Cryptocurrency: A New Investment Opportunity?

The invention of Bitcoin¹ by Satoshi Nakamoto (Nakamoto [2008]) in 2008 spurred the creation of many new cryptocurrencies known as altcoins. These altcoins use similar cryptographhy technology but employ different algorithmic designs. Many of these altcoins were invented for different purposes or to address the pain points of the Bitcoin network, such as the high usage of energy caused by its proof of work (PoW) consensus algorithm or the supply limit of 21 million coins, among others. As the network effect weighs in, the prices of bitcoin and its variants have risen in tandem. These innovations and the perceived investment potential have led to rapid growth in the number of altcoins and the market size of cryptocurrency. According to CoinMarketCap,² nearly 869 cryptocurrencies are currently trading around the world with a combined market capitalization of US$148.3 billion by circulating supply and US$321.5 billion by total supply as of October 6, 2017. The price of bitcoin surged to US$4,780.15 on September 2, 2017. Many have argued that, despite their payment utility, bitcoin and cryptocurrencies have no intrinsic value and may be the perfect vehicle for forming a bubble.

Even for those who believe that there is intrinsic value to cryptocurrencies, when their prices are rising, there will be doubts about prices running ahead of values. Technologists will argue that their value is higher than Linux and lower than the Internet--yet both are facilitators rather than an asset class. Finance traditionalists will argue that cryptocurrency is just another form of value transfer that raises funds globally using cryptography and creates little value beyond that. For perspective, with US$40 billion and US$100 billion market capitalization for bitcoin and total cryptocurrency, respectively, this investable asset class is minute in size compared to the US$66.8 trillion and US$48.2 trillion for listed equity and gold, respectively.

Cryptocurrency is a subset of the class of digital currency (Lee [2015]), but it has become an important type of digital currency. Unlike other digital currencies that can be centrally issued, circulated within a community or geographical location, or tied to fiat currency or the organizations issuing them, cryptocurrency has very different characteristics. The blockchain technology used by cryptocurrency, such as Bitcoin, is an open distributed ledger that records transactions. This solves the...