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Is Cryptocurrency the Same as a Fine Wine or Classic Cars?

What drives the value of cryptocurrency, and why Wealth Managers should take note

There is a definite buzz around cryptocurrency. Whether you are a fan, detractor, or somebody sitting on the sidelines, most people have an opinion especially on valuation. Bitcoin, the most widely known cryptocurrency, has had wild pricing swings over days, weeks and months - leaving investors guessing on where will it go next and whether the reward is worth the risk.

Traditionally, assets are valued based on various investment fundamentals such as cash flow, sales, earnings, estimated future value, and other common indicators. The value of fiat currencies is driven usually by the stability and stature of the sovereign state and the monetary values, policy, and tools of its central bank. Cryptocurrency does not share all the common characteristics of a currency and does not take the traditional approach sovereigns use to manage their currency, replacing institutions with modern technology. How should investors and their advisors approach this new asset class?

Isn’t Cryptocurrency a currency?

Well, no. But it can demonstrate some of the characteristics of a currency. Cryptocurrency does share most of the common characteristics of currency (e.g., medium of exchange, store of value, unit of account, interchangeable). However, it misses on others, mainly as in the BIS Working Paper, the ‘No Questions Asked’ principle requiring money to be accepted in a transaction without due diligence on its value (i.e., it doesn’t pass stability of value and legal tender tests). The volatile nature of the asset requires both the buyer and seller to confirm the value at time of purchase or possibly at the time of payment, adding a layer of uncertainty that does not exist with most fiat currencies. This does not mean that it cannot be used as a payment method or there is an issue with valuation. However, when contracting and settling each transaction, due diligence to determine transaction value is required. Given the key differences with fiat currencies, are there other asset classes that share more similarities with cryptocurrency?

Fine Wines, Classic Cars, and Cryptocurrency – an unusual combination

Which assets have a high sensitivity to changes in supply/demand supported by an ecosystem of evangelist specialists and celebrity influencers? Fine wines and classic cars seem like a perfect fit. Hype, style, age, vintage year, manufacturer, region, model, and production type come together to influence the price of the purchase. In a broader sense, physical commodities such as diamonds and gold are valued in much the same way. Recent statements from regulators have come to a similar conclusion, with the regulatory leaders in U.S. and Canada agreeing to treat crypto as a commodity. Similar to other commodities, many cryptocurrency networks set a finite supply of their coins. As waves of demand have crashed, volatility has positioned investors at either end of the gain/loss spectrum.

Moving towards the mainstream, who is going to strike [crypto] gold?

There are more than 4,000 different cryptocurrencies and they are not all created equally or have the same level of investor access. There are hundreds of exchanges providing liquidity for the coins. Thinly traded or access via a limited number of exchanges can have an influence on liquidity, price and ultimately demand. This demonstrates why it is critical to select the right partners that meet the specific needs for your business.

What is very clear is speculation always comes into play in the valuation of any asset. Even if the speculation is on government regulation. This appears to be very true with cryptocurrency and some have argued one of the main drivers to value. 

What does this all mean?

Wealth Managers should consider several things as the market evolves.

  1. Valuation methods will take time to mature, as with any new or niche asset class.
  2. For most of the coin offerings, participation in the market is driven primarily by speculation and evangelism of the projects run by cryptocurrency networks. So, be clear eyed about bad actors.
  3. Investors are demanding that their advisors bring the best their financial institution has to offer – not only products, but also needed support services.
  4. Stay nimble with your ecosystem, operational framework and partnership network as regulators set standards.
  5. Financial institutions that are serious about entering the space need to know the “competing” technology otherwise they will risk playing catch up with legacy systems.

While it is fun to compare the cryptocurrency value to a collectable and the similarities are striking, the better analogy is to compare cryptocurrencies to a commodity. Even then, like with any emerging asset class, we’ll stay tuned.

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