Cryptocurrency Valuation: Part II

In How to Value Cryptocurrency: The Equation of Exchange, we walked through the steps to valuing a currency based on its utility. Eat Sleep Crypto tries to be as straightforward as possible, but valuing cryptocurrency based on utility is a paradigm shift from the still-speculative market.

I may have overestimated the article’s clarity, but I passed it to my grandma, who’s very sharp and capable of understanding the subject. This was her actual response:

Nate

I sort of understand your article. But why is another valuation method needed? Isn’t the value what someone will pay? I.e. what the coin will purchase?

Love,

Grandma

Disclaimer: My grandma is more well-versed in politics, economics, and business than most people I’ve ever met. I hope my response is concise enough for all grandmas, but your mileage may vary.

Cryptocurrency Price Factors

Grandma,

You’re thinking of it correctly. The ‘valuation’ is a loose price floor created by demand for goods in that currency.

For example, say Ford wants to buy $1000 worth of parts from China. Chinese manufacturers demand payment in a new currency, the Gold Yuan.

If there is only $500 worth of Gold Yuan in circulation, Ford can’t pay. However, by buying Gold Yuan – assuming there is some outside demand for the currency, Ford raises the price of Gold Yuan until their holdings are valuable enough to pay the manufacturers.

The principle here is that the money supply of an economy must be valuable enough to support purchases in that economy. In the absence of market-makers, volatility may push the price under this price floor temporarily.

Speculators can push the price infinitely high, but as long as commercial transactions exist, there is a loose price floor waiting at the bottom.

Market Demand For Cryptocurrency

I sent the first email. I tend to realize what I left out after sending an email – a terrible habit, not unlike leaving the house without your keys – my other favorite. So I quickly sent the following:

As it relates to cryptocurrencies – online merchants demand them.

Some demand cryptocurrencies on principle, more demand them for privacy, and half the world demands crypto because they don’t have access to traditional finance.

I write about cryptocurrencies which are adopted for the latter two reasons. Eventually they will become the standard.

Thank you for sending the previously linked article, and thanks for asking these questions.

Conclusion

This is a lightly edited version of an actual exchange between my grandma and I. She’s sharp, but anyone understand cryptocurrency when it’s explained in common terms.

Fostering understanding is Eat Sleep Crypto’s mission. We detest the deviations from utility-based investing principles. Speculation delays adoption and doesn’t work. The sooner the market gets on board, the quicker cryptocurrencies will be adopted by the world – particularly by those with no alternatives.

We write about valuing cryptocurrencies using each cryptocurrency’s utility a medium of exchange to mirror Warren Buffett and Benjamin Graham’s style of value investing, and have created several articles on individual cryptocurrencies with this lens.