The Crypto Conundrum

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The conundrum facing current and potential investors in crypto currencies is, valuation.  Bitcoin does not derive its value from any assets or earnings.  Hence, the value depends entirely on what an investor is willing to pay for it.  Valuation metrics for more established investment vehicles have been fairly well established.

Bond valuations are based on prevailing interest rates.  If you buy an investment grade bond, you can be reasonably certain that, at maturity, you will receive the face value of the bond and, in the interim, you will have received the coupon interest rate.

Equity investment valuations are typically based on the present value of future earnings/dividends, calculated using prevailing or expected interest rates and estimates of future operating results.

Gold, which has historically been seen as an inflation hedge, is also a commodity with numerous commercial uses, plus its widespread desirability as jewelry.

There are no comparable metrics for crypto currency.  Bitcoin has found support, in part, based on a structural limitation on the number of coins.  Although there is no similar limit on the number of other existing or new crypto currencies, they tend to trade in unison with bitcoin.  Blockchain technology has also been cited as an important metric for valuing the potential for bitcoin, but there is the issue of whether blockchain depends on bitcoin or bitcoin depends on blockchain.

Investors should ask themselves whether there is a definitive reason for the current price of bitcoins, versus another higher or lower number.  Caveat Emptor.

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA®

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