While Bitcoin has enjoyed an impressive price rally since the beginning of this year, what has been less impressive is the performance of some of the other ‘alternative cryptocurrencies’.
Perhaps, the reason why Bitcoin’s price appreciation is not reflected, to the same extent, in the 2300+ alternative currencies combined, is that not enough attention has been given on how to actually value these assets.
For anyone interested in investing in cryptocurrencies, other than Bitcoin, I’d like to offer my thoughts on the subject of valuation.
Some may read this discrepancy in price appreciation as a critical commentary on the appeal of altcoins and utility tokens, but I believe it speaks to the need of gaining a deeper understanding of how to evaluate altcoins – which in my view represent an asset class of immense untapped potential.
Over the past year, a variety of promising frameworks have been proposed which investors can apply to value cryptocurrencies, and they’re definitely worth looking into, but in my view, there are three main factors that drive value:
Many cryptocurrencies, including Bitcoin, but also Ripple, Bitcoin Cash, EOS and Litecoin, are regarded as deflationary assets due to their finite nature. Some currencies even employ ‘coin burns’, where the maximum supply is systematically decreased over time.
A coin must have a strong use-case to incentivize participants on a blockchain to hold the coins. When we look at Ether (ETH), for example, we know that to execute commands and develop apps on the Ethereum blockchain, one must have ETH.
ETH is used as a form of fuel to drive transactions and development – the more people transact and develop apps, the greater the demand for ETH, the better its prospects.
Utility, and by extension blockchain activity, is a key metric to consider. Considering market cap as but one perspective, the Block’tivity platform provides useful insight into how active blockchains underpinning cryptocurrencies really are. It also takes the ratio of activity to the blockchain’s full capacity into account. This facilitates in taking a long view.
Real price discovery
As important as research into a coin’s overall ecosystem is, choosing the right digital asset and cryptocurrency exchange also requires due diligence.
Digital asset exchanges play a vital role in bringing together issuers and investors, and properly channeling capital to the best and most promising blockchain ventures.
But for true price discovery to take place, and to prevent or mitigate against the misplacement of capital, exchanges must have mechanisms in place to guard traders from market manipulation and bad actors who may seek to misuse digital assets for money laundering or other illicit activities.
Regulatory compliance is key here. Not only to keep bad actors at bay but also to create – in unison with strong security measures – a trusted and resilient environment suited to accommodate institutional investors.
Furthermore, in anticipation of a maturing market, true price discovery requires institutional-grade technology capable of handling deep liquidity and the power to process large volumes.
Ultimately, as a firm proponent of blockchain technology and cryptocurrencies as a new asset class fit for portfolio diversification, I believe that, next to Bitcoin, altcoins present investors with an immense opportunity.
But in order to unlock their potential, and attain healthy market dynamics, investors will need to develop valuation methods tailored to digital assets, and exchanges will need to keep raising their technological and procedural standards to foster true price discovery.
About the author
Thor Chan is the Chief Operating Officer at AAX.