Last weekend, hackers stole US$530 million dollars worth of NEM coins from a cryptocurrency exchange in Japan. NEM isn’t as well known as Bitcoin, but it has plenty of backers, and the theft affected more than a quarter of a million cryptocurrency investors.
Although this was the largest cryptocurrency theft to date, it wasn’t the first, and it’s unlikely to be the last. Hackers stole roughly US$400 million in Bitcoin from another Japanese exchange in 2014, and a Bitcoin exchange in South Korea just filed for bankruptcy because cybercriminals targeted the firm twice within a few months. Unsurprisingly, the price of NEM coins fell by almost 20% in response to the most recent theft. It’s recovered since then, but the situation left me thinking about cryptocurrencies and the technology behind them.
Looking beyond cryptocurrencies to blockchain technology
As we saw last weekend, the wallet apps that investors use to hold Bitcoin and other cryptocurrencies are vulnerable to hacking. For this, and several other reasons, we consider cryptocurrencies to be a speculative investment. I wrote about this last year, and I explained why MD portfolios don’t hold Bitcoin or any other cryptocurrencies. But where we do see opportunity is in the blockchain technology behind cryptocurrencies, which has the ability to change the way several industries do business.
What is blockchain?
It’s effectively a ledger system used to record ownership and transactions. Individual transactions are linked together into blocks of transactions in a chain, which is where the name “blockchain” comes from. Transactions can only be added to the chain. No transaction is ever modified or removed, so there’s a permanent, but evolving, record of every transaction ever made.
And while wallet apps can be hacked, the underlying blockchain is robust and secure. In a public blockchain, like Bitcoin, the blockchain is distributed over a peer-to-peer network of many nodes, where each node has a copy of the blockchain. This means if any one node fails, all the other nodes still have a copy of each transaction made. Virtually every single node in the network would have to fail for information to be lost, which is incredibly unlikely.
The technology is also good for transactions that need to be kept private, because of the cryptography and the many intermediaries involved in every transaction.
There’s a lot more to it, but I’d like to focus here on blockchain as a long-term investment opportunity. If you want to learn more about the underlying technology, start with this video.
Opportunities for long-term investors
Any activity that requires a high degree of trust or data validation has the potential to benefit from blockchain technology. Because the potential application of the technology is so varied, the companies involved in developing blockchain span across many industries and geographies.
For example, we’re seeing a lot of interest from banks, particularly when it comes to using the technology to process cash transactions and securities trading. Blockchain has the potential to decrease settlement times, reduce failed trade settlements and lower transaction costs. More than 50 banks have invested in blockchain, including Canadian banks. MD holdings involved in blockchain technology include Toronto-Dominion Bank, CIBC, Scotia Bank and National Bank of Canada.
Much still has to be done to manage the front end of blockchain-type applications. While blockchain technology is secure, we’ve seen hacking vulnerabilities in the way individuals interact with the blockchain. That type of secure interfacing is one of the areas in which big banks currently excel and have lots of trust with consumers. With future development, we see banks becoming even larger blockchain investors.
But it’s not just banks. Alphabet Inc. (Google), another MD holding, is the world’s second-most active blockchain investor. Over the past five years, it has made six large investments in the technology, including data storage provider Storj, cryptocurrency derivatives-trading platform LedgerX and merchant services firm Veem.
In the health care sector, blockchain technology could transform the way patient records and other medical information is managed. The technology could ensure electronic medical records are processed and validated more efficiently, and would ensure that records are secure and private. We are also seeing the technology being used in supply chain management. Specifically, in the pharmaceuticals industry to prevent counterfeit drugs. In fact, I would guess that nearly all large companies are at least investigating blockchain applications.
There are even blockchain games like CryptoKitties which have become so popular that it reportedly slowed down the Ethereum blockchain network. The Vancouver based company behind the game is doing a great job of making the technology accessible to everyone.
Staying the course
Although we continue to view cryptocurrencies as a speculative investment, we’re excited about the potential of the underlying technology. So, here’s our advice to long-term investors: If you want exposure to the blockchain, skip buying Bitcoin. Instead, invest in the companies that stand to benefit most from what the underlying technology has to offer. MD Funds and Pools have many positions that are involved in and stand to benefit from the further development of the technology.
But if you really want to play around with cryptocurrencies, you can always try getting your very own CryptoKitty.
About the Author
Mark Fairbairn, CFA, B.Eng., is a Senior Investment Analyst with the Investment Management team at MD Financial Management. He is responsible for the non-North American equity funds and pools as well as the currency overlay program within the equity funds.More Content by Mark Fairbairn