Cryptocurrency is a digital form of currency that uses cryptography for security purposes. It is decentralized and generally operates on a technology called blockchain, which is a distributed ledger that records all transactions across a network of computers.
Value is specific to a point in time
The valuation principle that states – value is specific to a point in time – is particularly relevant when considering the value of cryptocurrency. The value of digital assets fluctuates significantly based on a variety of factors including, but not limited to; market demand, regulatory changes, and media attention. For instance, between 2017 and 2018, the price of Bitcoin soared to almost $20,000 before crashing back to $3,000.
It is crucial for investors in cryptocurrency to keep track of market trends and stay informed about developments that could affect the value of their digital assets. Because cryptocurrency is so volatile, and valuations are made at a specific point in time, investors must be prepared to navigate the often volatile crypto market to make informed investment decisions.
Why are cryptocurrencies known for their high volatility?
- Lack of Regulation: Cryptocurrencies are not regulated by governments or financial institutions. There is no central authority that controls their supply or demand. Lack of regulation can result in significant fluctuations.
- Limited Adoption: Although the adoption of cryptocurrencies is growing, they are still relatively new and have not yet achieved widespread endorsement. As a result, the cryptocurrency market is relatively small and can be easily impacted or influenced by large trades or market manipulation.
- Speculation: Many people invest in cryptocurrencies with the hope of making quick profits. This can become a self-fulfilling prophecy, followed by a sharp return to reality. For example, say a number of individuals read an article on a less-than-credible information-sharing website about investment tips. They all seek out the opportunity, temporarily creating a false spike, only to see it crash again when the hope fades.
- Technical Factors: The underlying technology that powers cryptocurrencies, known as blockchain, is complex and can be difficult to understand. This can make it challenging for investors to make informed decisions based on fundamental technical analysis.
- The Fall of FTX and the Principle of Valuation is Specific to a Point in Time
The relevance of this principle to the collapse of FTX, a popular cryptocurrency exchange, is that the value of FTX was specific to a point in time. The external, yet mitigating, conditions that existed at that time contributed to its collapse. FTX, like many other cryptocurrency exchanges, was subject to a number of factors that affected its value and viability as a business, including regulatory challenges, market competition, and security concerns.In May 2021, FTX experienced a significant drop in trading volume due to regulatory crackdowns on cryptocurrency exchanges in China. This decline in trading volume was accompanied by a sharp drop in the value of FTX’s native token, FTT, which lost over 50% of its value in a matter of days. This drop in value ultimately contributed to the collapse of FTX, as the company was unable to maintain its operations in the face of declining revenue and mounting regulatory pressure.
The collapse of FTX illustrates the reality of value being specific to a point in time and demonstrates the risks associated with investing in cryptocurrency exchanges and other digital assets.
Cryptocurrencies have in recent years garnered a lot of attention and “fad like” popularity due to their ability to disrupt traditional financial systems and offer alternative possibilities. However, it is worth noting that the cryptocurrency market has demonstrated that it is highly speculative and extremely volatile. Investors should be forewarned, exercise caution, and conduct thorough research before participating in cryptocurrency transactions and investments.
Author: Ian Lobo, Principal, Valuations