The Wild Frontier

The Wild Frontier

The rapid rise in the value of cryptocurrencies has seen investors venture into this digital frontier in search of a fortune, but its volatile and relatively unregulated nature makes this brave new world fraught with challenges for advisers

CRYPTOCURRENCIES REPRESENT a bold step forward for the finance industry. These digital tokens were originally designed to decentralise money from the governments that had previously monopolised it. While they’re yet to usurp the place of traditional currencies, they have quickly become popular with mum and dad investors looking to make money via capital gains, owing in part to the large price rises enjoyed by many cryptocurrency tokens towards the end of 2017.


– Warrick Pleash, Bitcoin Trader

What separates cryptocurrencies from other fast-rising investments, however, is that their popularity has outpaced regulation, and, perhaps more importantly, outpaced investors’ understanding.

The history of cryptocurrencies is a long one, which began well before the concept’s mysterious founder Satoshi Nakamoto published his whitepaper on the use of cryptography to remove government power from cash.


According to Midwinter founder Julian Plummer, the history of cryptocurrencies begins instead with more general forms of cryptography.

“Cryptography started out in Roman times – if you wanted to get a message from one person to another they had to carry a piece of paper with something called a cypher on it, which is a secret code with which they could decode a message,” he says.

“When that person went running, someone could tackle them, get a hold of that code, and the whole cryptography was broken. That’s where cryptography remained for a long time.”

This changed, Mr Plummer says, during the 1970s, with the birth of the Advanced Research Projects Agency Network – a computer network used by universities in California to share research and other information, which formed the basis for the modern internet.

It was during this decade that two researchers, Whitfield Diffie and Martin Hellman, began looking for a way to solve a problem that had plagued cryptography for years – how can the sender of a message encrypt it securely if they’ve never met the recipient to share the cypher needed to decode it?

Their solution, described by Mr Plummer as “one of the greatest epiphanies to ever happen to human kind” was a public key encryption system, in which each individual had two cyphers, a publicly available one for encrypting their data, and a private one for decrypting.

This latter key, though mathematically linked to the first, is constructed in such a way that it is almost impossible for hackers to work out. Cryptocurrencies took this a step further, by applying the same process used to encrypt a message to allow money to be securely transferred.

“Cryptography allows two people who’ve never met and don’t trust each other to talk securely, and similarly you can send transactions via cryptography using bitcoin securely over the internet without having to worry about hackers,” Mr Plummer says.

“That’s the problem Satoshi Nakamoto was trying to solve – how do I get rid of the government and securely transfer information from one point to another, but that information is currency? That’s all it is – that’s bitcoin, and that’s where we’re at today.”

Gold in them there hills

Towards the end of 2017, cryptocurrency prices were enjoying large gains on the market, with bitcoin climbing from US$9,858.82 to US$19,193.72 per coin between 1 and 17 December alone, prompting many investors to join the fray hoping to take a slice of the capital gains on offer in the market.

New coins are even looking for celebrity endorsements to help separate them from the pack, with coins like C.R.E.A.M Cash and Bitcoiin2Gen enlisting the likes of ‘90s rapper Ghostface Killah and action movie star Steven Seagal, respectively, to help promote their launch.

Warrick Pleash, a partner manager with cryptocurrency brokerage firm Bitcoin Trader, explains that this presents a fresh challenge to the advice industry – namely that clients are asking for advice and assistance on cryptocurrency investment, and many advisers don’t know how to appropriately handle the sudden tide of these requests. This is especially true, he says, within the self-managed superannuation sector.

“The theme within the industry is that demand is coming from the bottom up, you’ve got a lot of superannuation trustees saying they want to buy cryptocurrencies, and it’s coming as a push from the clients into the advisers’ space,” Mr Pleash says.

What makes this even more difficult for advisers is the cowboy attitude of some investors, many of whom have been willing to put their hard-earned cash on the line regardless of how their adviser responds to their earlier requests – leaving many vulnerable not only to market fluctuations but the “unintentional potholes” associated with investing improperly. Consequently, advisers have felt the pressure.

“It’s probably the most common question I’ve had in the past three months on a regular daily basis from clients: ‘Should I invest into bitcoin or other cryptocurrencies?” says James Gerrard from, whose first response to the questions is to educate his clients.

“They don’t really know anything more than what they see from the news headlines.”


– Sarah Nulty, Voyager Wealth


Crypto cowboys

It’s the case more often than not: while interest and curiosity is high, clients’ knowledge hasn’t always been up to par. Investors are basing their decisions not on accurate, considered information, but because they’re finding it hard to resist the prospect of easy gains in a world where the virtual currencies are receiving hyperbolic levels of media attention.

Voyager Wealth director Sarah Nulty, who recently submitted her master’s thesis on the topic, reckons cryptocurrency has become the “cowboy” of the investment world.

“It’s creating illogical confidence in clients who believe they have done sufficient research or understand how the asset type works,” she says. “However, it is much more complex than the majority of people realise or can understand.”

To further complicate the issue for advisers, the hype is causing clients to act erratically and invest outside of their risk tolerance.

“Clients who are normally more conservative or balanced, who are wary of volatility in the share market since the GFC, are willing to take risks on cryptocurrencies as they are drawn into the hype and unbelievable gains that are being told around the water cooler,” Ms Nulty says.

However, this office enthusiasm is not shared by many advisers, who recognise the danger signs.

“Most of us are well-educated on historical asset bubbles and were certainly able to spot the similarities in the build-up of cryptocurrency prices,” says Wealthspring Financial’s Liz Hughes.

She wagers that the soars in crypto prices have not been from its intrinsic value, but rather sheer speculation and the ensuing hype.


High noon for client engagement

Differing opinions between clients and advisers has produced a more serious problem: it’s causing friction between the two groups and hurting client-adviser relationships.

Clients excited by the prospect of fast gains are turning to advisers to ask about investing in cryptocurrency – but are often left feeling disappointed or dissatisfied.

“I have seen clients start to doubt their adviser’s ability because they steered them away from it and it then had a spike, or that the adviser is only steering away from it because they can’t advise on it,” Ms Nulty says.

To emphasise this point, Ms Nulty gives the example of a client who did his own research and came to believe the too-good-to-be-true gains his friends and family had enjoyed were achievable by him too.

“This caused him to doubt my experience and knowledge, and to an extent created distrust between himself and me, that perhaps I was discrediting or discouraging the crypto investment because it wasn’t an asset I could advise on or deal with,” she says.

As robo-advisers enter the fray, some commentators have suggested the value proposition of advisers is in question, making the dents in client-adviser relationships caused by cryptocurrency especially serious.

It doesn’t stop there, however: cryptocurrency has exposed fissures within the advice industry itself in two ways, one of which recalls the age-old battle between aligned and non-aligned advisers.

Mr Gerrard acknowledges that while independent financial advisers have their reservations about the virtual coin, they are generally more likely to be bolder – and less restricted – than their counterparts to explore something new.

“It largely comes down to type of licensing and the arrangement that the adviser or the advisory firm is in,” Mr Gerrard says. “If advisers can only look at a certain type of managed fund, for example, it doesn’t really matter what else is happening out there with innovative products, with loans, properties and cryptocurrencies.”

Bank-aligned advisers, he says, who are focused on keeping their clients invested in traditional assets, would not be able to recommend these products anyway – and therefore are more likely to speak negatively about them.

“But then you have other advisers who are not aligned, like myself, and we’re really open to embracing new investments and reviewing things that can help our clients in the right direction financially,” Mr Gerrard says.

Cryptocurrency has also exposed differences between advisers in another way, raising questions about the extent to which advisers should be involved in the lives of their clients.

Ms Nulty recalls an incident in which she and a colleague both had clients that had lost money to bad investments in cryptocurrency and reflects upon the differences in their responses.

“My experience resulted in my practice implementing changes to prevent a re-occurrence and to assist our clients from making rash decisions like this in the future (or helping as much as we can),” she says, “whereas my colleague is of the frame of mind that we are not our clients’ parents – we can provide information and opinions and try to steer our clients in the right direction.

“Ultimately our clients will make their own calls, and we cannot hold their hand for every step they take in their life.

“Some advisers want to be involved with their clients in each stage of their life and become an integral part of their decisions. Other advisers prefer to remain transactional.”


The wilderness

In any case, many advisers have made it clear that they don’t take crypto seriously as an investment vehicle. Most of Mr Gerrard’s clients who have put money into it (despite his advice against doing so) have seen losses.

“I say to my clients: ‘look, if you want to invest into bitcoin or any other cryptocurrency like ethereum or whatever, great, do it. But only do it in a little if you really must’,” Mr Gerrard says. “I almost liken it to a lottery ticket. Expect to lose the money.

“And if it works out, great for you, I’m proven wrong, and maybe put more money into it. But I try to dissuade people from investing into cryptocurrencies.”

Glen James, an adviser who specialises in the Millennial demographic, is even more emphatic. “I think if anyone uses the word investing and bitcoin in the one sentence, you should run from them,” he says.

“I tell my clients, ‘it’s ultimately worthless until you can settle a government debt with it’.”

The lack of regulation has been the primary driving factor behind advisers’ aversion to crypto. Simply put, the unmitigated risks for clients – and by extension, advisers – are too great.

“Cryptocurrencies bypass regulated exchanges and intermediaries and offer very little in the way of protection for retail investors,” explains Ms Hughes. “Most advisers I have spoken with are understandably wary.” Until some rules of fair play have been established in the wild, wild west of cryptocurrency, it won’t be officially backed by advisers, according to Ms Nulty.

“There are very few advisers who will put their name to more formal recommendations as it’s not a regulated product, and far too unpredictable,” she says.

Dances with wolves

Subsequently, many in the advice space view cryptocurrencies as risky investments. In fact, a recent ifa reader poll revealed 68.1 per cent of advisers are “very unlikely” to recommend them to their clients – significantly more than the 15.3 per cent who responded that they were “very likely” to do so.

Mr Plummer, however, has taken an alternative view to this, arguing that such investments are “almost risk free”.

“It’s almost risk free because you know it’s going to be a disaster, so you know what the outcome’s going to be,” he says.

“Risk is where something happens where you weren’t expecting it to happen, and so you’re looking at bitcoin thinking ‘do you think this might have a lot of volatility around it? Do you think this might be a highly speculative investment?’ and the answer is yes, so it’s not risky at all because you know exactly what you’re going to get.

“It’s like jumping out of a plane with no parachute, is that a risk or is it not risky? You know you’re going to die, so there’s only one outcome; it’s risk-free.”

In fact, concerns about cryptocurrency investments have even been expressed by the founder of one of the most successful coins on the market.

Vitalik Buterin, the young founder of ethereum, arguably the second largest cryptocurrency, even took to Twitter in February to remind potential investors that these coins’ volatile nature makes for a risky investment.

“Reminder: cryptocurrencies are still a new and hyper-volatile asset class, and could drop to near-zero at any time,” he wrote.

“Don’t put in more money than you can afford to lose. If you’re trying to figure out where to store your life savings, traditional assets are still your safest bet.”

A new sheriff in town

While the cryptocurrency space may appear to be a lawless wilderness at present, a change appears to be on the horizon.

According to Adrian Przelozny, the chief executive of Sydney based cryptocurrency exchange Independent Reserve, the market is about to become more actively policed.

“The regulators are beginning to look at this more and more,” he says. “We’ve been working very closely with AUSTRAC, very closely over the last two years to educate AUSTRAC on how we believe that this whole space should be regulated, and we do believe that there is regulation required to protect the consumers from unscrupulous operators and bring it into a more mainstream space.”

It’s not just government agencies looking at the impacts of regulation on this space either, Mr Przelozny says, noting that he and his colleague, Independent Reserve head of strategy Lasanka Perera, have been working with a number of the country’s major accounting firms to help address the complications brought about by this fresh market.

“We can’t give you too much detail on it, but we’re trying to, I guess make it easier for people to report on their trading as well, which I guess some of our SMSF and more institutional investors have asked for,” Mr Perera says.

Mr Przelozny adds that questions regarding the tax compliance were among the chief concerns Independent Reserve’s clients had over investing in cryptocurrencies.

For those working in the space, the introduction of formal regulation is seen as a potential boon to the nascent industry; a chance for the digital frontier to grow beyond its lawless beginnings.

“It’ll bring it more in-line with other mainstream industries, so it’s really moving in the right direction,” says Mr Przelozny.

So, what form will cryptocurrency regulation take? According to KHQ Lawyers principal solicitor Darren Sommers, it will likely resemble current equity regulation.

“The message we are receiving is that initial coin offerings (ICO), cryptocurrencies and other crypto-assets will likely be brought further under the umbrella of securities laws, and laws which regulate the issue of financial products,” Mr Sommers says.

“Right now, as highlighted by ASIC in their recent ICO paper, only certain crypto assets are considered by ASIC to be ‘securities’ under our laws.

“What I expect is that ASIC, the SEC in the US, and other financial authorities around the world will rethink their position on which crypto-assets are or are not securities and broaden the net. It is possible that this might be done with additional legislation, but it is too early to tell – however, that could change at any time; in this space the position changes daily.”


– Liz Hughes, Wealthspring Financial

Notably, Mr Sommers believes that increased regulation will make cryptocurrencies a more attractive prospect for advisers, in that it will provide them with a regulatory framework on which to base their investment decisions.

“A financial adviser will still need to consider cryptocurrencies a prudent investment before recommending them as an investment product,” he says.

“Prices are fluctuating wildly, which provides opportunity to make money, but also lose it.

“Before participating in an ICO or purchasing a cryptocurrency, advisers should do their due diligence on the underlying token – for example, what rights attach to it? What disclosure has been provided by the issuer? What is the market demand for the relevant token? In what country and legal regime is the issuer located?”


The good, the bad and the regulated

A greater level of regulation could be just what cryptocurrencies need to reach their full potential.

Mr Pleash believes these investments will eventually be viewed as just another asset class, and perhaps pass into every day usage in the place of conventional currencies as time goes on and better oversight of the market is instilled.

“We think regulation in this industry is a good thing,” he says.

“With any new asset sector, there has to be clarity from government institutions as to how it’ll be treated because that gives people confidence and security around making prudent investment decisions, so that’s only one bit of the regulation that we see coming further down the track.

“We see advisers in time will potentially have to have an investment certificate or qualification in the cryptocurrency space, just as they would if they gave margin lending advice or self-managed super advice, in fact we’re working on an education program at the current time and we’re working towards that because we see that coming.”

Mr Pleash even suggested that cryptocurrencies already bear a lot of similarities to other, existing markets – adding that this may be evidence the cryptocurrency market is not in a bubble, as many others suspect.

“We hear the story all the time, that people only buy cryptocurrency so it goes up in value so they can sell it to someone else,” he said.

“Well, quite frankly, isn’t that how gold’s treated in the world? Isn’t that how land is treated in the world? Isn’t that how property is treated in the world?

“People buy assets for capital gain, so they just don’t understand this concept of buying crypto assets to try and get a capital gain – because it sounds like an investment on a capital gains basis to me.”


The quick and the dead

As with all new technologies, opinions on the role cryptocurrencies will play in the future of the finance sector are varied and numerous, with strong cases being made for both the positives and negatives.

This vast and unregulated market presents huge opportunities, but the risks associated may be more than the eventual payoff is worth – but that’s a decision only the investor (and their adviser) can make.

So where does it go from here? What does the future hold for this digital frontier?

For some, the risks are too great and the path ahead too uncertain, while others press onward, spurred by the knowledge that regulation is coming and the pitfalls on the road to this digital manifest destiny are being progressively filled in.

One of the more interesting takes on this question is that cryptocurrency is the future, but not in its current form.

“My view is that there will be a version 2.0 of bitcoin, and that will be the one that takes off – it’s a bit like web 1.0, where you had the crash in around 2003,” said Midwinter’s Mr Plummer. “You had all this web 1.0 innovation, but it was web 2.0 that really took off.”

Mr Plummer believes the concept has merit, but the brave pioneers who have carved the path so far are unlikely to be the ones that lead the crypto market of tomorrow.

Already the shape of the cryptocurrency market is beginning to change, with various regulatory bodies such as ASIC and the ATO signalling plans to move into the space.

However the future plays out, one thing is certain, the crypto cowboys of the current market will have to straighten up and fly right in order to transition to a world of increased regulatory scrutiny.

The story of cryptocurrency, much like the history of the Wild West, is a story of exploration, of experimentation and, ultimately, of progress in the face of uncertainty and hardship.


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