A year ago, the idea that bitcoin and cryptocurrencies were going to change the world was becoming the consensus opinion. Today, not so much.

The digital currency fell below $4,000 last week. It's down more than 20% this month, and 80% off its high near $20,000 in January. Other cryptos are collapsing, too.

Investors should have seen this coming. It was obvious.

There is a catalyst. People who follow digital tokens blame the hard fork of bitcoin cash. The smaller namesake cryptocurrency is itself a fork of bitcoin proper. But last week its developers and miners could not agree on the future of the digital token. So they decided to split into two competing cryptos, Bitcoin ABC and Bitcoin Satoshi's Vision.

If that seems like an inherently bad idea, it is. But again, investors should have seen it coming. Bitcoin is an open source project. Developers are free to duplicate the base code and create cryptocurrencies at will. And they have.

Through mid-November 2018, there are 2,502 cryptocurrencies, according to a list compiled at Investing.com. The cumulative market capitalization of these tokens is $142 billion, although it had been much higher.

Forgive me. I'm burying the lede. The problem with bitcoin, and cryptocurrency in general, is not forking. It's that developers should not be able to create currency, at all.

I began writing in January that most cryptocurrencies were headed to zero. At the time it was not a popular position. I prefaced my view on two things every potential investor should have understood about "me too" digital coins: There is no use case, and worse, it's unlikely they will ever represent a store of value.

Keep in mind, many things can represent a store in value. Collectibles like art, baseball cards and signed memorabilia immediately come to mind. Cryptocurrencies, at least the vast majority of them, will never be that.

Bill Harris, a former chief executive officer at Paypal (PYPL) , made headlines in August when he wrote at Recode; "Okay, I'll say it: bitcoin is a scam." He argues bitcoin is a pump and dump scheme, where promoters push up the value of dubious investments with hype and relentless advocacy. As the price surges and enthusiasm is greatest, they dump everything, leaving unsuspecting investors holding worthless securities.

 I have made this case about so-called alternative coins. Investing in an initial coin offering is like speculating in a highly promoted junior gold mining company where the prospect of finding actual gold is nil. There will be price volatility, plenty of promises made, but in the end, the investment is worthless. And it was always going to be worthless.

Harris is conflating bitcoin, with alternative coins. That is a mistake, I believe.

A pure digital currency is a good idea. It takes power away from central authority. The problem is oversupply. There are currently too many coins and too many charlatans.

This will pass. The Securities and Exchange Commission will round up the fraudsters. Their fake investment premises will lead to a great reckoning. Most ICOs will go to zero because they will be unable to pass the test of legitimate government oversight.

That should leave bitcoin as the last digital coin standing. When that happens, my guess is it will ultimately be more valuable than it is today. However, there is plenty of pain ahead as pump and dump schemes are uncovered, and most coins collapse, souring the mood for all their peers.

The play for investors is blockchain, bitcoin's cryptographic infrastructure. Ultimately, this digital ledger system is going to find its way into global supply chains and financial services because it systematically removes middling trusted agents for verification.

Blockchain will make legions of accountants, lawyers and back office personnel redundant.

IDC, a global information technology research firm, sees blockchain as part of a larger digital transformation. The shift could be worth $7 trillion by 2022.

Microsoft  (MSFT) was an early convert to the power of blockchain. It began working with financial services start-ups in 2016. More recently, the Redmond software giant has been touting the scalability of its Azure cloud computing platform to run ledger systems. The company is even working on a blockchain-as-a-service tool.

Shares trade at 20x forward earnings. The market capitalization has come down to $790 billion in the latest leg of the tech wreck. The stock would be a great pickup in the  low $80s.

To learn more about my recommendations at the crossroads of communications and technology, check out my daily newsletter Strategic Advantage.

To learn about my practical research in the short-term timing of market indexes and commodities, check out my daily newsletter Invariant Futures.
 
 
 

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Jon Markman owns shares of Microsoft.

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