Investment options and valuation models for crypto assets

The key CFA institute released a report entitled “Cryptoassets, Guide to Bitcoin, Blockchain and Cryptocurrency for Investment Professionals,” which highlighted the interest of institutional investing and the needs of the market for investing. The purpose of this document is to explain how to create a basic guide. So explain what they are and what they are not so that there is a better understanding for those who want to invest in crypto assets (have positions). While they point out that the crypto-asset and blockchain market will persist and generate a lot of euphoria, there are also significant challenges for investors as they approach the market.

The first thing they mention is that the quality of the information is poor and that basic data like commercialization volume is difficult to come by. They also show that price theory models have not been tested and are often “poorly” designed, underscoring the need for professionally managed portfolios.

Likewise, lack of knowledge is important as many people still don’t really understand what crypto is or why it is important and ask questions like: Is it an alternate currency? A technology? A venture capital investment? A speculative bubble? In this way, there are two visions: for fintech executives and central bankers, the crypto ecosystem poses a threat to their own industry, and on the other hand, professional investors can enjoy the attractive returns and low correlations of crypto assets, such as Bitcoin, with other assets.

Investment options and valuation models for crypto assets
Investment options and valuation models for crypto assets

The first part looks at the basics of Bitcoin, how crypto assets work and what they mean. The real problem that Bitcoin solves is why a single distributed database is required and how transactions with Bitcoin work.

In a next section, Bitcoin as a novel economic phenomenon and the impact of this protocol on the world are analyzed. With that in mind, they broadly define three areas in which they believe that some properties of Bitcoin will have an impact on the world:

  • Fast, inexpensive processing around the clock.
  • The creation of scarcity and property rights in the digital world.
  • Smart contracts.

An interesting aspect of this document, is the analysis of the use of crypto as an investment opportunity and the valuation of crypto assets.

The analysis shows that valuing crypto assets is one of the most complex and challenging aspects. With that in mind, they take a critical look at the five most widely used cryptoasset valuation techniques and conclude with a suggestion on how the problem could be fully addressed.

The first approach looks at the entire bitcon in the market, i.e. the degree of scarcity. They state that if this were comparable to gold, the value of Bitcoin would likely be around $ 620,000 (at full dilution); That said, if Bitcoin conquered 10% of the gold market, each Bitcoin would be worth around $ 62,000. and so on. The second approach takes up the much discussed alternative valuation model proposed by Chris Burniske, the monetary exchange equation that determines its calculation:


Where M is the market capitalization of crypto assets; V is the average rate at which one unit of the crypto-asset is issued; P is the average price of the transactions carried out in the examined period and Q is the number of transactions carried out in the examined period. This equation takes traditional currency value models and is based on the assumption that the value of a currency is related to the size of the market it supports and the speed at which it moves through that market. What is striking is that based on Federal Reserve data, the speed of crypto assets is faster than the speed of zero maturity money (MZM), so a small change leads to large valuation changes.

A third approach is based on a theory that takes technology into account and says that the value of a network is proportional to the square of the number of participants. This rating was first proposed by Ken Alabi using the number of active daily users joining the network. Though it highlights cons such as the relative ratings between crypto assets or the proxy for current ratings based on historical analogues. Another potential downside is that each participant receives the same weight, which is less true in financial situations than in ad-based social media.

Form 4 of assessment is based on the cost of production proposed by Hayes in 2015, which claims that, like any commodity, it is subject to traditional supply-side price challenges. Hayes and others suggest that if one views bitcoin as a commodity, and according to traditional microeconomic theory, the cost of producing any marginal bitcoin should be in line with the price of that bitcoin. However, this valuation has some drawbacks as it is circular in its rationale, as the decision of miners to enter or exit the market depends on the price of the crypto-assets. The use of two necessarily cointegrated variables to evaluate each other has very little predictive or explanatory power. Although production costs in the past have roughly matched the prices of some crypto assets, the cause-effect relationship is unclear and its predictive value for the future is highly questionable.

Finally, a fifth valuation model is Stock-to-Flow (S2F), published by user PlanB, which states that the price of Bitcoin is a reflection of its scarcity and that scarcity can be measured by the relationship between action and Flow: The Relationship between the existing bitcoin value and the amount of new bitcoin produced each year. The downside they find in this proposal is the following seems to confuse correlation with causality. While one of Bitcoin’s strengths is its tightly limited supply, the assumption that this is the only factor that determines price is an excess. It is emphasized that this is too convenient for “cryptocurrencies” as the ratio of stocks to bitcoin flow increases programmatically over time and therefore “predicts” a steadily increasing price for the asset in this model. Given the programmatic nature of the model, many have suggested that the market should be valued (if only modestly efficient) taking into account the implications of Bitcoin’s future S2F ratio in order to take advantage of its future value today. Although much debated in some crypto circles, the relationship between stocks and flows is not seriously considered by academic researchers.

The final sections of the document deal with the role of the investor in an institutional portfolio. This is important as there have been various corporate investments in Bitcoin over the past few months. This part covers aspects such as:

  • Features in Bitcoin’s Historical Performance
  • The performance characteristics of crypto assets
  • The Impact of Crypto Assets on a Diversified Portfolio
  • The future of crypto asset returns

The document addresses important investor considerations and risks such as custody, taxation and regulation. With that in mind, it addresses the potential risk of a user managing their own passwords. In this way, they recommend that on a business level, retention by professional third parties like Anchorage, BitGo, or Fidelity is the most convenient.

Finally, it describes various ways that investors can invest in crypto assets. There are six investment approaches:

  • Brokerage apps
  • Private funds
  • Listed stocks
  • Direct holdings at the custodian bank
  • CME futures
  • Venture capital funds

Each of the above points out the companies that provide these services and, in some cases, the commissions they charge, plus advantages and disadvantages.

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