Curmi & Partners

The Intrinsic Value of Cryptocurrencies

by Matthias Busuttil

It is hard to ignore the fast growing popularity of cryptocurrencies. It all started off in late 2008 as a mere experiment of inventing a digital alternative to traditional currency. One which is not controlled by a central bank and relies on cryptography and a fully distributed ledger system called blockchain to execute transactions amongst peers. While the technical details of how this works are outside the scope of this article, what the latter implies is a secure non-trust based system which is free from intermediaries, such as banks.

There is no physical cash in hand, only digital balances maintained on a public ledger online in the name of the various account holders, which can be exchanged among participants by adding a new entry to the ledger. Imagine the speed and cost-efficiency with which one can effect cross-border payments, when a normal transaction can take a few days, if not weeks, and can involve various transfer charges.

The first of such currencies was invented by the anonymous Satoshi Yakamoto and is called Bitcoin. What really grabbed everyone's attention is the sheer explosion in the value of bitcoins. One bitcoin was worth only a few cents in 2010, whereas today one bitcoin is worth 3,900 euro!

While there are now hundreds of different cryptocurrencies, all intended to serve varying purposes, what I would like to focus on are those, like bitcoin, which were primarily designed to replicate the use of traditional money, also referred to as Fiat money.

So what gives value to cryptocurrencies? In order to explain this in economic terms, one must go back to the basic properties of money, which are three.

The first is that money serves as a medium of exchange. It must be a widely accepted means of receiving payment for goods and services.

The second is that it serves as a unit of account. Money is used as a unit of measuring the market value of goods, services and assets.

Thirdly, money is a store of value. It can be used to store value accumulated today and to be spent in the future.

Traditional money holds value not only because it is generally accepted by everyone as a means of exchange but, more importantly, because it is a legal tender. Fiat money is debt-based. It is an IOU backed by a government who has the authority to lean against current and future taxes to services its debts.

On the other hand, a cryptocurrency is, in a sense, a self-regulated equivalent. Its value is derived from the fact that all the users agree that it has value and are willing to exchange it amongst themselves and against fiat currency. Hence, its success and ability to store value depends on its adoption and recognition by the users themselves.

As long as there are participants who are willing to transact, it will hold value. As long as there are participants who are willing to convert fiat currency to cryptocurrency, it will provide a level of security backing . The more participants are willing to adopt it, the more it will increase in value.

The speed, cost-efficiency and the unregulated nature of a cryptocurrency have surely contributed immensely to its appeal to new entrants. This explains the steady rise in its adoption and ultimately the sharp increase in the value of the vehicle.

Cryptocurrencies are now not only being set up to facilitate transactions amongst peers but have also evolved into a highly effective means of crowd funding. This is where traditional currency is raised from the public in exchange of "tokens" or "coins" in order to fund a business idea or project through what are called ICOs - Initial Coin Offerings.

Today, the entire cryptocurrency market is estimated to be worth circa EUR 143 billion with the largest constituents being Bitcoin, Ethereum and Ripple making up 77% of the market. The technology is phenomenal, however the application needs to be improved. The current practice does not afford the users or investors the peace of mind that their interests are being protected or safeguarded by law. Nor are the new, or existing, coin offerings being tested to meet any kind of minimum requirement criteria set out by law to ensure that participants do not get a rotten deal.

This lack of regulation has resulted in a few ICOs being scams and individuals robbed through hacking or abuse of the respective system – the same type of abuse which is also found in traditional money systems. This market is heading in the same direction as the traditional financial markets and exchanges did many years ago, and that is the introduction of regulation.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.