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Narratives on the price of crypto assets

“We have started the year with falls of more than 50% on average (at the time of writing) in the price of the main crypto assets. The question is whether something abnormal is happening when traditional assets, such as equity markets, they have only fallen between 8% and 12% from maximum"

When it comes to understanding why the price of digital assets, also called cryptocurrencies or cryptoactives, fluctuates, it is important to understand the dominant explanation, and if it is plausible or if there may be one, or several, alternative narratives.

We have started the year with falls of more than 50% on average (at the time of writing) in the price of the main crypto assets since the highs reached by Bitcoin and Ether last October of $68.000 and $4.800 respectively. Bitcoin and Ether are still the flagships from a market of 16.000 crypto assets with a market value of about $1,6 trillion. Consequently, their movements have a strong impact in all categories. You have to try to understand Bitcoin and Ether to explain, at least currently, the variations in the price of the rest.

The question is whether something abnormal is happening when traditional assets, such as stock markets, are only down 8% to 12% from peaks, according to the S&P 500 or Nasdaq 100 indices.

To put it in perspective, both Bitcoin and Ether have multiplied their price 1,3 times and 3 times respectively during 2021 and even more since the minimum prices at the beginning of the Covid-19 pandemic.

Bitcoin is already an asset traditional

The most recent explanation for the collapse is due to the publication of the minutes of the US Federal Reserve (Fed), where some anticipate a more rapid rise in key interest rates, and the beginning of the reduction in the Libra of assets of the Fed, which has reached $8,6 trillion in its attempt to avoid the economic collapse caused by Covid-19.

If stocks go down and interest rates go up, crypto asset markets will move in sync with traditional risky assets like stocks, according to recent analysis from the IMF.

The big question, for those who support the value of crypto assets, is whether this correlation can be broken in the long term in the same way that the prices of US technology companies took off from the stock indices of traditional companies such as the Dow Jones Industrial Average. . For the deniers, the value of crypto assets will plummet, and for the in-betweens, there will be continuous change in ranking or version waiting until the winners are consolidated, as is now the case with the great world technology companies.

Difficulty of mining and prohibition

Another narrative placed part of the blame on the sudden reduction in hash rate o mining rate caused by the temporary blocking of the internet caused by the riots in Kazakhstan, converted according to Visual capitalist in the second country in the world in proportion of Bitcoin mining with 18% compared to 35% in the United States.

The geographical concentration of Bitcoin mining is key and very worrying, since its famous decentralization is questioned not only because of the relatively small number of the main miners, but also because of their geographical location.

More recently the Vice President of ESMA has proposed a ban on PoW proofs of work (Proof of Work) that support mining by their energy consumption. Even a report from the Central Bank of Russia proposes the banning of all operations with crypto assets in Russia, in addition to PoW mining.

The unique characteristics of Bitcoin and Ethereum

The narrative that I want to propose is different, and is linked on the one hand to the nature of crypto assets, especially Bitcoin, and on the other hand to the role that their underlying blockchains can play in the development of the transformation of many technological processes and business models. both existing and new businesses, as is the famous case of NFTs or DeFi decentralized finance.

I speak of Bitcoin because today it is still the dominant cryptoactive, and therefore, its evolution continues to largely determine the direction of the price of the rest of the digital assets.

Bitcoin is criticized as an asset without intrinsic value and this is explained by texts like this one from Bank Underground, from a group of Bank of England economists who publish their opinions on a personal level. On the other hand, there are multiple proponents of Bitcoin as an investment asset that must be considered with a new analysis framework as the investment manager does. ARK by Cathi Wood.

That is, there are narratives Minimalist that warn that the value of Bitcoin can go to zero, and narratives maximalists that support meteoric prices, competing as the new digital gold alternative to current physical gold. After all, the digital unit produced as Bitcoin has so far demonstrated unique conditions: to be traceable, immutable and transferable between digital wallets or digital wallets. All the hacks These have not affected the Bitcoin blockchain, but the providers of key custody services. And all the mining bans that have occurred have not prevented the operation of Bitcoin, until now, at all times.

The problem with the maximalist narrative is that together with the maximum emission allowed in Bitcoin programming of 21.000.000 (of which 18.750.000 have already been issued) makes there is no price cap above, if the protocol is never hacked and the purchase, investment or transmission of Bitcoins is not prohibited as has happened in China. And the equivalent of those who support the narrative Minimalist is that does not invest or participate in the development of cryptocurrencies because he thinks that they will end up disappearing.

The problem between the sky and the ground is that there is a lot of space.

At this point it is therefore a matter of belief feeling, something very different from what happens in the stock or bond markets, whose price narrative is governed, in addition to undoubted psychological factors, by comparative valuation methods discounting the future cash flows generated by any investment with certain multipliers. This assuming that the activity is not declared illegal in a general way, or that there is a failure in the operation of the Bitcoin protocol.

In the case of crypto assets, it is necessary to calculate the rate of return derived from their possession, in the case of investors, and the cost of mining against the value of the crypto asset generated (including energy cost, investment in hardware, …). In the case of Bitcoin, the main source of profitability comes from the appreciation in its price, since unlike cryptocurrencies based on blockchains that allow smart contracts they can be used for the development of other cryptocurrencies or proposals that generate demand for calls crypto assets that build infrastructureFor example, to develop decentralized applications on the Ethereum network, you have to acquire Ether and pay the miners a fee or gas.

Therefore, and without defending the minimalist or minimalist narrative, what is certain is that additional volatility must be tolerated in these digital assets, with respect to more traditional financial assets, more subject to economic and intrinsic events typical of their operation. business.

Henry Titos

Independent Director. Advisory Counselor. Director of WG "Digital Money and Payment Systems" of Fide, Academic Advisor of Fide

Article originally published in the Palace of Ideas on January 25, 2022

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