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The puzzle of cryptocurrency – Nashville Business Journal – Nashville Business Journal

Despite the growing popularity of cryptocurrencies, many traditional investors remain on the fence about these enigmas. Even monetary economists struggle to understand what gives crypto its value or what role, if any, it should play in a conservative portfolio. It doesn’t readily fit into the traditional asset classifications of cash or equity.
However, thinking about crypto as an asset having characteristics of both cash and equity may make this newfangled medium of exchange more understandable.
Cryptocurrency essentially is a form of digital payment where you buy tokens (like at an arcade or chips in a casino) that can then be traded or used to buy goods and services. Instead of a bank account or stock portfolio, investors have digital “wallets” through online applications. Cryptocurrencies, such as Bitcoin, Ethereum, and Stellar Lumens, are not backed by any government or commodity. Rather, crypto derives its value from its constrained supply and the blockchain technology that verifies transactions in a decentralized fashion. It is hard to see what crypto brings to the table in terms of long-term value creation, especially for those that remember the dot-com bubble. It seems to have all the warning signs of a speculative bubble.
There are some features of crypto that might provide insight into the value that investors see in it. The first is as a quasi-equity investment. Crypto fans won’t like this definition since it validates the IRS’s decision to tax profits from trading crypto as capital gains. Aside from the IRS, however, most people don’t see crypto as equity because it lacks some key features of equity; primarily, ownership and making it cheaper for firms with high stock values to obtain capital for further investment.
But crypto does provide the essential features of equity, albeit in an indirect fashion. While holding crypto certainly does not give ownership and control to the degree that common stock shareholders do, those holding specific crypto can get the community of investors to create changes in that crypto through “hard forks.” Ethereum investors, for instance, are currently staking their coins to “vote” for a transition to an upgraded Ethereum 2.0.
Similarly, while holding crypto does not lower the capital costs for that specific coin, higher crypto prices do channel resources into advancing the computing technology necessary to verify transactions to “mine” more coin. Higher crypto prices also lower the financing costs for entrepreneurs innovating new advanced forms of crypto that may fix some of the perceived problems with the original cryptos or expand crypto into new territories, such as the sports and entertainment industries.
The cash-like features of crypto are more easily recognized, like being tied to the demand for crypto as a medium of exchange. Crypto has become increasingly accessible due to platforms such as crypto exchange company Coinbase and mobile payment service Venmo, making it easy to trade and spend. This feature makes most cryptos very liquid.
There are at least three major reasons why there is an ongoing demand for crypto as a currency. First and foremost, crypto is being used in collapsed (or collapsing) states or in hyperinflationary environments where even the volatility of crypto is small in comparison. There has been a drastic increase in crypto in Afghanistan, for instance, following the Taliban’s takeover. Second, crypto is also driving decentralized finance (DeFi), which can disrupt the inefficiencies of the traditional banking sector as long as regulators don’t stifle it.
Finally, there is perpetual demand for the anonymity that some cryptocurrencies provide for discrete transactions. While some of this is undoubtedly for illegal transactions, there are legitimate reasons to maintain privacy, even for legal transactions.
As a new financial product with constant innovations and a lot of uncertainty, cryptocurrency remains a risky investment. Overzealous regulatory or tax policies could also undermine its long-term value. But, despite these risks, investors see the value of crypto in their portfolios as an asset that contains features of cash and equity.
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