What happens when the bitcoin party ends?

In 2018, the outlook for the technology sector remains strong. We are seeing robust economic growth around the globe and technology is pivotal in driving a fourth industrial revolution. People worry when they see a particular sector doing well but we are confident that the recent increases in tech stock prices mark the start of something, not the end. 

Our confidence comes from the idea of a ‘fourth industrial revolution’. We have seen these leaps before, whether it be in the form of steam power or electronics, and they represent shifts in the way we work and live. This fourth revolution will be driven by cloud computing, artificial intelligence, automation, and information. 

Advances in these technologies are changing the way we work and driving efficiency and productivity growth across a broad range of sectors. They pose a challenge to all companies, great and small, and it is our belief that companies who are truly innovative and offer a real benefit to users will continue to benefit from corporate investment, and continue to flourish. While there are plenty of these opportunities for investors, there are also risks to be aware of.

One of the most interesting developments that has come out of our increased interconnectivity is the idea of a digital currency. Indeed, there can be few technology phenomena that have attracted as many headlines as cryptocurrencies. Although they have been around since 2009, interest has hit fever-pitch in 2017, with around 900 digital currencies now available.

The technology can be used to trade bonds, stocks and other financial assets. Companies in search of early-stage funding believe it may help them circumvent the need for venture capital, potentially allowing management to retain greater control. However, their uses to date have been limited, and the prices extremely volatile. Investors are apparently willing to pay high prices for a technology still in its infancy.

A lot of people have already made a lot of money from cryptocurrencies; the question is what will happen when the party ends? From our analysis of the market, many market participants are buying into cryptocurrencies with the idea that they can trade them, rather than examining what they really own. This is leading to some clear excesses in the market. We are seeing this in the private equity and venture capital areas, where it is helping to drive valuations higher.

-2018 predictions: Which cryptocurrency will be the next bitcoin?

Worse, we see that in some cases cryptocurrencies are being used as a way to support criminal activity. Cryptocurrencies can be a way to transact and to make these transactions invisible, moving money to places where it can’t be traced. To our mind, the market looks unstable. For many, dealing in cryptocurrencies is simply gambling - aiming to sell at a higher price than the purchase price. Equally, at the moment pricing seems to be too volatile for it to be of significant use for, say, sending money to relatives in another country. As such, there is not a lot supporting most of the business models of these cryptocurrencies, including bitcoin.

The underlying technology of a unique ledger has a place and cryptocurrencies may yet be a way for companies to transfer money at reduced costs. Companies such as Ripple are using their currency, XRP, as a trusted and secure medium to reduce the costs of cross border transactions and eliminate the need for a high cost letter of credit to enable these transactions.  It is applications like those that may reduce costs of that type of transaction and may establish a value of their currency as a medium of transitional exchange.  However, for investors, our view is that without a fundamental usage for a currency, owning one is based on sentiment and looks like a house of cards.

Whilst we remain unconvinced by most cryptocurrencies, the US technology climate remains favourable and despite its recent strong run we believe the fundamentals of the sector have more to give. Over the next year we will be closely following the increasing prevalence of robots, and the companies that make them. It is an exciting time to work in the technology sector and we look forward to seeing how companies and countries adapt to the changes they are bringing to our lives. 

Walter Price is senior portfolio manager at Allianz Global Investors.

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