Cryptobuzz Report: No. 11

Big News: Finding Value in a Speculative Haystack

Crypto assets have reached a new all time high this week with the total market cap surpassing $150 Billion (up from below $18 Billion at the start of this year!) Given such a meteoric rise this year alone, it’s no wonder people use words like “bubble” and “digital tulip mania” to describe the phenomenon. Plus, if we look beyond crypto to the broader economy we find overvaluation of historic proportions, or as Jesse Felder describes it, we’re in the midst of the “Everything Bubble”. So how do you navigate through bubbles and booms and find true value? Here are a couple of models to help think about investing in the crypto space.

Utility vs. Speculation

Are people speculating on cryptoassets? Absolutely - in a very big way. However, it’s important to realize that all forms of investing involve some form of speculation. When I buy stocks, I speculate that the company’s future cash flows will be more valuable tomorrow than they are today. Chris Burniske gives a great model for deciphering value in this new world of crypto. He explains that the price of a cryptoasset is made up of two components:

  • Current Utility Value: the value that the token/coin adds to the network and the economy more broadly

  • Discounted Expected Utility Value: can be thought of as “speculative” value.

Just like stocks have a book value, cryptoassets have a base utility value, albeit a lot harder to determine. Bitcoin’s utility value could be measured in many different ways: global remittances market share, store of value (% of gold market), the cost of mining bitcoin, etc. Ethereum has different utility related to computing power and the ability to process smart contracts. Uncovering this utility value is the tricky part, I can’t just pop over to Yahoo Finance and look up the Utility Value of Litecoin. Additionally, there is currently far greater speculative value than actual utility value, which means you have to cut through a lot more speculation to uncover the true utility.

CUV.png

Just like stocks have a book value, cryptoassets have a base utility value, albeit a lot harder to determine. Bitcoin’s utility value could be measured in many different ways: global remittances market share, store of value (% of gold market), the cost of mining bitcoin, etc. Ethereum has different utility related to computing power and the ability to process smart contracts. Uncovering this utility value is the tricky part, I can’t just pop over to Yahoo Finance and look up the Utility Value of Litecoin. Additionally, there is currently far greater speculative value than actual utility value, which means you have to cut through a lot more speculation to uncover the true utility.

 

All of this speculation causes cycles - booms and busts. You can think about these booms and busts as fluctuations around the Utility Value of the token. During the booms, as a % of the price, cryptoassets have a low Utility Value and very high Speculative Value. Then as these assets sell off, Speculative Value % declines and the price is comprised of a higher % of Utility Value. Burniske refers to this as the new “crypto J-curve”.

jcurve.png

Risk Adjusted Returns

Another interesting exercise in determining the value of crypto assets is the Sortino Ratio. I think it’s safe to say that most people would consider Bitcoin a “risky investment”, but if we can understand this risk and plan accordingly, we are positioned to make some substantial gains. The Sortino Ratio is a “useful way to evaluate an investment's return for a given level of bad risk”. You can check the details of the formula on Investopedia, but essentially you are getting a risk adjusted return that is not penalized for upside volatility (i.e. if Bitcoin shoots up by 75% this is a great thing for me).

Bitcoin blew away all major asset classes over the last 5 years in terms of Sortino Ratio. See the chart and get the details behind the calculations here.

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Interesting Articles

  • Cryptocurrencies will never be seen a safe havens. Link

  • A list of upcoming ICOs and different events. Link

  • Ethereum will be doing hardfork in late September. This hardfork was planned well in advance and should be a positive overall as it allows upgrades to the software. Link

  • The IRS has been using Bitcoin tracking software since 2015. They are still in a legal battle with Coinbase, but it looks like either way they’re able to track transactions. It didn’t mention tracking other cryptocurrencies. Link

  • Microsoft launched the Coco framework as a solution to increase transaction speed and create governance around consortiums. Link

  • Netflix has a Bitcoin documentary. It does a good job providing a good history through 2014. It doesn’t focus much on the underlying technology as much as it does on who could be Satoshi Nakamoto. Link

 

Chart of the Week

BTC price goes up... people get interested and search Google for “bitcoin”... BTC price goes up… and repeat. Chris Burniske with more great analysis on the factors driving price swings in crypto and how the market has matured over the years.