Cryptocurrencies simply couldn't be stopped in 2017. Having begun the year with a market cap of $17.7 billion, virtual currencies ended the year having gained almost $600 billion in market cap, or more than 3,300%. It's very likely the single-best year we've ever seen (and may ever see) for any asset class.
This year has been markedly different. After hitting an all-time market cap high of $835 billion on Jan. 7, cryptocurrencies briefly dipped below $250 billion in early April, according to CoinMarketCap.com. The faces of the virtual currency rally -- bitcoin, Ethereum, Litecoin, and Ripple -- have completely stalled.
Crypto's most prominent tokens rally behind the potential for blockchain
Some crypto advocates would suggest that an across-the-board drop of 60% to 90% in the well-known virtual currencies mentioned above is the perfect buying opportunity, and there are certainly reasons to believe these premier virtual currencies could bounce back.
Front and center among the many catalysts that could drive brand-name virtual currencies higher is the emergence of blockchain technology. For those of you unfamiliar with blockchain, we're talking about the digital, distributed, and decentralized ledger responsible for logging all transactions without the need for a financial intermediary, like a bank. In other words, it's an entirely new way of transmitting "funds" (which are often in virtual tokens) from one party to another without the need to use traditional banking channels. It's also a way of transparently and immutably (i.e., in an unchanging manner) recording data.
Blockchain itself evolved from the idea that the current banking system was inadequate. In particular, there's the perception that banks are taking too big of a fee by acting as an intermediary, and that banks are taking too long when it comes to validating and settling transactions, especially in the cross-border setting, which can take up to five business days. Blockchain resolves this by settling transactions considerably faster (sometimes in real-time), as well as by circumventing banks altogether, which may lower transaction fees.
It's worth pointing out that blockchain has plenty of applications in the non-currency setting, too. It can be used to manage supply chains, create digital IDs, maintain loyalty points programs for retailers, and so much more.
Another major catalyst for bitcoin, Ethereum, Litecoin, and Ripple has been the lack of institutional investor participation. With retail investors leading the charge, and access to short-selling -- i.e., betting on a downside move in an equity -- limited, the natural course of action for investors has been to buy.
Why I won't invest in even the most established virtual currencies
Yet, in spite of these key catalysts, I have zero intention of investing in bitcoin, Ethereum, Litecoin, or Ripple. Here are five reasons behind that decision.
1. Blockchain is a long way from being a real-world solution
Arguably the biggest issue is that blockchain technology is still a long way from being a viable real-world solution. To date, we've witnessed countless small-scale projects and demos, most of which have been resoundingly successful. As an example, there are more than 200 organizations taking part in the Enterprise Ethereum Alliance and testing versions of Ethereum's blockchain across a host of industries and sectors. Meanwhile Ripple, which is laser-focused on selling its blockchain software to financial institutions, has no less than five major partners.
Despite these small-scale projects and demos, the training wheels are still very much on blockchain -- and they don't look to come off anytime soon. The problem really boils down to a Catch-22. Namely, businesses won't make the jump to blockchain until the technology proves its ability to scale. However, this can't be proven in the real-world until businesses make the leap and give blockchain a try without the so-called training wheels.
What's more, not all industries will benefit from blockchain, while other industries could be facing a costly and time-consuming transition should they choose blockchain over an existing network. In short, you have a recipe for short- and intermediate-term investor disappointment.
2. The barrier to entry is exceptionally low
Another reason not to buy? How about the exceptionally low barrier to entry in developing a digital currency and/or blockchain. All it takes to join the ever-crowded field is time, money, and a team that understands how to write computer code. There are now well over 1,600 different virtual currencies that investors can buy into (most of which have their own tethered blockchain), along with numerous blockchain projects being developed by brand-name companies themselves.
The real concern with a low barrier to entry is there's no way to guarantee that today's technology won't become obsolete within a matter of months. This is yet another reason why enterprises haven't taken the plunge with blockchain. Why buy into the concept if a next-generation blockchain comes along a few months later? Replacing and upgrading can be a costly and time-consuming process.
3. A need for regulation
Next, I wouldn't even think about buying into the cryptocurrency craze without a major improvement in regulation. The Securities and Exchange Commission (SEC) has come out on more than one occasion and cautioned investors about the dangers of virtual currencies. In particular, decentralized exchanges may record or process transactions outside the borders of the U.S., severely limiting the scope of what the SEC can do to get your money back if something goes wrong.
And should this regulation come to fruition, we're liable to see a decline in the market caps of prominent cryptos like bitcoin, Ethereum, Litecoin, and Ripple. Investors appreciate the perceived anonymity that comes with virtual currency investing, and regulating the market would likely mean putting an end to any form of anonymity. While I do believe this would be a good thing for cryptocurrencies over the long run, it's unlikely that investors would see it that way in the short- and intermediate-term.
4. Few tangible means to value cryptocurrencies
Fourth -- and this probably goes without saying -- there's no fundamental or logical way to value cryptocurrencies, which makes for a pretty good reason not to buy. Sure, the old adage that "an asset is worth what someone else will pay" for it is true, but hoping someone else buys back your tokens at a higher price than you paid isn't exactly a sound investing strategy.
One of the biggest misconceptions with virtual currencies is that mass adoption of their tokens means they're succeeding. Unfortunately, that's not the case. Using a virtual currency won't necessarily generate revenue or profits for the developers behind that token.
Furthermore, it's the blockchain technology that tends to hold the potential long-term value, not the token itself (in most instances). Therefore, buying into a token without actually getting ownership in the underlying blockchain doesn't make a lot of sense to this investor.
5. The tax situation is a nightmare
Last, but not least, I have absolutely no desire to deal with Uncle Sam. Investing in cryptocurrencies means the need to keep track of capital gains and losses for each and every transaction. Even using your tokens to buys goods and services becomes a taxable event, according to Internal Revenue Service (IRS) tax guidelines.
You might be thinking that since the IRS has been relatively lax on reporting standards with crypto capital gains until now that this isn't a big deal -- but make no mistake, it is. The IRS recently won a court case against cryptocurrency exchange Coinbase that may allow it to go after thousands of tax evaders. Also, the Tax Cuts and Jobs Act eliminated a profitable tax loophole known as the "like-kind exchange," which had allowed investors to sell one cryptocurrency and buy another (or others), all while avoiding capital gains taxes. Now, all sales should be reported as a capital gain or loss.
In sum, there are plenty of good reasons to keep your distance from cryptocurrencies.
Sean Williams has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool has a disclosure policy.