Sorting out the value, volatility and durability of cryptocurrencies

Rising prices may be increasing their allure but there are considerable risks

Ian MadsenThe value of cryptocurrencies such as Bitcoin, Ethereum and others recently hit new record highs, in the thousands of dollars per unit. This escalation has attracted more speculators, further boosting prices over the past several months.

Much of this is the result of investors fearing they will miss out on a chance to profit.

While rising prices certainly increase the allure of these products, it does nothing to reduce their risks, which are considerable.

It does, however, raise some interesting opportunities.

It’s impossible to calculate any realistic value for Bitcoin and its sister cryptocurrencies, just as it’s hard to value any other speculative or high-growth asset, such as a much-hyped technology stock.

The touted benefits of Bitcoin are the same as they were when it was trading in the hundreds of dollars. Those benefits are several:

  • a form of money that’s impossible for any government to debase via inflation;
  • a way to pay for things anonymously;
  • counterfeiting is impossible;
  • avoidance of intermediaries (such as money transfer companies) in transactions;
  • an asset class with its own merits, without being managed or rated by investment firms;
  • a secure store of value that can’t be stolen while in direct possession;
  • the potential to supplant some or all other currencies in pricing other things.

It’s this last promoted benefit that could be elusive or even delusional. Some companies, notably Tesla, have recently priced their products in Bitcoin or other digital currencies. But it remains very difficult for companies and their customers to base sales on prices that can fluctuate wildly.

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Someone would be bound to feel cheated and the seller could face major losses if the digital money fell in value while the firm’s expenses in ordinary money remained the same or went up. This problem, along with the slowness of transactions using digital money, make it unlikely for cryptocurrencies to supplant traditional options, in the short term at least.

There are ways around this. The company offering goods or services for cryptocurrency could price its wares very dynamically, changing them instantly as the quoted digital money price changes. However, this could frustrate the customer, and time lags could create great uncertainty and loss of confidence in the process.

Options or futures could be used to hedge the price of digital coinage. While this introduces another significant cost, it increases trust for the buyer and seller that the agreed-upon price will be firm and gives certainty of profit to the seller. These derivatives already exist, with just speculative appeal thus far. However, they could be key to making Bitcoin and other such currencies viable in transactions.

Central banks should stay clear of cryptocurrencies by Paz Gomez

Since slow transactions and currency mining remain, the likely use of cryptocurrencies will be in large commercial transactions, such as international trade. Oil, liquefied natural gas, grain and metals could be priced in cryptocurrency to lower foreign exchange costs.

So there seems to be limited potential for cryptocurrency use to escalate.

Central banks’ versions of cryptocurrencies are unattractive, since they’re suspected of being just glorified ordinary money and many don’t offer anonymity. There’s likely little desire, for example, for the People’s Bank of China’s new digital yuan. 

However, there is still a legitimate role for digital money as a risk-reduction tool in investors’ wealth portfolios. Cryptocurrencies’ returns have a very low correlation to the returns of stocks, bonds, real estate or other asset classes. Adding them to a portfolio greatly reduces its overall volatility, the most common measure of risk in financial markets.

So the strongest selling point of cryptocurrency is that it’s just so different and inherently contrary that it’s very attractive for improving safety, despite its erratic and wild performance in recent months.

Ian Madsen is a senior policy analyst with the Frontier Centre for Public Policy.

Ian is a Troy Media Thought Leader. For interview requests, click here.


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