Disruptive Innovation

I didn't know whether to be horrified or impressed when my son recently disclosed that he made a modest killing investing in a crypto-currency called 'Ethereum'.  He had even set up his iPhone to buy and sell using the currency - apparently there are now a variety of "apps for that".  For someone like me, who ekes out an existence within the stultifying culture of FCA regulation, all of this felt a bit like entering the world of Tron, a film I recall watching with my kids many moons ago.  Mind you, anyone who has recently had to deal with the FOS will already be keenly aware of alternative reality.

Ethereum, and the rather better-known Bitcoin, are examples of disruptive innovation, designed to create new markets and networks, and have the effect of subverting or disrupting existing markets - you know, the kinds of market that we, as IFAs are used to.  I find it intriguing that kids such as my son, who would never, in a million years, consider approaching an IFA for advice, seem to naturally migrate to this kind of thing - and inevitably my own ability to interact intelligently with the subject is influenced by a rather rigid set of 'dos and donts' which are in part a product of habit (I'd like to think good habits) as well as a kind of institutional softening-up at the hands of successive regulatory bodies.

This gets especially complex when you consider that crypto-currencies are now only a subset of a much bigger, and more ambitious technology called Blockchain.  I am torn between encouraging you to check yourself into some remote monastic retreat for the protection of your own sanity, or to alternatively advise you to grapple with it.  On balance, I think it better to develop your understanding of the subject, so you know what you're dealing with.  You'll notice that this blogpost contains quite a few hyperlinks - they are there to assist you in improving your awareness.  Well, we do aim to serve.

There are clearly opportunities here.  Even I, with my relatively thin perceptions of the subject can see that.  But I can also see some dangers.  One of those dangers is a product of cultural amnesia.  The generation which is enthusing about Bitcoin is a generation which is peculiarly devoid of any historic awareness.  You actually don't need to be a history geek to have some awareness of Tulip Mania, or the South Seas Bubble, or Black Monday, or more recently, the Credit Crunch.  The responsible individual - and, in particular, the careful Adviser - bears this kind of history in the back of his or her mind.  Human beings may have the capability of great technological innovation, but we also seem to have an infinite capacity to foul it all up.  A very great deal of what we see happening within these historic events could easily have been foreseen, or perhaps predicted based upon an analysis of history.  But, no, there are always those amnesiacs who somehow have to keep re-learning exactly the same lessons, living as they do within a kind of goldfish bowl.  Hitching your financial wagon to crypto-currencies may well involve tying your life up with people who operate without any awareness of the past - and that should at least merit pausing for thought.

Not that this is the only danger.  Crypto-currencies are being utilised by islamic terrorists in order to transfer funds between themselves, Saudi Wahhabi supporters and arms dealers.  The very nature of the technology lends itself to such organisations, those that don't sign up to responsible models of human rights and associated regulations.  It's possible to overstate that kind of risk, but it should inform our approach to the subject.

Furthermore, because these currencies have the feature of encryption in common, this attribute may have the unhelpful side-effect of making investors more complacent about the risks.  The fact is that large amounts of crypto-currency units have been lost by those who entrusted them to unregulated Bitcoin "banks" and "exchanges".  Jim Rickards in his useful book 'The Big Drop' tells us that crypto-currencies are equally susceptible to good old-fashioned fraud.  Most enthusiastic adopters are likely to overlook these issues - and, from an Advisory perspective, they are also likely to overlook the necessary matter of reporting gains to HMRC.  Rickards believes that a significant proportion of such investors are very likely involved in tax evasion, and for those of us who are subject to the regulations that does raise something of an ethical problem.

At ValidPath, in recent years we've been encouraging our Members to 'back test' their investment models, so that both client and adviser have an informed view of how bad things might have been.  Our own Centralised Investment Proposition uses 20-years of continuous data for this purpose, and our Members now have the ability to overlay actual (historic) market crashes onto their clients' cashflow forecasts, in order to stress-test the model.  But Bitcoin technologies don't have that kind of track-record.  They were launched in 2009 after the worst of the credit-crunch, and have operated in a market which has (so far) been characterised by weak expansion.  Nobody knows how these crypto-currencies might survive some really serious upheaval.

At ValidPath, we're looking at technologies which some might regard as 'disruptive', in that they have the potential to change how advice and financial solutions are delivered to the end consumer, the client.  I would prefer to describe them as 'transformative' as that reflects the IFA's intent when it comes to improving his or her clients' financial outcomes.  There's more to be said on this subject!

Kevin Moss, 25/08/2017