At first, everyone should understand that cryptocurrencies are fundamentally different from stocks. Stocks have intrinsic value – they represent a real piece of physical business. In the short run, stocks can swing up and down for no apparent reason, but in the long run, as a company’s intrinsic value increases or decreases, the stock tends to move in the same direction. In contrast, cryptocurrencies have zero intrinsic value – they are just computer code. That makes it difficult to predict future ticket prices.
However, I believe that there is a basic economic principle that we can apply to our advantage. This is the principle I used when deciding to buy bitcoin and Ether (the tokens for the Ethereum network) in 2018. And the same principle that anyone can use to this day to guide their thinking about any cryptocurrency investment.
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Supply and demand
In economics, few principles are as basic as the law of supply and demand. Price is determined by how much is available (supply) and how much people want or need it (demand). When it comes to cryptocurrencies, the supply is different in each case. Bitcoin supply is well known, and bitcoin aficionados dispute this proves its future value.
However, supply is only half of the equation. Do you remember Beanie Babies? Ty, the company that made them, periodically “retires” at Beanie Babies, limiting their supply forever. This limited supply prompted some collectors to buy the transfer fist, causing their value to soar in the ’90s. Some even fetched thousands of dollars. However, Beanie Babies prices plummeted after their short peak – most still sell for a fraction of what they sold for in the ’90s. But the supply has not changed; they still do not the expired. Demand changed. People don’t want them so much anymore, so they’re worth less.
Many cryptocurrencies have known supplies. That is extremely useful. But an educated view of the value of a future ticket requires a prediction for future demand. Thinking through both supplies a demand led me to buy an equal amount of bitcoin and Ether over the thousands of other options. In my opinion, they are the two cryptocurrency candidates most likely to be in demand going forward and the ones I would buy today (but more on that in a while).
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Why did I buy Ether
I bought Ether because the Ethereum blockchain has utility in the real world. While tokens can be used for digital payments, more practical things like smart contracts and applications can be built on top of the Ethereum blockchain. Think of it as a tank of gas. Sure, the gas tank has value. But it also has practical uses. Continuing this analogy, some cryptocurrencies are just tanks of gas in non-engineered worlds. But Ethereum blockchain in a gas-powered engine.
Ethereum is not the only blockchain network like this, but it is arguably the best known. That is important because blockchain networks benefit from network impact. That is, the more people using one system, the more likely it is that more people will use the system. For me, if people were going to build on the existing blockchain technology, Ethereum must surely be among the best candidates.
Many businesses are already seeing the value of using blockchain technology. And some, like DocuSign, is already building on the Ethereum blockchain. To execute a transaction on the blockchain, you will be charged a fee in Ether. As more real-world applications are powered by the Ethereum blockchain, there is likely to be an increasing demand for Ether to make it run. This could still send its value higher – its value is already up around 350% in 2020.
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Why did I buy bitcoin
Bitcoin has less usability than Ethereum, but that hasn’t stopped it from maintaining its title as the most valuable cryptocurrency in the world. Some believe it could become a one-world currency, creating a huge demand. But to me, that sounds far-reaching. It seems that people are not using bitcoin for transactions but rather as a growth investment or as a digital repository of value.
In my opinion, calling bitcoin as a store of value is far less than what it would be as a currency or some other everyday convenience. That said, bitcoin’s upside could be great considering its supply is far more limited than Ether’s supply. Consider that there can only be 21 million bitcoin tokens. In contrast, Ether and many others do not have a pretty ceiling. Ether has annual mining limits, which keep track of new supply. But bitcoin’s mining process is even more limited.
Every time there is a transaction on the bitcoin network, decentralized computers process it and the fastest computer is rewarded with new bitcoin tokens. However, every few years the bitcoin prize is cut in half, most recently in May. This means that miners are currently being rewarded with 6.25 bitcoin tokens, as opposed to 12.5 earlier in the year.
Because less bitcoin is coming into circulation now, the price of bitcoin could rise if demand remains constant. A remarkable development this year is that new demand is rapidly pouring in from corporate entities. For example, Square has just purchased over 4,700 bitcoin tokens. And the growing corporate demand, coupled with the new supply cut in half, has helped drive bitcoin’s price higher in 2020 – up over 160% a year to date.
What to do
After considering the issue of supply and demand, here is my cryptocurrency investment thesis: Bitcoin and Ether have a high chance of being used in the future. And their supplies are limited enough to send the value of these tickets higher as demand increases. I think that applies as much today as it did when I bought bitcoin and Ether in 2018.
When I bought, I committed to hold for at least five years. I made that commitment because, with two very speculative investments, I recognize that this is likely to be a volatile journey and I want to make sure I have given my thesis enough time to play out. However, because this is speculative, I recognize that the value of cryptocurrencies could plummet to zero. Accordingly, I only invested a small amount. And while my thesis may seem to be playing out, I won’t even consider adding more as prices rise. Since cryptocurrencies have no intrinsic value, the risk is simply too disproportionate to me.
If you like the promise of cryptocurrency but don’t want the big risk, there are other ways to invest in the trend. In particular, stocks benefit from blockchain technology. This allows you to buy shares in real businesses that generate real revenues from cryptocurrencies, rather than speculating on things beyond your control.