2018 once they have a regulatory infrastructure in place. China was one of the largest markets for cryptocurrencies before the ban, so this change could actually result in capital inflows and price appreciation from pent up demand.

On a side note, the Chinese ban illustrated the resilience of decentralized currencies. China was one of the largest countries active in the space and the nationwide ban caused a large, but short-lived dip. For example, Bitcoin dropped over 30% to $3,000 after the ban, but quickly jumped back past $5,000 and rallied to over $13,000 only three months later to end 2017. No single country or actor controls the fate of the digital asset class.

In the United States, the U.S. Securities and Exchange Commission (SEC) recently shut down an ICO for Munchee, a food review platform, deeming that it was an unregistered securities offering. Munchee had been marketing the ICO not only as a utility token for their platform, but as an investment that could result in significant returns. SEC regulation will likely detract nefarious actors, and provide some reassurance for individuals and institutional investors looking at the space. Funds will flow towards more legitimate projects, and frothy speculation and volatility should be reduced over the long term. Additionally, if we look deeper into the SEC statement, they are promoting innovation and capital investment in the space, but want to ensure it is done while considering the appropriate rules and regulations. I believe this controlled, thoughtful approach by the SEC will add stability to the market and set a good example for other governmental agencies around the world.

Innovation

In 2017, coins and decentralized applications (DApps) began to emerge with real world applications, showing a promising vision of the future.

Leeroy is a Twitter-like DApp. Although it is still a work in progress, it shows the potential for what a decentralized internet could be — content creators are compensated fairly, private data is not harvested and sold for targeted advertising, and platforms are designed and governed by users.

Cryptokitties is another DApp that made mainstream headlines in 2017. At a high level, it sounds ridiculous that people are spending thousands of dollars on digital kittens, but diving deeper shows huge potential for future applications. The kitties are collectibles similar to Pokemon cards, but are digital and more dynamic with breeding abilities and complex genetic makeups. It is easy to see how similar technology can be applied to video games to create in-game assets, which is a multi-billion dollar industry. Most importantly, Cryptokitties exemplify the potential for asset tokenization — the ability to hold and trade real assets using blockchain smart contracts. Asset tokenization applications are endless — spanning land titles, supply chain, digital identities, securities, mortgages, healthcare records, etc.

Toshi is a browser developed by Coinbase that will allow individuals to access decentralized applications on the Ethereum blockchain via a mobile device. This will be the entry point for global participants to enter this blossoming ecosystem.

2018 could be the year of the DApp. I believe more DApps with better usability and more complex use cases will begin to emerge, which will spur further growth in the cryptocurrency market as more real-world use cases are solved via blockchain solutions.

Security

Security in the cryptocurrency space continues to be a huge issue. Numerous hacks have resulted in millions of dollars in coins being stolen. The highest profile hack was of the Mt. Gox exchange in 2014, which led to a multiyear bear market. These issues still persist and there have been multiple high-profile hacks in 2017 where millions of dollars in coins were lost including Parity, Nicehash, and most recently Tether.

The meteoric rise in cryptocurrency market cap has also resulted in individuals with large sums of wealth in cryptocurrency who have no knowledge of how to securely store their assets. I have literally met multiple crypto millionaires that had never even heard of cold storage. One person I met opened his Coinbase app (without any PIN) while standing next to me to reveal a $1.5 million balance. If he left his phone untended, someone could easily have sent the entire balance to another account in seconds.

Custodian services are starting to emerge in the space. Both Coinbase and Gemini released institutional custody platforms in 2017. However, besides issues with price (they are extremely expensive), these platforms have multiple touchpoints, which increases the attack surface for loss of private keys.

In 2018, we are bound to see more targeted hacks of exchanges and hot wallets, which will continue to cause uncertainty and volatility in the space.

Conclusion

In 2018, I believe the cryptocurrency market will continue to grow exponentially. The continued development of scalable, secure blockchain technologies will help differentiate legitimate cryptocurrencies that have real-world use cases. Regulators will continue to build out the legal infrastructure that will dissuade illicit behavior. This will encourage more sophisticated institutional players to adopt and invest in blockchain technologies and cryptocurrencies more heavily, driving the market higher and further differentiating legitimate cryptocurrencies with real-world use cases from other coins. While volatility will continue from security breaches and the exposure of less practical coins, this market has proven it is resilient. Cryptocurrencies are an extremely exciting, innovative space that continues to look highly attractive from an investment perspective if done in a thoughtful, secure way.