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Valuation in an Information Economy

 4 min read / 

Investment in intangible assets is growing at an ever-increasing rate, outpacing investment into capital machinery, equipment and all other tangible things. Companies in the US collectively hold more than $8 trillion in intangible assets, almost half of the S&P 500 at the time of study. While intangible assets consist of rights, relationships and intellectual property, one particular form stands out: intellectual property, which encompasses the result of R&D spending; the bread and butter of any modern organisation. This creates a perplexed investor. The current fundamental problem reflects the inability of the price mechanism to attach a price to a good of abundance. Inevitably, the valuation of intangibles will be distorted by unsuitable accounting policies and valuation methods of the 21st century.

 

Valuation in the 21st Century

A combination of unsuitable accounting policies and complacency within models create a cause for concern in the world of equity valuation. Despite almost every company exhibiting a high proportion of intangibles, accounting regulations and valuation methods are not congruent with the technological developments of the 21st century. Regulatory bodies such as the IFRS only recognise intangibles when a transaction takes place, such as an acquisition. While this may be useful in some cases, it does not account for the existing, internally created intangibles which create shareholder value. The significance becomes stark when $30.1tn is considered to be ‘Undisclosed value’ out of the mammoth $89tn enterprise value figure.

Secondly, the classification of expenses may inaccurately portray certain metrics, which directly affects valuation models such as discounted cash flow. The primary expense which drives the informational innovation is R&D. The income statement labels this certain expense as operational, while by nature it represents an expense that creates long-term economic benefits. By manually reconfiguring the income statement and rendering R&D spending as a capital expense, a more accurate representation of earnings is created.

An analyst may use several approaches to mitigate the increasing levels of information amidst unsuitable accounting policies. Common methods include the income approach and the market approach. The former aims to identify the incremental cash flows which are created as a result of consuming information in the production process. The latter involves looking at transactions involving the transfer of similar intangibles between firms while performing an adjustment using multiples to account for differences between the two intangible assets compared.

However, the following methods still make it difficult to quantify and attribute the contribution of intangibles to cash flow, while market-data on traded intangibles is unlikely to be publicly available and is heavily reliant on adjustments, making valuation of modern companies increasingly difficult. Over the long-term, there needs to be a pricing system capable of quantifying information, leading to a spillover effect into equity valuation.

The Fundamental Problem

The fundamental problem resides in the inability of the price mechanism to price something that is not finite. Market forces and the whole economic system can’t imagine a world where information embodied goods will have a diminishing marginal cost, eventually approaching zero. It costs nothing for a company to reproduce multiple lines of code and copy data. Consequently, natural market mechanisms can’t create a price.

While some studies show that information consumes processing power when deleting “one bit” of information, a more robust system is required to record value.

The solution is likely to lie in classical pricing theories, allied with heavy calculations which are made possible by today’s computational power. Theories such as labor theory of value could be utilised and modified to acknowledge profit and measure the amount of effort that creates the respective good or service. Effort can be measured by physical hours worked, cognitive activity which stimulates creativity and innovation and other emotions related to work. Currently, this idea may seem utopian without taking into account recent developments. With the advancements in Neurotechnology, it is possible to quantify neuro-based activity using technical and computation tools. This can enable pricing theories such as the labor theory of value to be fully functional.

Conclusion

The short-term solution is likely to lie in current accounting policies. Some countries are starting to move closer to acknowledging the value of intangibles within the reporting framework. For example, China is slowly shifting away from capital intensive industries to technology and services. As a result, new policies are introduced in anticipation to capture the externalities associated with intangibles. While this provides clarity, it does not provide a robust pricing system that the current business environment requires. Could the next long economic cycle provide what is required?

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Crypto Briefing: Bitcoin Futures, Scams and ICOs

 11 min read / 

Crypto Briefing

 The Week of the Altcoins

This graph show how prices have changed since the midnight December 7th with prices at that point being rebased to 100
Prices as of 11:59 PM UTC 13/12/17 (Source: coinmarketcap)

The cryptocurrency market has seen another week of volatility. Litecoin’s market cap has increased by over 200% as it becomes a popular alternative to bitcoin, as the latter has faced fears of increased regulation. XRP has also been riding the wave, seeing a 50% price hike from last week.

1. Bitcoin Futures Live on Cboe

The Story

Plans to launch bitcoin futures contracts on the Chicago Board Options Exchange have gone ahead as contracts began trading at 23:00 GMT on Sunday. The contracts will allow investors to bet on the future value of bitcoin. On the news bitcoin’s price rose significantly.

Why It’s Important

The contract allows individuals to bet on bitcoin’s price at a specified time in the future. Given bitcoin’s rise of over 1,000% this year, many investors are keen to get in on the action; CBOE’s  Bitcoin futures contract will enable investors to do so without actually owning the cryptocurrency. Additionally, it will be possible to short sell the digital asset for the first time, allowing investors to profit from price falls.

The move suggests the cryptocurrency is now becoming a mainstream investment, however, Bitcoin remains to be traded on unregulated markets. Consequently, its price is likely to remain volatile.

High Volatility

In an effort to ease volatility, the CBOE decided it would suspend trading for two minutes for price fluctuations of more than 10% and five minutes for more than 20%. In the contract’s first session, trading was stopped twice: once for two minutes and once for five minutes. While bitcoin remains traded on largely unregulated markets, it is questionable whether this policy will have any effect on the underlying cryptocurrency’s volatility.

The Future

Bloomberg’s Adam Haigh said the futures contracts was “an incremental step that allows Wall Street and indeed the professional finance community to make a bet either way on bitcoin.” The Chicago Mercantile Exchange is expected to list a similar contract next week, and Nasdaq has announced plans to host such trading too.

Last week Revolut’s decision to facilitate the trading of bitcoin and other cryptocurrencies could increase demand for the underlying asset.

Allegations that 1,000 people own 40% of all bitcoins in circulation suggest its price could be manipulated by a relatively small number of individuals.

2. 1,000 People Apparently Own 40% of Bitcoin

The_Winklevoss_twins

The Winklevoss twins invest $11m in bitcoin back in 2013. (Attribution: By cellanr [CC BY-SA 2.0 (https://creativecommons.org/licenses/by-sa/2.0)], via Wikimedia Commons)

The Story

Roughly 40% of the cryptocurrency is owned by 1,000 people, claims Aaron Brown, head of financial markets research at AQR Capital Management. In such an unregulated market, Brown said large holders of bitcoin could potentially be working together to orchestrate price changes. Given bitcoin’s recent spike, now could be a great opportunity for these users to part with a portion of their bitcoins, locking in the near 1600% price increase since the start of the year.

BTC price

Source: Coinmarketcap.com

Why It’s Important

Bitcoin appears to be making its way into mainstream investing. Last Friday the US regulator gave the CME group and CBOE Global Markets the green light to launch bitcoin futures. Just yesterday, London-based digital banking company Revolut launched Bitcoin, Litecoin and Ether trading for their users.

As the cryptocurrency becomes a more mainstream investment and demand for it rises, these bitcoin ‘whales’ will be able to part with their bitcoins for a hefty profit. This could leave new investors with an asset in the midst of a bubble.

Roger Ver, a well known early adopter of bitcoin said, regarding ‘whales’ working together, “I suspect that is likely true, and people should be able to do whatever they want with their own money.”

While the question of whether Brown’s allegation is true must be approached with scepticism, there is evidence of some very large investors in the space. Bloomberg recently reported that on November 12th, “someone moved almost 25,000 bitcoins, worth about $159 million at the time, to an online exchange.” Bitcoin’s market cap is roughly $270bn at the time of writing, but if this investor was to sell on a single exchange, it could potentially crash the market.

Large Bitcoin Investors

Cameron and Tyler Winklevoss, who gained fame for attempting to take control of Facebook, invested $11m in bitcoin back in 2013. This amount has many times over.

Tim Draper, a billionaire venture capitalist best known for his investment in Skype – during the companies early days – bought 30,000 bitcoins back in 2014. He has since invested in Tezos’ ICO.

Barry Silbert, the founder of the Digital Currency Group, picked up 48,000 bitcoins when the cryptocurrency was worth $350 a piece.

3. Ethereum Wallet Scam Closed Down

The Story

Digital wallet provider myetherwallet.com announced yesterday that it had no affiliation with an iOS-based cryptocurrency wallet app using its name. The app, which became the third most popular on the finance section of the App Store, allows users to import and open a digital wallet to store ether. Fake digital wallets could lose investors their cryptocurrencies permanently, so it is important investors (and app stores) keep an eye out for scams.

Security and Ethereum

In July, a developer error on the ethereum network meant a hacker pocket $31m worth of ether. While the technology is still in its infancy mistakes are bound to be made. However, several digital wallet hacks have emerged since cryptocurrency prices have skyrocketed and users need to take security seriously while safeguards are not in place.

When it comes to cryptocurrencies security, the owness is with the users. Sending ether from a digital wallet means I am responsible for my transfers. If I make a mistake when typing in the amount, or address of the receiver, I cannot call my bank and ask them to void the transaction. Consequently, user’s wallets are being targeted by scammers.

So far there have been no reports that the fake wallet stole from anyone. The company may have simply used the name for its familiarity in the ethereum community.

Myetherwallet.com have since announced the removal of the app from the iOS store.

4. San Francisco ICO Closed Down by SEC

The Story

San Francisco-based restaurant reviewing app Munchee has been forced to stop its initial coin offering (ICO) and reimburse investors after regulators raised concerns over the company’s tokens not meeting securities regulations. Munchee was looking to obtain $15m to “improve an existing iPhone app centred on restaurant meal reviews and create an “ecosystem” in which Munchee and others would buy and sell goods and services using the tokens,” according to the US Securities and Exchange Commission (SEC).

However, “in the course of the offering, the company and other promoters emphasized that investors could expect that efforts by the company and others would lead to an increase in value of the tokens,” they added. The regulator felt investors were led to believe they would gain a return on their tokens, however, the tokens did not meet the authority’s standards. The company was not fined due to its quick response to the SEC’s requests.

Why It’s Important

Last week PlexCoin’s founders were charged with defrauding investors. This was the first time the SEC’s newly established Cyber Unit filed charges. The regulator issued a statement back in July saying ICOs will be subject to US security laws.

Both cases suggest a serious commitment to ensuring investors are not mis-sold securities, particularly in the ICO space.

5. Goldman Sachs: Bitcoin Not A Substitute for Gold

Source: Tradingeconomics.com

The Story

The simultaneous rise of bitcoin and relatively poor performance of gold has provoked many to ask whether the two assets are in competition. The short answer is no, they are not.

“Bitcoin has real potential, if it were to become digital gold it might have tremendous space to grow,” said Gabor Gurbacs, Vaneck Securities Director of Digital Asset Strategy. It is this sentiment which has put the two in contest. However, the investor pool for each is “vastly different”, according to Jeffrey Currie, head of commodities research at Goldman Sachs.

Gold based exchange-traded funds are currently at close to their highest since May 2013, suggesting the metal remains part of investor’s portfolios, and not that investors have not cashed out and moved over to bitcoin. The reason this is not the case lies in comparing the function each asset serves and the investors it attracts.

Comparing Bitcoin and Gold

Bitcoin attracts more speculative investors looking for quick returns, while gold is often held as a portion of investment portfolios to spread risk. In times of economic downturn gold tends to go up in price, balancing any losses from stocks and bonds. The two assets currently serve distinct purposes. Consequently, bitcoin’s price rise is unlikely to have turned investors away from gold.

6. Jamie Dimon Eases Hostility Towards Bitcoin After Futures Contracts Go Live

Source: By Steve Jurvetson (Flickr: Jamie Dimon, CEO of JPMorgan Chase) [CC BY 2.0 (http://creativecommons.org/licenses/by/2.0)], via Wikimedia Commons

The Story

Source: CNBC

“I remain highly skeptical of it,” said JPMorgan’s CEO Jamie Dimon, when recently asked about bitcoin. “I’m open-minded to uses of cryptocurrency if properly controlled and regulated,” Dimon added. The executive, who famously called bitcoin a “fraud” appears to have softened his opinion just days after the bitcoin-based futures derivative began trading on the Chicago Board Options Exchange.

Why It’s Important

This is the first time Dimon has spoken about bitcoin for two months. The timing of Dimon’s comments might suggest JPMorgan will offer the bitcoin derivative to its clients. The contract would allow clients to take long or short positions on bitcoin’s price.

Similar contracts will trade on the CME and Nasdaq exchanges in the near future.

7. Cryptocurrency as Collateral for Loans 

The Story

A growing number of early cryptocurrency adopters, who have seen astronomical gains, will now be able to use their cryptocurrencies as collateral for loans. London-based Nebeus is helping third-party lenders create loans guaranteed by cryptocurrency collateral. The company created 100 of these loans on its first day and has made 1,000 more since says Nebeus’ Managing Director Konstantin Zaripov.

Given bitcoin’s market cap of almost $300bn, and a total cryptocurrency market cap of over $500bn, the market for these loans could be colossal. However, some worry that these assets are in a bubble, and their collapse makes these loans hugely risky for lenders.

Why It’s Important

Around 40% of all bitcoins are held by 1,000 people, Bloomberg reported last week. Prior to this innovation, these users would only be able to cash in on their gains by selling their cryptocurrencies. “I can see a lending industry in the tens of billions of dollars,” said Aaron Brown, former managing director at AQR Capital Management.

The loans could attract attention from cryptocurrency miners, who earn tokens for processing blockchain network transactions. This group are typically ideologically attached to the idea of decentralised currencies, and such loans could allow them to hold on to their cryptocurrencies while they cover their overheads.

However, bitcoin’s 1700% rise since the start of the year has caused many to stay clear. A collapse of these digital assets would leave lenders in a tough position.

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Keep reading |  11 min read

Companies

Cryptocurrency as Collateral for Loans: Risky Business?

 2 min read / 

Cryptocurrency Loans

The Story

A growing number of early cryptocurrency adopters, who have seen astronomical gains, will now be able to use their cryptocurrencies as collateral for loans. London-based Nebeus is helping third-party lenders create loans guaranteed by cryptocurrency collateral. The company created 100 of these loans on its first day and has made 1,000 more since says Nebeus’ Managing Director Konstantin Zaripov.

Given bitcoin’s market cap of almost $300bn, and a total cryptocurrency market cap of over $500bn, the market for these loans could be colossal. However, some worry that these assets are in a bubble, and their collapse makes these loans hugely risky for lenders.

Why It’s Important

Around 40% of all bitcoins are held by 1,000 people, Bloomberg reported last week. Prior to this innovation, these users would only be able to cash in on their gains by selling their cryptocurrencies. “I can see a lending industry in the tens of billions of dollars,” said Aaron Brown, former managing director at AQR Capital Management.

The loans could attract attention from cryptocurrency miners, who earn tokens for processing blockchain network transactions. This group are typically ideologically attached to the idea of decentralised currencies, and such loans could allow them to hold on to their cryptocurrencies while they cover their overheads.

However, bitcoin’s 1700% rise since the start of the year has caused many to stay clear. A collapse of these digital assets would leave lenders in a tough position.

Keep reading |  2 min read

Cryptocurrencies

South Korea Bitcoin Regulation on the Horizon

 1 min read / 

South Korea Bitcoin

The Story

South Korea’s government held an emergency meeting to discuss the impact of cryptocurrency speculation last Wednesday. Banning minors from investing and introducing capital gains tax on cryptocurrency were suggested as means of protecting citizens, reports say.

The meeting was a response to talk of cryptocurrencies being in an asset bubble and the impact investing is having on younger generations. New measures to tackle this problem could be announced by the end of the week, according to Reuters.

Why It’s Important

South Korean exchange Bithumb – the worlds busiest – has hit it off with students. The ease of opening an account and the option to invest small amounts has caught the attention of many young people.

This group’s obsession with the digital assets prompted the emergency meeting. President Moon recently expressed his fear of students joining the trend and becoming obsessed with the rapid price changes of cryptocurrency prices. He labelled this a “serious pathological phenomenon.”

“Some even abandoned their studies and part-time jobs as they believed they could make much more money by investing in bitcoin,” said Reuter Correspondent Dahee Kim. The trend appears to be causing social problems in the country.

The country banned initial coin offerings back in September.

Keep reading |  1 min read

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