Crypto Speculation and Rational Investing – Trustnodes

Crypto Speculation and Rational Investing


We often hear bankers and politicians state crypto is speculation or in a bubble, with many of them stating there is no way of evaluating a given crypto because they have no inherent value, but is that necessarily true?

Value, although sometimes subjective, is often based on utility. Bread feeds you, a nice bed gives you a good rest. A diamond ring gives you some prestige.

For money, its value comes primarily from its function of operating as a means of exchange. Money in itself is of course worth nothing. You can’t eat paper. But money as a means of exchange is extremely valuable.

It’s primarily from that function as a means of exchange that money derives its store of value and unit of account. The more widely it can be converted for goods, then the more valuable it should be, because the more demand it would have.

The dollar, for example, or the pound, is far more valuable than the Rupee. The main reason for the dollar is because its economy is far bigger, thus it can be accepted for far more goods, as well as it being used internationally. While for the pound it is a legacy of the British empire, which makes the pound widely accepted across the world.

What of digital currencies? As with any evaluation, it is a very inexact science, with unpredictable parameters, but it isn’t so inexact that one would call it outright gambling because there are factors which might have some predictive quality.

One such factor is Metcalfe’s law of network effects. Which is why many pay close attention to transaction numbers. Such numbers can be faked, but since that would apply to all chains, that factor might cancel itself out.

A plain readings of these numbers is ethereum handling some four times to five times more transactions than bitcoin. But that might be slightly misleading because bitcoin has more demand for transactions than it can serve, while ethereum can accommodate all of it, to some extent.

A better estimate, therefore, might be the amount of transactions per second they are processing. To gain an average of it for ethereum is easy, standing at around 11 tx/s based on one million transactions a day.

An average for bitcoin is more difficult as it requires constantly keeping track of how many transactions it is processing at any given second, then averaging it out. You could of course see what it is processing at this point (13 tx/s), but the very point you look at might be either the peak or during a very quiet time.

That’s just one factor. Another factor to consider is the size of the ecosystem or of the economy for any given crypto. One easy way to do so for ethereum is to see the number of tokens built on top of it (around 300), then estimate the number of companies working on eth, while also trying to keep track of how they are growing.

Since one is trying to price in the unpredictable future, you’d also have to guess how the above factors might grow in the near or long term.

One way to do so is to use a “hunch.” Another way is to use data. That data will necessarily have to come from the past, which isn’t by default predictive of the future, but might be indicative and might give some sort of anchor.

You could thus see how ethereum has grown so far, how that has affected its evaluation, whether that rate of growth has increased, decreased, or has remained static for a given period, and so on.

The subjective part would then be to decide how much risk you want to take, which could decide how much you discount certain data. If, for example, ethereum has grown at a rate of say 1,000%, you might give it a very low 10% probability that it will continue doing so going forward, which means a doubling in price.

Since you don’t know for sure it would do so, you might be conservative and allocate only 20% of your portfolio, or if you are young and in your 20s-30s, you might take a bit more risk and go to 40%.

Then you evaluate your portfolio based on any news which might affect your estimated medium to long term trajectory of growth. If, for example, development in certain aspects seem to be going better than expected, or if some project goes viral, you might want to increase the share and vice versa.

The process for traditional stocks isn’t really much different where investing is concerned. Few buy a stock just to park their money, with most instead trying to estimate its rate of growth. That necessarily is an inexact science, but it isn’t just pure speculation because data can be analyzed to make a reasonable informed guess of how the company might perform and grow.

There are of course some who try and trade every single price movement, but usually they lose all their money because of what poker players call rake, the fees exchanges take.

As such constant trading is a zero sum game, the addition of fees makes it negative sum, which means in the long run they all lose except for exchanges.

A rational investor, therefore, has a more long term view. He might re-evaluate that view based on recent events, but primarily to see how it would affect his estimates. Some could try and time bottoms or tops, but they usually fail as they learn from first hand experience.

Valuing any given digital currency or token, therefore, isn’t impossible, within reasonable bounds. One can never be certain and as with anything of value there is an element of subjectivity, but by analyzing data, gaining a rough idea of probabilities of success, then discounting it heavily for risk, followed by deciding just how much risk you wish to take, some feet on the ground can be kept.


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