In this article, I describe some considerations to help you decide whether investing in cryptoassets is right for you. There are many risks, but the markets are exciting, and people have made and lost fortunes in these markets.

CRYPTOASSETS PRICING

How do you put a value on cryptocurrencies or cryptoassets? For tokens that are a claim on an underlying asset such as 1 oz of gold, the price of the token should more or less track the price of the underlying asset. However, as previously discussed, cryptocurrencies are not a claim on any asset, nor are they backed by an entity. Is there a way to calculate a fair value for them?

We can ask three independent questions:

1. What is the current price of the Cryptoassets?
2. What causes prices to change for Cryptoassets?
3. What should the price be for Cryptoassets ?

What is the current price of the Cryptoassets ?

The current price of any asset is determined by the market. Cryptoassets trade on one or more exchanges, and both prices and liquidity can differ between exchanges. Exchanges that report the most trade volume provide a good measure of the price, as they are the most active and should have the most liquidity. Other exchanges may have higher or lower prices.

Coinmarketcap.com is one of many websites that provide data about the current price of tokens and which exchanges they trade on. If you click on the name of a token and then click on ‘Markets,’ you can see where that token trades and how much volume the exchange says it has traded. Note that some exchanges have been caught faking trade volume in order to generate business, and I am not confident this practice has been eliminated… beware!

What causes prices to change for Cryptoassets ?

The prices of cryptocurrencies and tokens behave like any other financial asset, driven by buyers and sellers who make trading decisions based on various factors:

1. Sentiment (how traders feel about the asset)
2. Gossip and chatter on forums and social media sites
3. Technical successes (e.g., when blockchains successfully implement technical upgrades that make them more useful, or when an ICO makes progress on its roadmap)
4. Technical failures (e.g., if transactions slow down or a weakness is found in the way the blockchain operates)
5. Celebrity endorsements (e.g., Paris Hilton’s endorsement of LydianCoin in Sept 2017, or John Mcafee’s occasional promotional tweets)
6. Founders getting arrested (e.g., when the founders of Centra token were arrested in the USA, and the price of the tokens fell by 60%)
7. Orchestrated Pump & Dumps where people coordinate to all buy a coin together to make the price go up and persuade others to buy it at a higher price, then sell the coins to unsuspecting new buyers
8. Manipulation by large holders of any particular token

What should the price be for Cryptoassets?

There have been a number of attempts to create models to find a fair value for cryptocurrencies and tokens. A common but flawed model for putting a value on a Bitcoin is the ‘if the money in gold went into Bitcoin’ model:

‘If x% of the money in gold (or other asset class) moved into Bitcoin, a single Bitcoin should be worth $y’.

The argument is as follows: The total value of gold in circulation is estimated at 8 trillion US dollars. If some small proportion of the people holding gold, say 5% (but you can use any number from 0-100% here), sold their gold for dollars, it would release a large amount of money, in this case $400 billion. If the dollar proceeds were used to buy bitcoins, the total value of bitcoins in circulation, commonly referred to as ‘market capitalisation’ or ‘market cap,’ would increase by the same amount, $400 billion. As we know, the total number of bitcoins in circulation, 17 million or so, then this must increase the price of each Bitcoin by $23.5k ($400bn / 17m).

But this logic is wrong. That is not how financial markets work at all. The ‘money going into Bitcoin’ doesn’t simply drop into the ‘market cap’. The reason is simple: When you buy $10,000 worth of Bitcoin, someone else is selling those bitcoins for $10,000. So any money ‘pumped in’ is also exactly equal to money ‘pumped out’ (excluding exchange fees, to keep things simple). The only thing that happens when you buy a Bitcoin is that the Bitcoin changes ownership and some cash changes ownership. There is no mathematical relationship between how much money you spend buying bitcoins from someone else and the market cap of Bitcoin.

Understanding the Value of Cryptoassets: A Data-Driven Analysis

Let’s put numbers to this and demonstrate the flawed logic with a counterexample… Let’s say the last price paid for BTC was $10,000. So the ‘market cap’ of Bitcoin, assuming 17 million Bitcoin outstanding, is: $10,000 x 17m = $170,000,000,000 ($170bn)

Now, let’s say you want to buy a tiny amount of BTC (say $10 worth), and the best price that you can see is $10,002. So you pay $10 and buy 0.0009998 BTC ($10 divided by $10,002 per Bitcoin). What has happened to the ‘market cap?’ It is now: $10,002 x 17m = $170,034,000,000.

The market cap has increased by $34 million just because of your measly $10 trade! You didn’t ‘pump in’ $34 million, but the market cap increased by that amount. So clearly the earlier argument is wrong.

Having said that…of course if there are more buyers with a greater desire to buy and pay whatever it takes to accumulate BTC, then the prices will increase. Likewise, if there are sellers who will sell bitcoins at any price, then prices will fall.

I also hear variations on, ‘cost of creation’ argument: The price of Bitcoin should be at least the cost of mining them, so the cost of mining puts a floor under the price of Bitcoin, and as difficulty increases, it costs more to mine bitcoins, so the price should rise. Alas, this is also false. The cost incurred by a miner (or even all the miners in aggregate) bears no relation to the market price of Bitcoin. The price of Bitcoin affects the profitability of miners, but there is no rule dictating that miners need to be profitable.

The unprofitable miner

If a miner is unprofitable, they will eventually stop mining, but this doesn’t affect the price of bitcoins. If it costs me $5,000 to dig up 1 oz of gold, this doesn’t mean the price of gold should be at least $5,000/oz. User ihrhase explains this with salmon and sauerkraut smoothies in a forum post in 2010:

Unfortunately, I have not yet come across a reasonable fair value model for cryptocurrencies.

ICO tokens should be easier to price. These tokens are redeemable for a certain good or service in the future, so putting a price on the token should be a case of figuring out what that good or service is worth. Right ?

Alas, it is never that easy. The fact is that ICOs who issue tokens want the price of their tokens to go up, as do their investors. Redemption is always described generically and not quantified. For example, they say, ‘Tokens will allow you access to cloud storage,’ rather than, ‘One token will give you 10 GB of cloud storage for 1 year starting in 2020’.

This is a deliberate strategy. If the issuers quantified the goods or services, you could figure out an appropriate ballpark price for the token. But this would constrain the price, preventing the price of the token from massively increasing (which is really what Initial coin offering issuers and investors really want). I have never seen an ICO whitepaper quantify exactly what a token will be redeemable for.

Exploring the Top Safe Crypto Assets for Investors

Safe crypto assets are a top priority for investors seeking to mitigate the risk of losing their money. Bitcoin, Ethereum, and Litecoin are some of the safest cryptocurrencies in the market and have a track record of being relatively stable. Other emerging cryptocurrencies such as Chainlink and Polkadot are also gaining popularity for their security and reliability. Investors should do their due diligence and research the market thoroughly before investing in any crypto assets.

Conclusion