Value Investing in Digital Currencies: Part 1

With the advent of cryptocurrency and the decade-long build-up in adoption and innovation thus far, we stand at a point in time where it can be said that digital currency will be an inevitable part of human life and commerce going forward. Add in the rapid digitization of all life during the Covid-19 pandemic and the announcements made by governments worldwide that they are going to introduce their own digital currencies, known as Central Bank Digital Currencies (CBDCs), we can see this technology is not even a matter of choice of adoption but will be forced upon us from multiple external pressures.

Given this standpoint that digital currency is a technology rapidly becoming normalized into society, investors will be looking for opportunities to gain and profit from the inevitable shift into a new paradigm of money. But with everything so new and changing so rapidly, there will be winners and losers much like in every new emerging and speculative market (think the dotcom bubble!).

In an effort to find value in this emerging technology of more than 3,000 cryptocurrencies and CBDCs on their way, this article will explore the properties of these digital assets that make certain technologies potentially more valuable and far better as an investment over the coming years and decades. These properties aim to enable an investor an opportunity to assess and measure each individual project to move beyond mere speculation and attempt to find value for the long term. They go as follows:

• Sound Money Principles: this technology is essentially coded software, so it will be very important that the code creates an auditable, clear to understand the monetary policy that avoids inflating the currency supply that could depreciate the purchasing power per unit of the currency. What we want to avoid is this. Or this.
• Decentralization: Because blockchain technology (the invention that enables these digital currencies to exist) enables networks to operate across the globe without a single point of control, we can avoid individual bad actors from manipulating or changing the protocol without the consensus approval from the entire network. Decentralization equalizes the playing field for all uses, strips power of centralized control of the network/money, and disallows censorship of any kind (think of how Twitter/Facebook can block people or remove posts because they are the central authority to their networks)
• Utility: Once we have determined a cryptocurrency has sound monetary principles hardcoded into its existence and its network is decentralized and out of control of any one point of failure, the next question we have is what makes it useful or what features does it have that makes it stand out against the rest? Obviously, digital and decentralized sound money is a “killer app” as is, but there will be niches and other use cases for these technologies that will bring them value as well. For example, there are coins specifically for privacy, other coins specifically for digital contracts, and even coins representing cloud storage across the internet.
• Network Effect: Another way to measure and assess a cryptocurrency’s future potential value is by network effect. Looking at how many people are using the technology today, how many people are contributing to its development, and the existing internet memes and brand recognition for the project can tell you a lot about where the project is going and how much traction it has to get there already.
• Market Cap: Once we have determined that a project has sound money principles, is decentralized, has useful utility features or serves a necessary niche, and has an organic growth of community users and developers, the next thing to look at is the Market Capitalization of the asset. This is synonymous with stocks in the essence that a smaller market cap means there is more room to grow. For reference, Bitcoin’s current market cap is $550+ Billion, while Ethereum’s market cap is $88 Billion. The lower the market cap, the easier one could imagine an asset’s price doubling, tripling, or 10xing, but it would be very dependent on the above-mentioned properties if it were to sustain long term growth.
• Future capabilities: Unlike gold or paper money, cryptocurrencies are digital software and thus they can be programmable and updated over time. It would be important to look into the world of developers and engineers contributing to the project to see what upgrades are coming, what is being proposed, and why it matters. Essentially, buying digital Gold isn’t just like buying Gold, because Gold 2.0 is continually evolving, adopting new technologies, side chains, efficiencies, etc all the time.

By standardizing the practice of assessing each digital currency by the above-mentioned criteria, we can start to decipher each individual project and hopefully find high-value investment opportunities. Part 2 will begin this process by assessing some of the more prominent cryptocurrencies and attempting to determine their future value.