Many articles have been written about Bitcoin, Ethereum and every other altcoin out there about its value, either perceived or actual. Most investors have been excited about whitepapers and have fallen into the ICO trap for coins which did not deliver on promises, or have made massive profits on coins that over delivered. To help you understand how Cryptocurrencies can fit inside of a trade portfolio and how you can value them.
The first thing to understand is that a Cryptocurrency is basically an application of blockchain technology. Blockchain technology allows for secure storage and interaction between parties without any intermediaries and different coins use this for different applications. We won’t go into the details of the different coins and their own unique properties yet, but will keep it high level for now and leave the details for a later article.
A value retaining vehicle.
This places cryptocurrencies in the commodity category. Every Cryptocurrency is based on a mathematical formula and by virtue of the number of solutions you know how many coins there will possibly be. For Bitcoin this number is 21 million coins. Just like with oil and gold, this makes it a rare commodity which is limited and that in itself has value.
When building a portfolio you will want to hedge your bets in different types of assets. When building a portfolio of investments you look at risk and based on how much risk you are comfortable with, you can have a higher or lower percentage of you funds in high risk / high rewards markets. Most portfolios have a percentage in Fiat currency, or cash, which is seen as the safest part of the portfolio. Cryptocurrencies allow for digital storage of value outside of third parties. Yes the price is volatile but as long as you protect your computer it is very similar to storing gold bars in a safe at home.
A new way of dealing with trust.
Way back when humanity lived in small villages you knew your butcher or mayor personally, as communities grew people wanted to be able to go to a store and purchase something without needing to trust the storekeeper, and storekeepers wanted a system where they did not need to have to trust a customer. This is where banks and credit card companies and other payment facilitators stepped in. A credit card company guaranteed a store keeper that the required funds are present and that the customer can walk around with access to his own funds. Blockchain technology doesn’t use a third party for these guarantees but uses a network of computers to guarantee information.
In the current economy it works like this: a customer walks into a shop and uses his or her payment vehicle to purchase something. The device sends a message to an acquiring party asking to validate the transaction based on things like credit card not being stolen and if there are enough funds or credit to be used. If so, the transaction is authorized and the funds are blocked from being used again until they leave the account and are sent to the shopkeeper. This is generally not a fast process and requires a credit card company, an acquiring bank, an issuing bank and normally two regular banks and every party takes a cut in this process.
The idea with blockchain technology is that the lead up is similar but when a customer makes a payment it isn’t an authorization between the shopkeeper, their acquirer and the customers issuer who are all working to authorize the payment, but it is a check on the entire network where enough “nodes” or computers check to make sure that the currency is available and then agree that the currency now belongs to the wallet of the shopkeeper.
In this example I used a currency as this is the most common example and closest to the name of Cryptocurrency, but there are many applications of blockchain technology. Think of domain names on the blockchain, removing the need for those companies who take an annual amount for owning a domain name. Smart contracts, competing with trading companies who act as intermediaries and take a percentage of these trades.
When building your portfolio, know that cryptocurrencies innovate the financial processes so certain cryptocurrencies can be added to the fintech part of your portfolio.
Besides the financial innovation as explained above, there are also technical innovations. blockchain technology is already being used for security purposes. Most companies experience multiple hacking attempts over their lifetime and security is certainly an important part of that. Also, regulatory issues such as the European PSD2 regulation require companies to find new and better ways to secure their information and many are looking at blockchain technology. When evaluating if you want to add a certain currency to your portfolio look at the changes already happening and where Cryptocurrencies fit in as tech disruptors.
I have below shown an example of a portfolio:
fiat currencies can be your safety basket ensuring that you will keep value. Intermediary risk is taken with Bitcoin, it fluctuates a lot but will most likely not go anywhere soon. Ripple can be your Financial tech disruptor and both ZCash and pennystocks can be your high risk high rewards part of you basket.
To conclude; there are many different cryptocurrencies, so look at what your portfolio can use and pick the right mix and percentages of Cryptocurrencies to complete your portfolio.