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Bitcoin investment: ace of spades

How can investors make money from cryptocurrencies without taking huge risks? Banks hope to do so by using the blockchain technology that underpins bitcoin to cut transaction costs. Cryptocurrency markets themselves remain a Klondike where dreamers mingle with arbitrageurs and crooks. This week, China’s state-controlled National Internet Finance Association followed regulators in the US and Singapore in warning of the perils of initial coin offerings.

Watchdogs fear investors may be defrauded via some ICOs, which typically raise funds for new ventures. Hedge funds that invest in a spread of cryptocurrencies and ICOs promise diversification. Research group Autonomous counted 55 such funds at the end of August.

While hedge funds at least extract a dependable income from management fees, they, too, would chalk up big losses if the sector collapsed. If you fear cryptocurrencies are a bubble, then a better opportunity may be exploited by the businesses that use computers to generate — or “mine” — crypto coins on a large scale.

To do so, the miners buy high performance processors, store them and incessantly execute computer code. Electricity, which is cheap in China, is their main variable cost. In June, RBC estimated electricity costs equated to just 10 per cent of revenues at a bitcoin price of $2,700. Returns should be even better at a recent bitcoin price of $4,700. However, miners also need to cover overheads such as chip purchases and to swap bitcoins for goods or other currencies, sharply cutting margins. They lose if exchange rates drop sharply.

If the price of bitcoin rises, the arbitrage becomes more profitable and the demand for processors increases. AMD, a Nasdaq-listed chip company, pointed to miners as a factor in its sales growth when it reported its first operating earnings for some time. Owning a shovel store is often the best way to profit from a gold rush.

The Lex team is interested in hearing more from readers. Do you think cryptocurrencies are just speculative instruments used for money laundering? Or are they a valid financial innovation? Please tell us what you think in the comments section below.