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Abu Dhabi, UAEWednesday 17 October 2018

‘Forget bitcoin, invest in bitcoin infrastructure,’ savvy investors say

It is said that in a gold rush, you should sell picks and shovels. Smart investors are looking at the cryptocurrency boom in the same way.

Graphic processing units sit stacked inside a "mining rig computer", used to mine cryptocurrencies. Investing in the blockchain technology needed to mine digital currency is the latest investment hot potato. Akos Stiller/Bloomberg
Graphic processing units sit stacked inside a "mining rig computer", used to mine cryptocurrencies. Investing in the blockchain technology needed to mine digital currency is the latest investment hot potato. Akos Stiller/Bloomberg

By the end of 2017, bitcoin had entered into a “panic buying” phase, with everyone from school kids to pensioners frantically trying to chase the cryptocurrency as it soared towards $20,000.

Even the recent sell-off hasn’t spoiled the party. “Buy the dip”, bitcoin enthusiasts declare on Twitter. “I’m a long-term HODLER” (that’s crypto-slang meaning “hold on for dear life”).

But you won’t find smart guys like Vlad Poliakovsky trying to play the wild swings in bitcoin’s price. The 29-year-old Russian businessman believes strongly that the real way to make money is not by investing in cryptocurrency itself, but rather, by investing in its underlying infrastructure.

“A lot of people bought bitcoin hoping it would continue going up, but this is not a very clever way of investing,” he tells The National, shaking his head sagely. “We didn’t do this – we decided to build the infrastructure around it instead.

“There’s no certainty at this point which cryptocurrency will still be around in two, five, 10 years. But the blockchain technology is here to stay – whether you like it or not, this is a new world. So that’s where we are investing.”

Mr Poliakovsky moved to London from Moscow after university and joined an asset management business. He started mining bitcoin in 2015 in his spare time, together with a friend. Bitcoin mining is the process by which transactions are verified and added to the public ledger, known as the blockchain, and also the means through which new bitcoin are released. The mining process involves compiling recent transactions into blocks and trying to solve a computationally difficult puzzle. The first miner to solve the problem is rewarded in bitcoin and the transaction is added to the blockchain. The ledger is maintained by a random group of peers rather than any central agency or authority.

“It was very amateur then, just my business partner and I, doing it as a side personal investment,” says Mr Poliakovsky.

But as the enterprise grew, he became more and more convinced about its high potential and decided to quit his job and focus on it full-time. He founded Picatrix Consulting, which sets up and operates bitcoin farms, and last October he moved his operations into a data centre in Croydon, south London, where he runs 63 mining computers. He plans to grow this to 400 by next year.

The business, he says, is hugely profitable. “Our running cost is around 25 per cent of our revenue, which makes our net profit around 75 per cent, despite volatility,” he said. “That’s a very high margin, and that’s what’s attracting people to this.”

The breakeven point for a mining farm could be anywhere between four to seven months. That’s a lot shorter than when you open a cafe or a restaurant, Mr Poliakovsky points out.

“You could be really unlucky, and the bitcoin price could collapse the day after you open the farm. But at the same time if you can survive for just a couple of months, then you can already get your money back.”

As the popularity of bitcoin has grown, so has the number of transactions. It is through facilitating these transactions that Mr Poliakovsky makes most of his money.

“Sometimes you open a new block, sometimes you open a block that already exists – which means you’re helping to facilitate a transaction,” he says.

“The reality is that most of the time is that you’re not getting new bitcoins. Since the end of October, we’ve only actually mined two new bitcoins. The rest of our income comes from transaction fees.”

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He estimates that for most mining farms, 95 per cent of their income comes from commissions for facilitating transactions, rather than from actually mining new bitcoins.

Blockchain now holds the promise of changing how transactions are handled in many different industries, not just cryptocurrencies, he says.

“Blockchain is a revolution,” Mr Poliakovsky says. “It will change the world, it will change finance, it will change the way transactions work forever.”

He now spends most of his time up at his office in central London, exploring other ways to play the theme.

“We’re using the positive cashflow from our mining business to start building the other infrastructure around bitcoin,” he says.

“We want to build a secondary market in bitcoin, using the blockchain. For instance, bitcoin futures already exist, but not forward contracts. I want to build an integrated ecosystem that allows us to sell forward contracts in bitcoin.”

He also has ambitious plans to create ETFs (exchange traded funds) in bitcoin, as well as a market index for cryptocurrencies, which would be connected to the top 15 digital currencies.

“The list goes on and on,” he says “We’re looking at applying all the basic rules of financial markets to bitcoin.”

Others have also spotted the huge potential in blockchain and are seeking to apply it to their own businesses, for instance to enhance security or create efficiencies in financial transactions.

Last year, the German airline group Lufthansa paired up with Switzerland-based start-up Winding Tree to build blockchain-based travel apps as the carrier looks at new ways of distributing tickets and services to customers.

TUI, a leading European travel group, has also developed its own blockchain-based inventory system for hotel bookings.

Bankers have said blockchain could also be used in trade finance or cross-border payments, although in most cases, such plans have not gone beyond the pilot stage.

Independent investor Edward Vranic tells The National that blockchain is definitely the place to be.

“I am neither bullish nor bearish on the current bitcoin bubble, but I am bullish on blockchain and the underlying bitcoin infrastructure,” he says.

It is said that in a gold rush, you should sell picks and shovels. Smart investors are looking at the cryptocurrency boom in the same way. Instead of trying to “get rich quick” by piling into bitcoin and other digital currencies, they are building the products and services that will assist their delivery.

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While Mr Poliakovsky wants to use the technology to enhance trading in banks, Mr Vranic believes an opportunity also exists in getting bitcoin into the hands of non-traders.

"I’m thinking about the 'average Joes' out there, who want to be able to buy and transact in bitcoin when they go to a store,” he says.

One company that is exploring this theme is Fintech Select, a microcap company listed on the Canadian exchange that has been investing heavily in blockchain infrastructure.

Fintech Select is creating its own cryptocurrency ATM network, which will allow consumers to buy bitcoin and other digital currencies from physical locations.

The firm has ambitious plans to open thousands of cryptocurrency exchanges across Canada.

“Our solution will play a critical role within the cryptocurrency sector, by simplifying the process for regular people to buy bitcoins and other cryptocurrencies,” Mohammad Abuleil, chief executive and president of Fintech Select, tells The National.

The idea is that customers can walk into any of their points of sale locations, activate a card, create a digital wallet and purchase cryptocurrencies. Mr Abuleil hopes that buying cryptocurrencies will become “as easy as going into a convenience store to buy milk”.

He believes blockchain is a technology that’s here to stay. “There’s no way we can go back,” he says. “It might take one year, two years, 10 years for people to believe in it and apply it. But it’s just a matter of time.”

Mr Vranic says that if Fintech Select opens all of the locations it has promised, the company will do extremely well.

“It is easier said than done. But if it’s successful, there will be huge money to be made in it.”

Another player is The Mint Corp, which provides payroll services to approximately 400,000 expatriate workers in the UAE through its subsidiary, Mint Middle East.

One of the key parts of Mint’s business is to provide remittance services via its mobile wallet for its customers, most of whom transfer money home to their families through their partner exchange houses.

Mr Abdulrazzaq Al Abdullah, chairman of Mint Middle East, tells The National that the firm plans to integrate blockchain into its existing financial technology in order to reduce costs and streamline its domestic and cross border services.

“By introducing blockchain-enabled technology, we can speed up our domestic and cross border remittance and other value added services and make it more efficient for our different strategic partners and clients,” he says. “It is a logical next step for Mint and will enhance our core business.”

The company plans to launch a pilot to trial blockchain solutions later this year, and then get it commercialised after that.

“The application of blockchain technology is still evolving, and people are still figuring out the different verticals,” Mr Al Abdullah says. “But we strongly believe that remittance is one area in which blockchain will gain increasing traction.”

Mint is well placed to develop its blockchain solutions, given the UAE is taking a lead in this area. The Dubai Government has set a goal to become the first blockchain-powered government in the world by 2020. It is also actively working to develop a globally renowned fintech hub in Dubai.

Companies that have jumped on the blockchain bandwagon are being bid up by investors in a manner not dissimilar to that seen at the time of the dot-com bubble of the late 1990s. At that time, investors poured money into any start-up that had a “.com” or an “e-something” in its name. Now, share prices of companies that have changed their name to include “blockchain” are soaring, according to Reuters data.

Mr Poliakovsky says the comparison to the dot-com mania is warranted.

“I see it as a very similar situation to the dotcom boom in the 1990s, where internet just appeared,” he says. “No one really understood how to use it properly, there were loads of new companies and websites appearing out of nowhere. At that time, you couldn’t see what was going to become Google, and what was going to collapse.

“Blockchain is something similar. The whole model is here to stay. Everyone is now trying to make this new system accessible to everyday people, the same way as when credit cards were first introduced.

“But it’s very important to understand that a lot of companies working in this new technology now will not survive. It’s very hard to see which ones will end up disappearing, and which one will end up dominating the market.

“Of course, we’re hoping that we’re the new Google.”