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Blockchain technology may be for real - but the astonishing rise of bitcoin looks a lot like tech bubble 2.0

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Saturday, November 11, 2017 – Page B6

Clad in a baseball cap and a dark polo shirt, Anthony Di Iorio is a stark contrast against the sea of suits. He paces across the stage as he addresses a crowd of more than 400 portfolio managers, investment advisers and high-net-worth investors gathered in Toronto's financial district to learn about bitcoin.

"How many here are thinking that they want to invest in the space?" Mr. Di Iorio asks.

Most of the hands in the room shoot up.

"That's what I kind of figured."

The Design Exchange, located inside the historic building that once housed the Toronto Stock Exchange, is a suitable venue for Mr. Di Iorio's speech about how technology is poised to disrupt the world of finance. Many years ago, this place was home to a bustling trading floor and an army of stockbrokers.

Today, it serves as an old-world backdrop against which entrepreneurs such as Mr. Di Iorio - who briefly served as chief digital officer for the TSX - are pitching Bay Street on the new world of cyptocurrencies.

The dramatic run-up in the price of bitcoins in recent months has thrust cryptocurrencies - and the blockchain technology that underpins them - into the limelight. In the past six months alone, the price of one bitcoin has surged roughly 300 per cent, hitting more than $7,000 (U.S.) recently and bringing the total value of all bitcoins in circulation to more than $100-billion. (The price slipped back to $6,600 on Friday.)

That parabolic rise has caused a stir in financial circles, with JPMorgan Chase & Co. chief executive Jamie Dimon among those to declare bitcoins a fraud; he likened it to the Dutch tulip mania of the 17th century.

Derivatives marketplace CME Group recently announced plans to launch bitcoin futures this year. Meanwhile, celebrities such as Paris Hilton and the Wu-Tang Clan's Ghostface Killah are jumping into the fray by promoting initial coin offerings, or ICOs, a new method of fundraising. Early-stage companies use ICOs to sell new cryptocurrency to finance their ventures - without any of the usual disclosure that securities regulators require to protect the investing public.

The cryptocurrency craze sweeping the world is capturing imaginations on Bay Street as well. Eager to make a quick buck, investors are piling into digital currencies because gains are dramatically outpacing the stock market.

Much as they did during the dot-com boom of the 1990s, some investors are tossing aside the traditional rules of investing to chase a risky, speculative asset that many of them barely understand.

The Oct. 25 event at which Mr. Di Iorio was speaking sold out in a mere 48 hours - a level of demand that surprised even its organizer.

"I've never seen a response like that before," said Genevieve Roch-Decter, CEO of Grit Capital, a Toronto-based advisory firm specializing in blockchain (a digital ledger of transactions that are encrypted and stored in blocks) and cryptocurrency. "Anything that moves that quickly, where millionaires are made overnight, will capture the greed part of Bay Street."

Money managers are racing to create publicly traded ETFs and crypto-investment funds and pouring cash into companies such as Hive Blockchain Technologies Ltd. The "cryptocurrency mining" company, which recently went public via a reverse takeover on the TSX Venture Exchange, has quickly become Canada's first publicly traded billiondollar blockchain firm - despite the fact it was a junior gold company a couple of months ago and has yet to report a quarter of results under its new guise.

Over the past few years, bitcoin - a decentralized digital currency invented to subvert traditional finance in the wake of the 2008 global financial crisis - has gone from a libertarian plaything used to buy drugs anonymously on the internet to an investment touted as the Next Big Thing. At financial conferences, bankers, lawyers and anti-fraud professionals discuss the possible implications of blockchain technology on every facet of society. In response to a surge in demand from prospective clients, a number of Canadian law firms, including Gowling WLG and Borden Ladner Gervais LLP, have created working groups devoted to navigating the murky, largely unregulated world of cryptocurrency.

"It's almost like a shoe dropped six months ago and everybody wants to get into blockchain," said Troy Wong, CEO of Vancouverbased private-equity firm Neptune Group.

Speaking at a recent breakfast event hosted by Gowling, Mr. Wong added: "We're seeing companies increasing their share price by 30 per cent by adding blockchain to the end of their name."

It all bears a striking resemblance to the frenzy that gripped internet companies in the late 1990s - just prior to the crash.

"That's very reminiscent of the dot-com boom, where firms would put .com in their name and they'd instantly get a valuation bump," said Mark Kamstra, a professor of finance at York University's Schulich School of Business, who specializes in the study of financial bubbles.

If blockchain is the internet 2.0, as its proponents claim, then investors would be wise to heed the lessons from the rise of internet 1.0.

When the dot-com bubble burst, it wiped away more than $1.7-trillion of stock-market value.

Bitcoin is a classic bubble because its value is based on nothing more than the expectation that its price will continue to rise, Prof.

Kamstra said. There is nothing tangible - no bar of gold, no promise from a central bank, not even a tulip bulb - backing the currency.

"It will burst," Prof. Kamstra said. "I couldn't tell you when. That's the thing about bubbles - they're driven by this irrational exuberance over future price gains. And when does that stop? When do people stare at the naked man walking down the street and say the emperor has no clothes? I don't know."

One of the places where the bubble is most evident is in ICOs. Similar to crowdfunding, initial coin offerings help early-stage companies avoid venture capitalists and the highly regulated stock markets and raise money directly from investors by selling digital tokens or coins.

Some companies have managed to raise millions of dollars very quickly this way.

What's troubling, however, is that many of the ventures being financed this way have little more behind them than a brief white paper outlining their business plans. There have been more than 200 ICOs in 2017, raising a total of more than $3.26-billion, according to ICO tracker Coinschedule. But regulators are starting to get wise to the existence of a shadow market that flouts the normal practices and rules for raising capital. The U.S. Securities and Exchange Commission has cautioned that many such coin offerings look like securities, suggesting the agency will start regulating ICOs.

Even early adopters and cryptocurrency proponents, such as Andreas Antonopoulos, are speaking out about the frothiness of the ICO market. Mr. Antonopoulos - a self-professed "digital nomad" and well-known figure in the bitcoin world - calls it an "absolute flood of scams and money grabs."

While issuing a digital token or coin may be a legitimate way to finance a project, many have cautioned that the sector is rife with fraud and pump-and-dump schemes - coins that offer little value besides the opportunity to make a quick buck by reselling them in the secondary market. Earlier this year, the SEC took regulatory action against two ICOs that were purportedly backed by real estate and diamonds; the regulator alleged the coins being peddled by REcoin Group Foundation and DRC World didn't really exist.

The tremendous amount of clutter in the ICO space has made it difficult to distinguish the projects that have value from those that don't, Mr. Di Iorio said.

"I think there's a bubble forming and we're seeing people jumping in," he said, speaking at another blockchain event on Bay Street, hosted by Gowling in early November. "It's the wild, Wild West out there, and there's going to be a lot of issues and it's going to blow up eventually. And I just hope the people here are not on the wrong side of it when it does."

The story of bitcoin begins in 2009 with a mysterious founder who calls himself Satoshi Nakamoto. To this day, no one has been able to find Mr. Nakamoto, whose only interac-

tions with the programmers who helped him create bitcoin were via online chat. (There is a man named Satoshi Nakamoto living in Japan but he denies having had anything to do with bitcoin.)

The founder's absence has prompted various theories about his whereabouts. Some hypothesize that Mr. Nakamoto has died, while others claim the moniker may be a pseudonym for a group of individuals.

According to a white paper posted to a cryptography mailing list in August, 2008, Mr. Nakamoto was aiming to build a peer-to-peer version of electronic cash - one that, because of its lack of a central authority, could not be manipulated by any one person or entity, including a central bank.

Every bitcoin transaction is recorded in a public ledger using cryptography - hence, the term cryptocurrency. But unlike a ledger operated by a bank, the bitcoin ledger is not stored in any one central place. Instead, it is distributed across a network of participating computers. Those computers - referred to as miners - contribute their computing power by recording bitcoin transactions and solving complex mathematical problems.

They are paid for those tasks in bitcoins, which can be sold for cash or used to purchase goods.

One of the features of bitcoin that has made it appealing to early adopters is its finite supply. While fiat currencies can become inflated by central banks printing more money, the algorithm that governs bitcoin caps the total supply at about 21 million. The website indicates that there are about 16.7 million bitcoins in existence today, up from 16 million last December.

As Ms. Roch-Decter, the Grit Capital CEO said, there is almost a "religious" quality to the bitcoin movement, whose believers tout it as the antidote to an era of monetary stimulus. The gospel of bitcoin is spreading beyond the currency as well, to the blockchain technology that underpins it.

Proponents of the blockchain call it the biggest game-changer since the invention of the internet and speak of its ability to revolutionize everything from cross-border payments to capital raising to health records and more. Even bitcoin skeptic Mr. Dimon of JPMorgan Chase said the technology is valid, and his bank is working on a blockchain-based global payment system.

But bitcoin's rise to mainstream prominence has been riddled with drama and controversy. Soon after its adoption, it gained a reputation for being a convenient method for laundering money, hiding from the taxman and purchasing all sorts of illicit goods - from drugs to weapons to child pornography - on the dark web. However, industry insiders say criminals have grown wary of bitcoin ever since the 2013 bust of an online black market called Silk Road proved that bitcoin transactions are traceable.

The currency's reputation took another hit the following year when Mt. Gox - then the world's largest bitcoin exchange - was hacked and lost hundreds of thousands of its users' bitcoins. The Tokyo-based exchange promptly filed for bankruptcy.

All the while, the price of bitcoins has fluctuated wildly. In late 2013, it climbed more than 400 per cent, from around $180, to almost $1,000 in just over a month. Its recent upward streak has created surprise windfalls for a number of early adopters, including Nathan Wosnack.

In the spring of 2010, Mr. Wosnack was hanging out at his Vancouver office when a friend offered to trade him 10 bitcoins for half a case of Rickard's Honeybrown ale. Bitcoins were trading roughly on par with the U.S. dollar at the time, so Mr.

Wosnack agreed. (By today's values, the bitcoins he received for that half-case are worth about $67,000 - surely the most lopsided trade yet.)

He forgot about the bitcoins until almost four years later when he was home sick with the flu and running low on cash. He ran the bitcoin wallet software on his old laptop. It took several hours for the code, which was out of date, to update. At 2 a.m., a pop-up window alerted him that the bitcoins were still there. They were trading at about $900 a pop.

Soon after, he unearthed another, much larger stockpile of bitcoins stashed away in another digital wallet. "But I don't kiss and tell on that on," said Mr. Wosnack, who is now involved with three blockchainrelated startups. "Let's just say I took two years off from work and returned to the crypto space forever."

With cryptocurrency prices rising at such an astronomical rate, it's fairly clear that this is a bubble.

What's less certain is what stage of that bubble it's in. After all, the dotcom bubble persisted for years before it finally burst in 2000.

"It feels more like 1995," said Avi Goldfarb, a professor at the University of Toronto's Rotman School of Management.

By 1999, people had a pretty good sense of what the internet could do and where the opportunities to make money might be, Prof. Goldfarb explains. It was still unclear which business models would win - a number of early bets didn't pan out, and many of the modern-day internet giants such as Facebook Inc. and Google Inc. either didn't exist or didn't go public until much later. But by 1999 there were a number of established internet companies.

"Blockchain feels earlier," Prof. Goldfarb said. "We don't even know who the big players could be."

That makes investment decisions tricky. It's hard to bank on this cryptocurrency or that blockchain startup when the future leaders of the sector may be companies that don't even exist yet, he said.

When Matt Lefebvre first started mining bitcoin in 2010, he had no clue what it was for. By the end of the year the Richmond Hill, Ont.

resident had amassed roughly 13,000 bitcoins - the modern-day equivalent of more than $90-million - on a USB stick.

But the following year, Mr. Lefebvre made a disastrous mistake.

He accidentally wrote over the data with Windows 8 - "arguably the worst possible operating system since Windows ME," he said.

It has taken him years to get over the loss, while the price of bitcoins has continued to climb.

"I tried literally everything to get the data back," said Mr. Lefebvre, who is now a professional YouTuber who creates videos about technology. He often daydreams about what he would have done with the money. Home ownership is at the top of his list.

"I had a winning lottery ticket, didn't know it was a winning lottery ticket and set it on fire," he said.

There is no recourse for people such as Mr. Lefebvre who lose access to their coins, which will likely sit dormant in cyberspace forever. And unfortunately, tales like his are not uncommon.

Perhaps the most famous of such stories is that of British resident James Howells, who in 2013 accidentally tossed away a hard drive containing roughly 8,000 bitcoins.

Today his virtual fortune - currently worth more than $50-million - sits in a landfill the size of several football fields.

Mr. Howells has visited the landfill but was unable to get permission from the local council to search the site - despite offering them a 10-per-cent cut and having numerous financial backers willing to finance the venture. But the Newport resident has not given up.

Bitcoin's rapidly accelerating price in recent months has buoyed his hopes.

"As the price continues to rise, I'm confident I will be given permission to search for the hard drive at some point in the future," he told The Globe and Mail via e-mail. "Even at current prices, the value of the drive is too high for the council to keep ignoring."

Lost coins are just one example of the myriad of things that can go awry. As with many of their global counterparts, Canadian regulators are failing to keep pace with the change brought on by these technological advancements. A staff notice issued by the Canadian Securities Administrators last August left some ambiguity as to whether new cryptocurrency offerings constitute securities or not.

Cryptocurrency transactions occur outside the mainstream financial system and the purview of regulators, making them vulnerable to money laundering and tax avoidance schemes. FinTRAC, the federal anti-money laundering agency, has introduced new rules governing cryptocurrency exchanges. But the rules, which would require the exchanges to register as moneyservices businesses, report suspicious transactions and identify their clients have not yet come into force.

Meanwhile, criminals have reportedly moved on to other cryptocurrencies, such as Monero and Zcash, which offer a higher level of anonymity.

The confusion swirling around the crypto bubble has even left some regulators pointing fingers at one another. Speaking to hundreds of anti-fraud professionals at a Toronto conference recently, the Ontario Securities Commission's director of enforcement, Jeff Kehoe, slammed the Bank of Canada for having its "head in the sand" with regards to cryptocurrencies. As he later explained it, Mr. Kehoe wants the central bank to provide some guidance as to whether bitcoin is a currency or some other type of entity. The bank fired back with a transcript of Deputy Governor Carolyn Wilkins' recent comments at the Sibos banking and financial conference, where she characterized bitcoin as more commodity than currency.

"We don't consider them to be money because they don't meet the fundamental qualities of that," Ms. Wilkins said at the time.

Although bitcoin was created to be a medium of exchange, there are a number of factors that make it illsuited for the job. First of all, most major retailers don't accept it. Secondly, its wildly fluctuating value makes spending it a gamble.

Just ask Ben Perrin, a Calgary resident who spent December of 2014 living exclusively off bitcoin as part of an online challenge. During that month, Mr. Perrin and his now-wife would frequent Starbucks and, using a gift card he had purchased with bitcoins, would spend the equivalent of $30 (Canadian) on coffee and food. Those turned out to be expensive meals - costing about $600 each, using today's value of bitcoins.

"All you can really do is just look at it and laugh," Mr. Perrin said.

"I'm a little bit more conservative any time I use bitcoin now. I hold on to it as a store of value, or more of an investment, as opposed to a spending tool."

Some people, such as Mr. Antonopoulos, are not too troubled by the parallels between bitcoin and the dot-com boom. What's more important, they say, is the technology behind the movement: the blockchain.

"The space as it is today is a mess, but this exact same technology is going to radically transform a trillion-dollar industry within the next 10 years, without any doubt in my mind," Mr. Antonopoulos said.

Sure, a lot of people will lose money along the way, just like in 2000 when the tech bubble burst.

There will be much "gnashing of teeth and rending of garments," Mr. Antonopoulos said. "It's exactly the same way we saw the internet develop - with a giant bubble that burned through a trillion [dollars] of investments."

But in the end, the internet went on to transform every facet of our lives.

"We had to go through that boom-and-bust cycle, and I think that's repeating now," Mr. Antonopoulos said.

The good news, he adds, is that the majority of the money pouring into ICOs is coming from extraordinary gains made on cryptocurrency investments - for instance, on the back of the soaring value of bitcoin. "Part of the reason they're making bad decisions is because this money was easily gotten. That lowers people's risk aversion."

But Prof. Goldfarb is not certain that blockchain will be a long-term, viable industry. "For every technology, like the internet, that does transform society, there's many others that seem that way in the early going that don't," he said, citing the Segway as one example. When it first came out, there was talk that the Segway could displace the automobile and prove to be a more significant invention than the personal computer. Today, the vehicle has practically faded into oblivion, relegated to warehouses and retirement communities. Blockchain could theoretically suffer a similar fate.

"It's a very interesting technology, but whether there's money to be made in the long run is still an open question," Prof. Goldfarb said.

Back at the Design Exchange, Mr. Di Iorio has wrapped up his speech, and Sean Clark has taken his place on stage.

"What we're actually here to do right now is to participate in the next inflection point of the digital age," said Mr. Clark, co-founder and CEO of bitcoin investment fund First Block Capital.

As with Mr. Di Iorio, he acknowledges the frothy nature of the ICO market. "There's a lot of junk out there that's going to get washed away in the next correction," he said. But those companies with sound business fundamentals will prevail, he added. "Like in 2000 after the bubble burst, the Googles and Facebooks and Amazons will emerge."

Associated Graphic

Anthony Di Iorio has become wary of the rise in the value of bitcoin. 'It's the wild, Wild West out there ... and it's going to blow up eventually.'


Ben Perrin, of Calgary, has been dabbling in bitcoin for two years. These days, however, 'I hold on to it as a store of value, or more of an investment, as opposed to a spending tool.'



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