Ins & Outs of Blockchain & Cryptocurrencies

04/03/2018 By Anthony Kosinski, GW & Wade Associate

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It’s likely you have seen a lot of commentary regarding blockchain technology and cryptocurrencies. Yet, many individual investors have a difficult time understanding these new technologies and their relevancy. Beyond the hype, we think there is some validity surrounding these trends. However, what remains to be seen is whether they’ll be revolutionary, game-changing technologies.

My goal today is to provide a bird’s eye view of these new crypto trends.

Blockchain Technology

Specifically, a blockchain is a continuously growing list of records, called blocks, which are linked and secured using cryptography.[1] By design, a blockchain is inherently resistant to modification of data. It is a publicly viewable, super-sized ledger with stringent security for recording enormous amounts of transactions between parties, efficiently, verifiably and permanently.[1]

Many types of transactions may be recorded, such as real estate, financial or medical transactions. The environment is a peer-to-peer network with no leader, and the overarching goal is to reach an agreement that events have occurred.

Here’s a quick analogy to help you understand how blockchain works:

Imagine you and your friends are building a brick wall. You lay down a brick and cement it in place. Then someone else adds another brick on top and cements it to the first brick, and so on. The pile of bricks serve as an incontestable chronological record. Everyone who is a member of the building process can see your brick activity and you can see theirs. In fact, if you were to pull a brick out, everyone would know and assume there was corruption, the only remedy for which would be to reset the brick wall back to its previous design before you removed the brick. The blockchain platform operates the same way: if someone attempts to corrupt a record, the community would recognize it and correct it, reverting the record to its original state.

For a deep dive into the blockchain recordkeeping process, this article[2] does an excellent job explaining the flow of information (blocks) throughout the recording process. 

Why are companies so interested in blockchain?

A recent Fortune article reports that the market for blockchain-related products and services will reach $7.7 billion in 2022, up from $242 million last year, and adds that almost 6 in 10 large corporations are considering using blockchain technology in their businesses.

Many large corporations are actively testing blockchain technology as a means to reduce costs and fraud, minimize reporting errors, and store large amounts of data and automate transactions in a highly secure, digital environment.

Given this corporate investment, it seems likely that blockchain technology is here to stay. That being said, blockchain is a very new technology. There are still many unknowns and untested features, including the impact on data privacy and the overall credibility of the initial data entered into the blockchain.

Cryptocurrencies

I.e., Digital Money

Although there are strong signs that blockchain technologies will continue to be integrated into how we do business, we aren’t as confident about cryptocurrencies, such as Bitcoin.

Let’s be clear on what Bitcoin is. CoinDesk (one of the major cryptocurrency exchanges) describes it as such: On the one hand, you have Bitcoin-the-token, a snippet of code that represents ownership of a digital concept, sort of like a virtual IOU. On the other hand, you have Bitcoin-the-protocol, a distributed network that maintains a ledger of balances of Bitcoin-the-token. Both are referred to as "Bitcoin." When people refer to Bitcoin, they could be either referring to the actual currency or to the hyperledger that records the currency transactions.

The key feature behind cryptocurrencies, including Bitcoin, Ethereum, Ripple, etc., is decentralization, meaning that no single government, company or person controls them. Although some may regard this as a virtue, it could also be viewed as a weakness because no government backs the value of the currency.

What’s more, not all cryptocurrencies are created equal.

For example, Bitcoin versus Ethereum:

Ethereum is a coin/token with its own interactive platform, meaning that it is potentially more useful than just a currency.  For example, its platform supports business-to-business smart contracts. It’s akin to Facebook in terms of its level of interactive capabilities. On the other hand, Bitcoin is merely a currency. This has led many cryptocurrency speculators to posit that the future of the space will be dominated by these platform-based cryptocurrencies.

Given our explosive digital economy, the marketplace is ripe for alternative ways to digitally, securely, inexpensively and instantly pay for goods and services, while avoiding government influence. Therefore, we believe that cryptocurrencies will more than likely be a part of our future. However, the value of these assets, as well as the actual cryptocurrencies that may become the standard, remains to be seen.

Before investing in a cryptocurrency, investors should consider the following:

  • Asset volatility & levels of speculation
  • Government oversight (or lack thereof) and support
  • Tax consequences – currently the Internal Revenue Service categorizes cryptocurrencies as a capital asset, meaning every transaction is a taxable event. Here is more detail regarding the tax implications of cryptocurrencies.[3] 

Do cryptocurrencies have a place in your portfolio?

The most important question to ask yourself when preparing to make an investment of any kind is: What is the role of this investment in my overall financial plan?

At this time, GW & Wade is not investing (or recommending that our clients invest) in Bitcoin or any other cryptocurrency. Presently, we believe these “assets” are far too volatile and speculative. Until we see consumers broadly adopt these currencies as a medium to exchange wealth, to us they will remain as purely speculative as a lottery ticket. Additionally, we believe that the volatility of their market price will continue until it becomes clear how the world’s governments will regulate and tax the space. However, the potential viability of these currencies shouldn’t be easily dismissed. So, in the meantime, we will continue to monitor developments, keeping in mind volatility and risk. 

If you have questions regarding blockchain technology or cryptocurrencies, please contact us at any time.

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The information provided above is general in nature and is not intended to represent specific investment or professional advice.  No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from GW & Wade, LLC, which can only be provided through a formal advisory relationship.  

Clients of the firm who have specific questions should contact their GW & Wade Counselor. All other inquiries, including a potential advisory relationship with GW & Wade, should be directed to:

Laurie Gerber, Client Development
GW & Wade, LLC
781-239-1188
lgerber@gwwade.com

 

[1] Cryptography is the process of using mathematical theory and computer science practice to prevent unintended recipients of communications and data from accessing the encrypted information.

[2] https://en.wikipedia.org/wiki/Blockchain

[3] http://dcicblog.umd.edu/cas/wp-content/uploads/sites/13/2017/06/Lemieux.pdf

[4] https://www.irs.gov/pub/irs-drop/n-14-21.pdf