In the past few weeks, we have seen a boom of the cryptocurrency market, in which the market cap grew from $14bn at the end of 2016 to around $100bn this month. On the one hand, this is caused by the increased valuation of the dominant coins, such as Bitcoin, Ether, and Litecoin, on the other by the substantial influx of new currencies. However, not surprisingly, the crypto rally has been interrupted by a series of corrections as the fear of a bubble increases. Hence, we ask ourselves the question, to what extent is the current value of cryptocurrencies substantiated.
- Even though the value of Bitcoin has risen with 300% since the end of 2016, Bitcoin lost ground to other cryptocurrencies as its market dominance has dropped from 85% to 40%.
- Bitcoin still finds itself in an impasse regarding the scaling of its operations. In response, a group of developers has proposed a “User Activated Soft Fork” (UASF) as a way to force an update. This could result in much uncertainty, leading to increased price volatility and the possibility of competing cryptocurrencies (e.g. Ethereum or Litecoin) to gain dominance.
- This year’s first big cryptocurrency rally was presumably caused by the recognition of crypto as a legal method of payment by Japan’s government, which resulted in a large demand for crypto in Asia.
- For quite some time Ethereum, a blockchain-based distributed computing platform for smart contracts, had to deal with the backlash that followed the DAO incident. However, the last few weeks Ethereum regained market interest, in part due to the many ICOs (Initial Coin Offerings) that were organized on its platform. As a result, Ether increased its value with roughly 4000% year-to-date.
- Among the many ICOs that have taken place in the last few weeks, Bancor, a smart token platform, was particularly successful in its crowdfunding, receiving $153m.
- IOTA, a decentralized Internet of things platform, launched its IOT coin on the cryptocurrency exchange Bitfinex. High user demand resulted in IOT becoming the 8th largest cryptocurrency based on a market cap (at the time of writing $1bn).
It is difficult to give a confident estimation of the true value of each of these currencies as it remains to be seen how many of their promises, ranging from decentralized computing to prediction markets, can be successfully realized. Hence, estimations are currently based on a wide set of determinants such as proposed functionality (as can be read in white papers), feasibility of the project, status quo of the project, trust in the community of developers and miners, scalability, network-effects, and the rule set for token supply, but also external variables such as competing cryptocurrencies, sentiment in the entire crypto market, technological progress with regards to infrastructure and the global economy. For instance, when we look at Bitcoin and Ethereum based on these variables, we see that Ethereum scores strongly on community trust and future applications, whereas Bitcoin’s value is mostly derived from its current network effects and capped money supply (a maximum of $21m bitcoins will be produced). In contrast, both struggle with scaling issues due to the fact that distributed systems rely on the capacity on the edges of the network. Nevertheless, this problem is not unsurmountable since scaling is a moving target due to the continuous improvement of bandwidth, storage, and computing power.
“However, as the history of the Internet has also shown us, a potential upcoming correction of the crypto market should not necessarily be seen as a rejection of the underlying technology and its potential.”
In the early days of the Internet, many of the promises of Internet companies were not able to materialize in the short term, resulting in a historical correction. The cryptocurrency sphere might await a similar fate, where many of the ICOs turn out to be unrealistic within the given timeframe resulting in distrust in the entire market. However, as the history of the Internet has also shown us, a potential upcoming correction of the crypto market should not necessarily be seen as a rejection of the underlying technology and its potential.