Investing in blockchain technology is associated with massive profit opportunities. It's not unusual to read about gains in excess of 1,000,000% over a period of just a few years. However, like most highly profitable investment classes (and new technologies in general), the blockchain sector is also associated with serious risks.
But you need not be put off by this. As the industry becomes more established, knowledge, understanding, and acceptance of the technology are improving, and it's getting easier to build a digital asset portfolio with a balanced risk profile.
So is investing in blockchain suitable for you? That depends on your goals and risk tolerance. If you're interested in learning how to invest in this fascinating industry, this article will cover some of the basics you need to know to become an informed blockchain investor.
Types of Blockchain-Based Assets
The first-ever blockchain asset was Bitcoin (BTC), a digital currency designed as a decentralized alternative to central bank-issued currencies like the Dollar or Euro. Since Bitcoin was first developed in 2011, many other cryptocurrencies have emerged, seeking to serve various market niches.
Following is an overview of the main types of cryptocurrencies. Of course, a digital asset may fit into more than one of the categories, but these categories can still give you an overview of the different needs blockchain-based assets aim to fill.
Store of Value
A store of value is an asset that investors trust to preserve their wealth over time. The most famous of these is gold. Some cryptocurrencies are viewed in the same manner as gold, especially in countries that face monetary instability.
Bitcoin is generally viewed as the premier “store of value” coin. Because of its strong track record of functionality, simple but robust code, and the large network supporting it, Bitcoin investing is viewed as a savings account by many investors.
Bitcoin is very transparent because all transaction details are publicly visible. It can be used to a large extent anonymously, because transactions are not directly linked to the users' personal data. However, it is easy to track how many Bitcoin are stored on which Bitcoin wallet addresses. A number of “privacy coins” seek to fill this gap.
These digital currencies have additional features that protect users' personal data and compete to offer the best technology for protecting users' information. The most well-known privacy coins are Monero (XMR), Dash (DASH), and Zcoin (ZEC), with dozens of smaller digital assets also trying to capture market share. Because many cryptocurrency enthusiasts are also interested in privacy, the demand for these digital assets, and their value, can be expected to rise over time.
Mediums of Exchange
The intention behind the creation of Bitcoin was to use it as a medium of exchange to replace fiat currencies. Bitcoin's high level of decentralization is designed to protect against government manipulation, but it also comes with fees. As Bitcoin gained popularity, these fees increased, and it became unrealistic to do things like buying a cup of coffee with Bitcoin.
More recently, many cryptocurrency advocates are pushing for second-layer solutions like the Lightning Network to solve this problem, but in the meantime, a number of other currencies moved to fill the gap. Most notable among these are Ripple (XRP) and Stellar (XLM).
Ripple and Stellar seek to provide extremely fast and cheap networks for the transfer of value. In other words, these networks specialize in providing a medium of exchange. In particular, they seek to work with major financial institutions by providing software tailored to the needs of that sector.
Decentralized Application Platforms
One of the significant advantages of digital currencies is that they are programmable. This means that many transactions can be automated utilizing smart contracts. Smart contracts are basically programs that are stored on the blockchain and executed when certain conditions are met.
They make it possible to improve efficiency and eliminate a lot of paperwork, which can translate to major productivity gains in many economic sectors. A decentralized application platform is a kind of blockchain network that is specially designed to run smart contracts.
The most well-known network of this kind is Ethereum. Ethereum's exploration of this concept was so successful that many other networks followed suit. Some of the most notable among these are Cardano, Polkadot, and EOS, among many others.
These networks try to offer the best possible environment for developing and deploying smart contracts and decentralized applications. Each network has a native currency used to pay for the use of the network, so the more successful the network is, the more valuable the currency is likely to become.
Stablecoins are cryptocurrencies whose value is pegged to another asset, for example fiat currencies or precious metals. They enable the quick exchange of a crypto asset into a traditional asset without having to leave the respective platform. The most widespread stablecoin is the Tether (USDT), but some major cryptocurrency companies like Coinbase (COIN) and Binance also issue stablecoins.
Security tokens are similar to traditional stocks or ETFs in that they represent ownership in real assets. The main difference is that they are stored and transferred on a blockchain rather than via brokerages. When it comes to security tokens, they are usually only as good as the legal guarantees linking them to the real asset, so it's important to do your due diligence before investing in them.
Utility token is a term usually used to describe some software that requires a digital currency or token to use it. Examples of utility tokens include Golem (GLM), a distributed computing network, and Filecoin (FIL), a decentralized data storage network.
Like Bitcoin or Ethereum, the idea here is that demand for the services provided by the network will support the value of its native currency. Utility tokens are usually tokens with a more narrow application than a general currency.
Valuing Traditional Assets vs Blockchain Assets
Valuing digital or blockchain-based assets is very different from valuing traditional stocks. With conventional stocks, you might look at factors like:
- Price to Earnings ratio
Digital assets are sometimes developed and supported by private companies, but generally, they are decentralized and autonomous. Some of the factors to look for when valuing a digital asset include:
- Active users
- Quality and quantity of developers
- The market value of solving the problem the asset aims to solve
- The software ecosystem surrounding a digital asset
Let's take a deeper look into each of these points.
There are several ways of measuring how many people are using a digital asset. One is to look at the transaction volume on a network. Another is to look at the number of active wallets. Trade volume on exchanges can also be a way to gauge the overall interest in an asset. It's important to be aware, though, that these indicators can be faked. This is more likely to happen with low market cap assets as part of pump-and-dump schemes.
Most digital assets are backed by software that is maintained and improved by software engineers. Some currencies are supported by open source contributors, while corporations and venture capitalists back others. Looking at the background of developers contributing to a network or project can be one indicator of whether it is a high quality, serious project. Some factors to look at might be the educational background of developers or if they worked on successful projects in the past.
What problem does it solve?
If you want to make a million dollars, solve a million problems. So the saying goes.
When evaluating a digital asset, consider what market its disrupting. Bitcoin, for example, challenges central banks and offers a solution to the problem of inflation – a huge problem. Ethereum promises to make business and government more transparent to cut down corruption and bureaucracy – also huge problems.
That's part of why the prices of Bitcoin and Ethereum are so high. If they succeed in solving these problems (and to some extent, they already are, especially in the case of Bitcoin), then the valuation of the currencies should be enormous because so many people might want to own them.
You also have to consider the competition. For every digital asset niche, there are multiple competitors trying to achieve dominance. Always consider what factors an asset has that make it likely to beat out the competition?
The Software Ecosystem
Digital assets do not stand alone. They require integration and software solutions so that people can use them and a wallet software. If you want to sell your asset, you could probably need to use the software of an online exchange. Part of Ethereum's popularity is that it includes an easy-to-use programming language to make the network easier to work with for developers.
A healthy software ecosystem makes it easier for users and developers to interact with and build on top of a blockchain, which is an indication that a blockchain is providing real value to users.
The Beginning of a Long Journey
As time goes on, digital assets are beginning to go more mainstream. Major financial institutions are starting to get more involved in the blockchain space and there is a growing perception that this technology is here to stay. However, we are still at a very early stage of development.
Valuation models for digital assets should continue to evolve, so this article is not an exhaustive guide but rather a first step on the road to understanding what a good blockchain investment looks like. Investing in blockchain profitably requires keeping up to date with developments and responding accordingly.
One of the positive developments in the space is the growing availability of trustworthy, easy to use solutions for investing in blockchain and holding digital assets. SMART VALOR is an excellent and secure place to start out on the exciting journey of investing in blockchain assets.