The True Value of Crypto

Bitcoin is an asset that creates nothing, according to Warren Buffett it depends on the excitement of the next buyers “mere speculation”. It’s true that what has driven the Bitcoin astronomical price increase so far is speculation and hype. Bitcoin and its successors of cryptocurrencies or digital assets don’t have the tangible properties compared to other traditional assets in financial markets, and therefore it’s possible to overlook the true potential value emerging from the underlying technology.

For value investors like Warren Buffett, cryptocurrencies don’t meet the criteria of a worthy investment. They are very volatile and speculative, and despite their potential and the utility that promises to transform industries and business models, they are yet to be implemented reliably to even achieve the primary use case described in Satoshi Nakamoto white paper, peer-to-peer electronic payment system.

Bitcoin has re-introduced money in a new paradigm, it has solved the double spend problem in digital currencies, and allowed transactions to be executed and recorded on a publicly distributed ledger, the blockchain. The main two selling points of cryptocurrency based payment beside the added value of DLT are (1) it eliminates the middleman such as the banks, and (2) it’s very fast and cheap compared to traditional fiat money.

The cryptocurrency use case as a payment system or a digital form of money, sort of works. But to the sceptics point, who wants to accept payment in a currency on which its value can swing 50% in the course of a year? Furthermore, some sceptics think that cryptocurrencies have no real value. It can’t be trusted because there is nothing to back it up. To think about this, we can examine to the classic argument of intrinsic value.

The intrinsic value of something, is the value it has “in itself” or “on its own right”. In finance, the value of an asset is calculated based on its fundamentals and in relation to time. When something is self-worth, like a farm or property, it can be either used on its own or exchanged for something else of equal value. This is how trading worked in a barter economy, it was straightforward but problematic because it relied on the double coincidence of wants situation. To solve the double coincidence problem, an intermediary like money is needed.

Although different forms of money have evolved over time, from bronze coins and cowrie shells to paper and banknote money; in principle, it has a value because it’s agreed upon (with the government or state), and has a utility because it’s a medium of exchange. Economists have defined money by three functions and six characteristics. Money is a medium of exchange, unit of account and a store of value, and must satisfy these characteristics: durability, portability, divisibility, uniformity, limited supply, and acceptability.

Cryptocurrencies appear to satisfy these functions and most of the characteristics if not all. It can even be argued that cryptocurrencies are a better replacement to fiat currencies. Consider inflation for example, money purchase power decreases over time. When the gold standard was abandoned by Britain and United Stated in 1931 and 1933, the fiat monetary system was allowed to fluctuate in the market and left prone to the impact of politics and flawed human decision making. Cryptocurrencies can potentially fix inflation, unlike fiat currencies, it has limited supply specified before it’s offered in the market. Once released for trading and circulation, the supply can’t be increased or manipulated by anyone. This makes it scarce like gold and can effectively slow down inflation. For digital assets however to become a reliable store of value, the price needs to stabilise and hold its value over time, this will depend largely and the maturity of the market as liquidity improves and fair trading is regulated.

With cryptocurrencies designed to be an efficient and secure medium of exchange, its purpose is to facilitate transactions. By eliminating the middleman, the digital asset model can scale well beyond the limits of traditional banking i.e. people in some parts of world with no electricity but have access to the Internet can still accept or send cryptocurrency payments. The intermediary mechanism enabled by the blockchain technology couples the transaction processing with the unit of account.

The above points and assumptions briefly examined the characteristics of cryptocurrencies and how it can function like money as well as hold intrinsic value similar to physical commodities or gold. We recognise the utility of cryptocurrencies and its potential to transform finance and other industries, however we are still early days with regards to adoption. The digital asset space is still limited to participants of highly speculative interests, technologists and early adopters. As institutions, governments and regulators start to show positive interest, cryptocurrencies will gain the legitimacy required to give it the status of a new standard asset class, namely the digital asset class.

This blog post was written by Mo, a Software Engineer and Data Architect with many years of experience in Finance and Investment Banking. He holds a bachelor degree in Computer Engineering with specialisation in Security and Cryptography.

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