1) What drives the price of a given cryptoasset?
The simple answer is supply and demand. However, for every major cryptoasset the supply is fixed (or growing at a predetermined rate) so price is primarily a function of demand.
Demand for a specific cryptoasset is driven by the buyers’ use case, such as:
- A store of value – digital gold such as Bitcoin
- Ability to purchase a good or service – such as compute power on the Golem network or smart-contract execution on the Ethereum network
- Voting rights on the changes to that network – In many blockchain networks, coin holders can vote on new features and functionality
- Ability to earn fees – Augur, TenX and others pay fees to their token holders
- Ability to transact anonymously – certain cryptoassets like Monero and Zcash can be sent 100% anonymously
The crypto economy’s ability to serve users in these ways grows according to the laws of network effects. This attracts more users and drives up demand. As demand grows, prices of cryptoassets will rise.
2) What does blockchain technology enable that wasn’t possible before?
Blockchain technology is a fundamental computer science breakthrough that enables digital transactions with no intermediaries or trust required. This means that you can have truly open global networks where anybody can join and participate with no questions asked – and most importantly no central party to ask them. This allows the networks to grow quickly to global scale. Networks of this magnitude create tremendous value for their participants.
Blockchain technology also enables a new ownership & governance structure for these open global networks. They are not owned or controlled by a company or state, but are rather owned and controlled by network participants themselves. As a blockchain network grows, it does not enrich and empower the select few. Instead, the very users who drive the value of the network also own the network.
3) What are regulatory risks?
Protocols themselves cannot be regulated. However, governments can and will regulate flows of fiat money into crypto. This is already commonplace in China.
Some industry participants are leveraging the fact that the protocols themselves cannot be regulated in order to issue securities to finance their companies. These offerings violate SEC rules, and the SEC will likely crack down on this behavior. Not all token sales, AKA initial coin offerings, are securities offerings.
We have a post that dives deeper on this question here.
4) Why are there multiple cryptoassets? What is the difference between them?
You can think of cryptoassets as digital commodities. Oil is useful because it helps your car go from point A to point B. Corn is useful because your body needs food. The value of each of these commodities is a function of its utility (driven by chemical properties), supply, and demand.
Each cryptoasset also has a unique structure (the protocol) which defines its utility. Some of the different use cases and examples of cryptoassets that serve that use case are:
- Store of value (digital gold) – Bitcoin, Litecoin
- Smart contract infrastructure – Ethereum, Stratis, WAVES, Tezos
- Distributed computing/storage – Golem, Maidsafe, Siacoin, Storj, Filecoin
- Distributed oracles/prediction markets – Gnosis, Augur, Stox
- Confidential transactions – Zcash, Monero, DASH, PIVX
There are many more cryptoassets.
5) What is the difference between cryptoassets and cryptocurrencies?
It’s helpful to borrow the digital commodity analogy from the last question.
Oil and corn are both valuable because they provide some utility. You could theoretically trade X barrels of oil for Y bushels of corn. But this would inefficient, as the number of people who want to make this particular trade is low. Instead, society denominates transactions in a currency – US dollars, Euros, Yen, etc. People who have oil and want corn trade oil for dollars and dollars for corn.
The same is true of cryptoassets. Today, Bitcoin is the dominant cryptocurrency. Cryptoassets have a price that is frequently quoted in US dollars on websites like coinmarketcap.com but most cryptoassets are actually denominated in Bitcoin and the prices you see have been converted to US dollars.
We’ll publish a post soon that covers this issue in more depth.
6) What makes one cryptoasset a better investment than another?
Some of the metrics we look at are:
- Aggregate network value
- Number of nodes
- Capacity of the network (the specific way to measure this varies by network and what the utility of that network is)
- Geographic data
- Coin inflation structure
- Numbers and types of on chain transactions
Most of the metrics we look at are proprietary. We also weigh each cryptoasset against qualitative criteria such as:
- Does this use case benefit from the blockchain’s unique technical properties or would it be better on a centralized database?
- Is the cryptoasset necessary for the core protocol function?
- How is the governance mechanism designed?
- Who are the lead developers?
- What are the switching costs for users?
- How strong are the network effects?
- Will the value of the cryptoasset increase as the network grows?
7) What are the biggest risks when investing in cryptoassets?
For a given cryptoasset, the largest risks are volatility and adoption risk.
Volatility is self explanatory. This is easy to see by looking at historical prices of any cryptoasset.
Adoption risk is the risk that the protocol and network of a given cryptoasset fail to materialize as the protocol developers anticipated. This is analogous to the risk of investing in startup companies – most will fail.
The best way to mitigate against that risk is to diversify. Diversification is proven to be an effective way to reduce risk in all asset classes.
8) What are the security risks?
When you own a cryptoasset, what that really means is that you are the only one who knows the private key (password) which controls that cryptoasset. There is no private key reset function. If you lose your private key you can no longer access your cryptoassets.
There is no way to reverse a transaction. Therefore, if someone else obtains your private key, they can send all of your cryptoassets to themselves. You will not have any recourse.
The other major risk is exchange risk. Exchanges such as Coinbase, Poloniex, Bittrex, Bitfinex, and others store private keys. If an exchange is successfully attacked while you have funds there, your funds may be at risk. Multicoin’s security processes are designed to minimize the amount of time that cryptoassets are on exchanges. Multicoin’s cryptoasset are stored in cold storage the vast majority of the time. See below for details about cold storage.
From a security perspective, private keys are the cryptoassets.
There are 3 industry best practices to securely store your private keys: cold storage, multi-signature, and diverse backups. Multicoin employs these practices and many others.
Cold storage means that your keys are held on a device which is not connected to the internet. If strictly enforced, that means that an attacker would have to physically possess the device that holds the keys in order to steal them. This does not prevent you from transacting as you can still sign transactions offline and then broadcast the transaction from a different computer. The logistical process of implementing cold storage is arduous but highly secure.
Multisignature means that you need to use multiple keys to transact the cryptoassets. There are multiple ways to accomplish this. Some cryptoassets have this functionality built into the protocol. For others, you can encrypt the private key in a file which requires multiple passwords to unlock. The idea behind this is the same idea as having someone initiate a wire and someone else approve it.
Diverse backups means having backups on different type of storage media (hard drives, flash drives, SD cards, etc) in different locations. This mitigates the risk of your only flash drive getting corrupted or a vault getting flooded and you losing your private keys.