Since the introduction of Bitcoin in 2009, many investors have been intrigued with the world of cryptocurrency, yet a range of reasonable concerns have kept most away. A decade later, cryptocurrency has begun to move into the mainstream, with by many reports over 5,000 cryptocurrencies or tokens created. However, despite growing investor interest, many still struggle when evaluating digital assets, put off by the complexity of the space or previous negative sentiment associated with it.
To shed more light on the world of cryptocurrencies, FTSE Russell's Kristen Mierzwa, managing director of ETP strategy and business development, recently sat down with Doug Schwenk, chairman of Digital Asset Research (DAR). DAR provides comprehensive data and research in the digital asset space for institutional market participants and has collaborated with FTSE Russell since the 2019 launch of its FTSE Digital Asset Indicative Index Series and FTSE DAR Reference Prices. A glossary of terms follows the Q&A between Kristen and Doug:
How long have digital assets been around, specifically cryptocurrencies?
Digital assets have existed for quite a while in various forms. But the current cryptocurrency framework allowing investment in digital assets began when Bitcoin was introduced to the marketplace in 2009. Bitcoin employs a combination of cryptography and economic incentives to develop an alternative form of currency or store of value. This has solved a number of problems other types of digital assets have struggled with, including the adoption of a loyal user base of separate parties who could transact among each other with a greater level of transparency.
What makes a digital asset successful, like Bitcoin?
There are several factors that contribute to a digital asset’s success, like having a compelling use case or value, and an active group of developers to constantly improve the product—an area where some fall short. Another important factor is operating on a safe, secure network to govern transactions. With its innovative blockchain technology, Bitcoin enabled a group of people to use it with more confidence, because the means of confirming bitcoin transactions makes it hard for people to collude to manipulate the asset itself.
What am I investing in when I buy a cryptocurrency? Is it a medium of exchange like currency or a store of value more like gold, or something else?
Many times, “crypto,” “cryptocurrency” or “digital assets” are used interchangeably, but it’s important to use clear terms and differentiate assets based on their application or use case. Think of digital assets as the overall category. Within that, there are some assets that can be used as a medium of exchange: a way to facilitate the buying and selling of goods and services. These might be called cryptocurrencies. There are also assets that are used as a store of value, assets that facilitate “smart-contract” platforms, assets meant to be collectibles, and many more. And there are creative technologists working every day to bring new uses to the world.
Let’s take Bitcoin as an example. Originally it was often considered a currency. As the network grew and the value of bitcoin grew and values were largely uncorrelated to traditional assets, others began seeing it as a store of value. It has many parallels with gold: For many years, gold was used to transact. More efficient fiat currencies with cheaper storage and transaction costs pushed gold toward a store of value. Buying gold to preserve wealth is a common theme today.
Bitcoin has not established itself as a smart contracting platform or many of the uses cases that other crypto assets are tackling. Given its decentralized nature and other factors, the CFTC has called it a commodity, which is the same regulatory bucket for gold. This is not necessarily the case for other digital assets, some of which are securities.
To assist in organizing the digital asset space, DAR has classified the most widely followed into a comprehensive taxonomy.
With no listing exchange, how do I know the price of a digital asset is the true price?
Digital asset prices will vary wildly depending on the type of token, quality and integrity of the exchange and geographic location. Similar to traditional currencies, the prices for digital assets will vary across countries based on perceived value, local market conditions or demand. These variations highlight the importance of having a standardized and supported price, or “clean price.” A clean price is a price on sufficiently liquid digital assets, calculated from reliable data sources that have been objectively vetted to ensure that the reported trades represent economic trading between a real buyer and seller. We encourage investors to use exchanges that have passed rigorous vetting and are licensed to operate in jurisdictions where they transact.
Isn’t this risky? What’s to prevent my digital assets account from being hacked?
There is some risk because if hacked, digital assets could disappear and be hard to retrieve. But there are ways to protect yourself. If handling the custody yourself, you’ll want to understand your security risk tolerance and implement best practices to keep your account safe. Alternatively, within the last few years, reputable third-party custodians have emerged with verifiable security protocols and insurance coverage. Some of the exchanges also have a reserve fund or third-party insurance to cover theft while balances sit with them.
Isn’t Bitcoin only used for nefarious activities like money laundering?
While there has been some negative use of cryptocurrencies in the past, it has only been a minor aspect of the entire network. As the ecosystem matures, new tools have emerged and more transparency has enabled a crackdown on the illicit use of Bitcoin and similar cryptocurrencies. We’ve seen a dramatic shift in the use of cryptocurrencies over the last three to five years, partly due to emerging technology firms like Chainalysis who develop the ability to trace digital assets and understand if a particular cryptocurrency has previously been involved in nefarious activity. This increased level of scrutiny and infrastructure along with new more reputable entrants has given more credibility to the space.
How does the performance of digital assets correlate with more traditional asset classes?
While it is difficult to typecast digital assets as a single asset class, certain digital assets such as bitcoin have been considered by investors as often uncorrelated to the broad equity markets and as a potential portfolio diversifier.
In March of 2020, bitcoin behaved like other asset classes, which can be interpreted to mean it is a risk on asset rather than being a store of value / safe haven asset. Bitcoin, like many asset classes, performed well post-March. However, given the periodic Bitcoin halving (a process to help cap inflation) in May 2020, the asset recovered quickly and without the help of a central bank stepping in, which is how other assets classes benefited and recovered as well.
Cryptocurrency and digital assets are an evolving market that can be susceptible to manipulation. For this reason, FTSE Russell has partnered with DAR to deliver clean prices for digital assets, provide scrutiny that allows investors to make suitable decisions, and serve as a catalyst for a more mature marketplace. For more information on FTSE Russell Digital asset data, visit us at ftserussell.com/digitalasset.
Digital Asset Explainer:
- Cryptocurrency – A decentralized digital asset secured by cryptography functions. Usually meant to indicate assets that are used as a medium of exchange.
- Blockchain – A continually growing distributed database or ledger where all past transactions are recorded chronologically.
- Cryptography – Technology underpinning the blockchain network that enables secure, encrypted data and messages. Along with other innovations, used to facilitate security on these networks.
- Digital Assets– An emerging asset class that combines cryptography, economic incentives and computer science to enable decentralized transfers of value (e.g., Bitcoin, Ether [Ethereum], etc.).
- Tokens– A unit of blockchain value.
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