The Inherent Value of Cryptocurrency
We live in a very weird time in the cryptocurrency era. Much like the internet revolution in the early 90’s, blockchain technology has shown amazing potential, but is still immature. But unlike the internet, cryptocurrency was able to find a liquidity model from very early on in the form of Token Distributions like ICOs. This rapidly expanded the pool of investors in the industry and has given rise to irrational exuberance. Speculators have overwhelmed the market with speculations, creating wild movements in price that are almost completely driven by sentiment.
This has given the impression that cryptocurrency prices are not driven by anything at all. ERC-20 tokens with no extraordinary properties commonly gain and lose billions of dollars over the course of a day. People point to this movement as proof that the market is driven almost wholly by speculation and that cryptocurrency prices are not support by anything at all.
But this is just an illusion. Even though tprices don’t match fundamentals, it does not mean that fundamentals are non-existant. Far from it, the fundamentals of a cryptocurrency are critical to the long-term growth and sustainability of any project, even if the market disagrees in the short-term.
In this article, I’m going to discuss the properties that will ultimately drive all future fundamental analysis. By understanding how projects support these properties, we can understand where to start looking for fundamental metrics that track to long-term value.
What Makes Cryptocurrency Inherently Valuable?
When Bitcoin was first released, there were a lot of goals in order to make a truly decentralized cryptocurrency. Among discussions of fault-tolerance and proper cryptography were the factors that create a valuable currency. In order for BTC to be adopted, there needed to be some base requirements. These include things like:
- Having a limited supply (BTC is capped at 21 million)
- Being easy to store and transfer (BTC can be sent in wallets via a number of options)
- Hard to forge (Bitcoin Network can’t create more BTC without network consensus)
- Highly Divisible (BTC is divisible to the 100,000,000th place)
- Fungible (Each unit of BTC is indistinguishable from another unit)
- Decentralized (No single point of failure)
When people question ‘what gives BTC value?’, one of the common responses is to list these properties as justification. Despite their importance to the ecosystem, these things do not inherently give BTC value. They make it possible for BTC to be usable as a currency, but don’t make it special on it’s own.
What does give BTC value? Ultimately, the answer to what gives BTC value is the same thing that gives Gold, Fiat and any other currency value: being adopted and commonly used by a population. This is the beginning, middle and end of what gives any cryptocurrency inherent value. If BTC remained a speculative project and was never picked up by the first group of small users, then there would be no adoption, and therefore no value. No other factor can explain why a currency like BTC is valuable, but a fork with identical properties is not valuable.
This leads us to the next question: How does a cryptocurrency get adopted in the first place? Why did Litecoin succeed, but other cryptocurrencies with equal merit in the early 2010’s fail? Why is Bitcoin still the top cryptocurrency despite many projects with objectively better technology being launched? To understand this, we need to discuss adoption drivers.
Understanding Adoption Drivers
Looking at some of the longer standing cryptocurrency projects, we can start to get a sense of which adoption drivers really matter. Unlike fiat currencies, which can be forced onto their population by their government, BTC and other cryptocurrencies can’t be forced. Much like a business, BTC must solve some critical problem in a market and convince a group that it’s worth using. Because of the nature of open source decentralization, projects can be forked, making innovations easy to copy. Adoption drivers have to come in the form of unique advantages that build only build particular blockchain and cryptocurrency.
Let’s take Ethereum as an example. Ethereum is a platform for decentralized services. While it shares many of the same properties of Bitcoin (like having a currency that is divisible and easy to trade), there are significant difference. The project focused very intently on being a good platform, allowing teams to develop smart contracts and launch Dapps to the public. The thing that ultimately drives adoption to Ethereum over other competitors is its ability to be a good at these factors. As more developers create projects, more people need to use ETH, which drives adoption and use among the population.
There are also adoption drivers emerging for project like Monero. Monero is a cryptocurrency that uses ring signatures and other cryptographics to make XMR untraceable on the blockchain. While it too shares many of the same properties of BTC, it’s main innovations come from providing anonymity. Adoption is derived from being a superior anonymous transaction platform. As more people use XMR and accept XMR, more users will demands this currency and create value.
In theses cases, we see the number of active transactions and users growing with each of these project. We see transaction usage growing and being discussed by people within the target population. If we were able to remove the speculators from the market, we know that there would still be a base of users using the cryptocurrency. This is vital for creating inherent value.
The Importance of Teams and Creation
Just like we know that long term price will ultimately be influenced by usage, we know that to acquire that user base, there needs to be solution to a problem: a need satisfied. But given the nature of technology, and the need to fit a solution to the varying needs of a market, significant work needs to be done to build a cryptocurrency. And not just work on the surface to attract people to your project, but the real work that constitutes ‘innovation’, the messy effort under the hood that makes the system work. This work to create a functional product is vital to sustaining value drivers.
We’re seeing this work in action today. Legacy cryptocurrency projects are currently undergoing massive changes to scale out their solution. The Lightning Network is working to deliver one of the first Layer-2 protocols services on to the blockchain, allowing for fast, instantaneous payments with BTC and LTC. Ethereum is developing their own version of Lightning (Raiden), as well as a project called ‘Plasma’ to scale their solution. A concerted effort from several teams (and many players) is needed to maintain and grow the network. If this work were to end, the projects would die with them, as would long-term adoption into those particular cryptocurrencies.
We see this happen with project regularly, as the list of dead cryptocurrencies now exceed 400 plus examples. In each of these cases, a few devs or even a team of users got together to create something and eventually abandoned it for green pastures. In each of these cases, the project would hold value, then slowly slump until eventually hitting some baseline defunct value. Without a team of people to promote the currency and build on it, there was no place for it to go.
No creation, no adoption, no value. This is the fundamental truth of the inherent value of cryptocurrency: the genesis of value does not come from inherent properties within the currency, but from a team’s ability to create a solution and be accepted by a market. This work does not have to come from one team (where would Bitcoin be without Mt Gox?), nor does the value have to be pre-planned or intended (remember when BTC wasn’t a Store of Value?). But without the act of creating a solution, there can be no value. Creation is the root of fundamental value, and all future fundamental analysis will be focused on understanding how this work.
What Does Not Create Value
This path between inherent value of a cryptocurrency and the work of a team to win a market is a one way road with no off ramp. There are many, many people in the industry that are ‘active members’ that have no impact on the long-term value of a cryptocurrency. Speculators do not create value for an industry, because their influence does not create a core base of users. Well wishers and supporter who love a cryptocurrency do not have an impact if they are not influencing the creation of that product. Writers giving an opinion on a projects have no impact if they don’t influence the core users of a project.
This is not to say that these groups are permanently on the outside of the creation process. A speculator who later uses her earnings to donate to projects she believes in becomes part of the creation process. A support who later recruits developers to a particular project will help be apart of that creation process and help fuel inherent value. A writer who makes documentation accessible to a larger market facilitates better development efforts and more work into the product.
Without the process of creation, in some form from some group of people, there can be no inherent value. A github repository that is forked and uploaded will never lead to value without work to build it. A product that is purely marketing with no substantial work will never be inherently valuable. Anything that is expected to grow in value based on future work is fully speculative until that work begins to be delivered. And as the market starts to buy into these changes and accept the solution from the team, inherent value begins to grow. This conversation between a team and a market creates this value.
Moving Forward: Fundamentals For Valuation
When I speak about the fundamentals, I am talking about this process of creation. We have some analogs to this today: looking at the number of commits and the substances of those commits can tell you about the quality of a project. Looking at the amount of unique researched produced by the founders of projects can help you understand where they’re going. Seeing the number of side projects and teams relying on that core technology can indicate adoption.
As time goes on, I believe that many of these metrics should be brought together to tell you about the fundamentals. There are certain things like social media account follows on Twitter, Medium, etc that will be somewhat valuable. But this is prone to abuse and can only be relied on so much. If we are going to create metrics to analyze fundamentals, I think these are some top candidates to start searching:
- Blockchain transaction analysis (number of active users, velocity of transactions, number of transactions, etc)
- Github repository analysis (number of users, number of commits and quality of commits, number of forks/reliant projects)
- Team Quality (collective hours working on project, number of joint projects, number of separate projects)
- Market Analysis (Total Addressable Market, Number of potential users, Number of current users, growth in users, etc)
Ultimately, fundamentals will follow the process that most closely match the reality of this creation and adoption process. All inherent value will flow from creation, as accepted by the larger population of users. This is the basis of inherent value in a cryptocurrency.