As explained in the previous parts (1,2) of this article, cryptocurrencies are not considered to be assets since they do not generate any cash flows and are not commodities in the traditional sense since they are not raw materials used to produce anything useful.
However, there are some digital currencies, like Ethereum, which take on characteristics of commodities due to their use in enabling smart contracts.
What’s Next for Digital Currencies?
While the first part of this article argued that Bitcoin and other digital currencies are currencies, they are not really acceptable ones yet, since they are too volatile to be used to store value and have only limited acceptance as a medium of exchange. Moving forward, there are three possible scenarios that could unfold for these digital currencies:
- A Global Medium of Exchange:
This is the best-case scenario, which would see cryptocurrency gaining universal acceptance all over the world and becoming a widely used medium of exchange. For this to occur, the cryptocurrency needs to stabilise (in relation to fiat currencies), governments and central banks should accept its use, and the shroud of mystery surrounding digital currencies must fade. If this scenario unfolds, then a cryptocurrency like Bitcoin will compete with traditional currencies, justifying its high price.
- Gold for the Millennial Generation:
In this case, cryptocurrencies could act as a safe haven for people who do not trust fiat currencies, governments or central banks. This scenario would see digital currencies take on the role that has been played by gold as a store of value for people who have no trust in centralised authority. Interestingly, the world of cryptocurrencies is filled with references to mining, so it is clear that the pioneers of these currencies seem to share this vision for their creations. Bitcoin’s fixed cap of 21 million coins would seem to fit in more with this case than the first scenario. If this scenario comes to pass, with currencies like Bitcoin showing the same staying power that gold does, then it should be expected to act as gold does; its price rising when there is a crisis and falling in sanguine times.
- The 21st Century Financial Bubble:
This is the worst-case scenario for the future of cryptocurrencies. In this case, the leading cryptocurrencies would be like shooting stars, drawing in more money from people who consider it a way to make quick and easy profits, with its price rising dramatically. However, they would quickly flare out when traders decide to move on to a new and different asset, with Bitcoin holders left with something worthless after putting in a lot of their money.
The Final Word
In the end, nobody can really invest in a cryptocurrency, they can only trade it. This is because they lack an essential ingredient that is necessary for any investment – an intrinsic value. In order to successfully trade cryptocurrencies, it is important to recognise that any price movements that you see have little or nothing to do with market fundamentals. These are movements that can be attributed to momentum and sentiment, with large price shifts possible due to incremental information. Also, check out our post on how cryptocurrency works in general.