After much hype and soaring valuations in the latter part of 2017, cryptocurrency prices dropped back to earth in 2018. While the crash in valuations vindicated critics, it does not appear to have deterred true cryptocurrency believers from selling its potential.
New cryptocurrencies continue to materialise (it is believed that there are now over 2000). Their precipitous falls – plummeting 90 percent for those who enjoyed the bubble – have prompted some in the market to construe this as a buying opportunity.
The expected investment case depends on two interdependent but inadequate ideas: first, that each cryptocurrency has inherent value; and second, that its price should appreciate as blockchain, (the distributed ledgers to which cryptocurrencies are tied) delivers on its potential as the next great disruptive technology. It likewise speculates that policymakers will permit these movements to continue on unhampered. To grasp the central issue with valuing cryptocurrencies, it is worth dwelling on the factors that make fiat money– that nation-states declare to be lawful tender so compelling.
Fiat money works because it is circulated by an authority that: has tax-raising powers; can pay interest; can achieve production in the form of trade; has a monopoly on minting new money; supports all of this with the legitimate use of physical force (through writing regulations and raising an army); and is recognised by other nation states. Thus the more stable the government and the international system is the higher societal trust there is in fiat money as a store of value.
Libertarians and cyber-utopians, which are among the loudest advocates of cryptocurrencies, point out that monetary authorities have debased their currencies. But, in comparison to fiat money, cryptocurrencies are a claim on nobody, cannot generate an income stream and are too volatile to be deemed safe for deposits. And they are every bit as susceptible to debasement as fiat money, not least because of the proliferation of platforms and the omission of a fundamental authority to establish a universal standard.
In this context, it is worth making an observation about gold, which likewise lacks some attributes that help fiat money succeed. While the metal has its detractors, it has proved itself as a store of value and over millennia.
The notion that a crypto currency’s value might be tied to the success of blockchain is just as contentious. Blockchain may bring about some utility in the form of enhanced security and reduced transaction costs, and may indeed turn out to be transformative. But it does not follow that the tokens used to support transactions should be elevated to the status of tradable currency and positioned as a store of value, or worse still, an investment opportunity. It seems those distributed ledgers that adopt a fixed exchange rate, asset-backed tokens — a digital version of the chips used in casinos — stand a better chance of succeeding in the longer run.
As an asset or a currency, then, the value of a cryptocurrency is in the eye of the beholder. It has no intrinsic value, so to buy in now on the basis of how far the coins have fallen in price would be to succumb to a value trap on a grand scale. In short, cryptocurrencies are wholly unsuitable for investment. Whatever the future uses of blockchain, investors should steer clear of cryptocurrencies as an investable asset. Instead, they would be best advised to seek returns through active asset allocation that support societal and economic development.