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The Fundamentals of Cryptocurrency Valuation

Liz Louw
12 December 2017

On social media we often get asked for cryptocurrency investment advice or our valuation of a particular coin. What will the price be at the end of the year? Is this token a keeper? Do you think that cryptocurrency X will be the next Bitcoin? Is it wise to invest in Bitcoin at the current price point?

While crypto market advice belongs within a client-advisor relationship and not on social media, we feel that the unprecedented bitcoin price swings around the launch of bitcoin futures necessitates a discussion on the fundamentals of cryptocurrency investing.

The Valuation of a Cryptocurrency Investment

In the traditional investment industry, stock brokers and value investors base their valuations on a company’s fundamentals. The appraisal of a stock’s value will probably include aspects like the business’s ability to sustainably generate cash, the quality of earnings, the calibre of leadership, management, and experience, and the risks that are inherent to that industry. A high risk/reward ratio might be lucrative to those who can stomach the uncertainty, but certainly “not for widows and orphans”, a phrase commonly used by traders.

When it comes to cryptocurrency, an asset unlike any we have seen before, how does one judge whether it is a good store of value or market frenzy? While it is extremely difficult to accurately calculate the intrinsic value of a new and groundbreaking technology, it is incredibly helpful to consider the criteria that any asset needs to meet in order to qualify as a good store of value.

To this end, let us take a look at the origins of ‘money’, and how it became a store of value in the first place.

The History of Money

In an interview on the Vin Armani Show Dr Craig S Wright, Australian computer scientist and Chief Scientist at nChain, draws our attention back to the origin of money:

“The concept of non-state money goes back centuries”, he begins. “Most payment systems do not start off as a store of value. Back in the middle-neolithic period, the earliest farming communities kept tabs of the amount of grain that each one contributed to the regional grain storage by means of a tally-stick. This was one of the earliest tab or token systems, and we see mention of it in ancient documents referencing talent sticks (the Bible). While the tokens were later converted into silver, the purpose was to tokenise the goods that everybody used - commodities. A example of this lies in the origin of the word salary, which is salarium in Latin, and meant salt. Everyone needed salt, but it was expensive and scarce. Salt mines in Africa traded their salt reserves as far away as the region we know today as Germany. Roman soldiers were paid their wages in salt. It was a commodity used by many people, which made it easy to transfer it into a different commodity. It is this liquidity that made it a store of value - because you could know that there would always be demand for your goods.”

The Appraisal of a Cryptocurrency

Just like with other forms of money, the value of a cryptocurrency depends on its utility and application. It simply cannot be a store of value unless it has underlying utility. And, as Dr Wright points out, liquidity is an incredibly important requirement for any payment system. In order for a currency to be a store of value, it has to be highly liquid. If something has a function, then someone else will always be willing to trade for it, which delivers this liquidity.

In the blockchain sphere, the utility of a token can represent a broad range of innovations, from blockchain data storage systems to blockchain operating systems for health care or insurance, online marketing platforms, social media networks, and cryptocurrency mining rigs that run on hydropower. Whatever the proposed application, it is by this utility and the value of its application that we assess the representative cryptocurrency by.

Speculation Ends in Tears

“We have a sudden boom in BTC just before a major exchange comes out with shorting.Troubling.Not good for anyone. Fundamentals matter and when they are abandoned... trouble.Remember housing in 2008?Speculation without fundamentals rarely ends well.” Dr Craig Wright on Twitter

The adoption of new technologies tend to grow in spurts with pullbacks along the way as users are brimming with excitement, yet also with uncertainty. While the rise and fall of bubbles along the way is inevitable, markets that are based on intrinsically valuable assets eventually recover to top the peak bubble values. The bursting of these bubbles along the way does not necessarily matter if you have invested early enough in an asset with real underlying value and long-term potential. It is these fundamentals that separate frenzy from sustainable growth.

The Golden Rule for Responsible Cryptocurrency Investing

One of the golden rules for investing in cryptocurrency is to only invest an amount that reflects your comprehension of the market and the underlying technologies, no more. If your understanding is low to non-existent, it would be wise to contract cryptocurrency market advice.

At bitstocks, we do not speculate, and we do not invest according to the hype. Our team comprises a range of specialists, including computer scientists and market analysts, who evaluate the fundamentals of new cryptocurrencies. Those that show promise of contributing new or improved applications to the world are the ones we single out for investment, early on while it is still undervalued by the market.

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