Finance Monthly - December 2021

asset ever created. Societies have always based the price of a currency on this concept of scarcity, which is why precious metals have been the pillar of many economies for centuries. Bitcoin supply had low inflation built-in from day one. To ensure that the issuing of Bitcoin would eventually cease completely, its creator Satoshi Nakamoto encoded a way to halve Bitcoin’s mining reward roughly every four years; the Bitcoin supply will thereby never exceed 21 million coins. But what is driving that faith? And what is underpinning the huge increases in the value of cryptocurrencies? This is more to do with its ability to store worth relative to other asset classes. Widespread social adoption, together with their privacy, security, and transferability, make cryptocurrencies a significant asset class to store values. Cryptocurrencies do not follow the same rules as fiat currencies, or even secured assets; instead, matters tend to get complicated. Given that a cryptocurrency does not generate or support cash flow, it needs to be valued against potential and —critically—future prices. That then opens the door to several different valuation methods and guess what—our old friend gold is back. Amongst the differing valuation models now available— the stock-to-flow method, institutional participation method, and high-net-worth participation method—we find the gold valuation method. But let’s not forget this is a new asset class, so we would expect investors will consider a range of valuation methodologies to estimate future value. This is, however, not risk- free. It is a new asset class and one that does not exist physically. It is not gold, as we have repeatedly said. Risks do exist and they are well known, and some would argue, substantial. We are therefore firm believers that the financial industry needs to address—and support— government initiatives around regulation. The key questions remain: Should institutional investors dive in, and is this in fact a dedicated new asset class? El Salvador became the first country in the world to adopt Bitcoin as its national currency, allowing people to use a digital wallet to pay for everyday goods. Many countries are considering issuing their own central bank digital currencies. All these developments tell of cryptocurrencies’ future potential in line with an asset class. The primary reason why some do not regard cryptocurrency as an asset class is because of its unclear regulatory environment and high volatility. However, more and more institutional investors use cryptocurrencies to hedge against inflation and currency debasement and to diversify their portfolios in the pursuit of higher risk-adjusted returns. This is, without doubt, a new asset class and one that will increasingly gain acceptance and the participation of institutional investors as time goes on. Finance Monthly. F i nanc i a l Innov a t i on & F i nTech 51