Historically, the stock market has been the greatest creator of wealth. Over the long term, stocks have returned an average of 7% annually, inclusive of dividend reinvestment. By comparison, bonds, gold, oil, and even home prices have lagged on an inflation-adjusted basis.
The year of the cryptocurrency
But in 2017, cryptocurrencies like bitcoin and Ethereum turned this traditional mantra on its head. The aggregate value of more than 1,200 digital currencies combined has jumped from $17.7 billion at the beginning of the year, to about $192 billion, as of Nov. 12. That's nearing a 1,000% gain in just a little over 10 months.
Leading the way has been bitcoin, which has the largest cryptocurrency market cap by a mile at $95 billion, and Ethereum, which has risen by nearly 3,700% year to date. Whereas bitcoin's notoriety is based on its size, first-to-market advantage, and the fact that a handful of large merchants accepts its virtual currency, Ethereum's hot 2017 is entirely based on the potential of its underlying blockchain technology. The Enterprise Ethereum Alliance currently has more than 150 organizations, including nine well-known companies, testing versions of Ethereum's blockchain in financial, industrial, and energy projects of varying scales.
What makes Ethereum so much different from every other blockchain technology is its incorporation of "smart contracts." These are computer protocols built into the blockchain that aid in facilitating, verifying, or enforcing the negotiation of a contract. In other words, it helps with financial supply-chain procedures and compliance processes in a secure and efficient manner. With so many organizations testing out Ethereum's blockchain, there's the chance that it could become the go-to choice for the financial-services industry.
Big rewards come with big risks
While that might sound great on paper, and there's little arguing against an almost 3,700% return in 2017, investing in virtual currencies like ether (the digital token of Ethereum) still comes with big risks. How big, you ask? How about $280 million big.
As reported by CNBC, around $280 million worth of ether (about 1% of the outstanding value of Ethereum at the moment) was frozen last week because of a vulnerability in cryptocurrency wallet provider Parity. According to a security alert from Parity on Tuesday, Nov. 7, this vulnerability allowed users to change code and become the owners of wallets that weren't theirs. Things were made worse when a user suicided the wallet and deleted the code, freezing roughly $280 million in ether assets. Because of this action, users can't move their virtual currency out of the wallet, and it's unclear when there will be a remedy. Would this ever happen with investments in the stock market? Highly unlikely.
And this is far from the only questionable instance of investing in ether. In an instance of deja vu, Parity announced in July that hackers had gained access to some of its users' cryptocurrency wallets and wound up stealing $32 million worth of ether at the time. Parity specifically pointed to a vulnerability in the wallets' multisignature technology. In other words, this is the second time in four months that its users have been compromised by a vulnerability.
But I'm still not done. Back on June 21, 2017, the price of ether on the GDAX cryptocurrency exchange cratered from $319 to $0.10 (seriously, ten cents) in one second, but rebounded a few minutes later. According to a GDAX spokesperson following the event, a large sell order drove ether down initially to $224.48 before triggering about 800 stop-loss orders. Initially, GDAX told these investors who'd been stopped out because of a digital flash crash that they were out of luck and wouldn't be getting their money back. However, after a few days of bad publicity, GDAX changed its mind, despite sticking by the idea that its software worked properly.
Cryptocurrencies have other possible issues, too
Those three instances describe some of the issues Ethereum has run into over the past couple of months -- but there are far bigger concerns at hand for the digital currencies as a whole.
Possibly the biggest issue, and the reason digital currencies should be avoided, is that most investors are focused on the potential of virtual currencies, when it's the underlying blockchain platform that has the real value. Trying to live off bitcoin would be very difficult, while ether is only accepted at one major retailer, Overstock.com.
Even if investors are focusing on the correct aspect, blockchain, there's no telling how much blockchain technology will ultimately be worth, or how quickly it'll be adopted. If we look back at recent breakthrough technologies, like genome mapping, 3D printing, and even the business-to-business commerce that sprang from the internet, investors have overestimated how quickly this technology would be adopted in every instance. My belief is we'll see a repeat with blockchain technology, which could take time to find its way into everyday transactions.
Regulation remains another critical concern. Even though actions like the CME Group's announcement of plans to list bitcoin futures by the end of the year is a good thing for cryptocurrencies, and it helps validate bitcoin as a new asset class, it also opens the door for other countries to shut bitcoin out. Both South Korea and China have recently put the kibosh on initial coin offerings, with China taking things a step further and announcing the closure of domestic cryptocurrency exchanges.
Despite the strong gains we've seen from bitcoin and Ethereum, they could just as easily disappear.