Last updated on June 9th, 2018 at 12:43 pm
You don’t have to have been monitoring cryptocurrency developments for more than a few months to have seen the same pattern play out with Bitcoin half a dozen times. A new all-time high is reached, the price creeps up higher, then it falls back at a rate that would be considered catastrophic with traditional investments.
As the insane growth in Bitcoin’s value continues, these peaks and rollbacks are becoming evermore dramatic. Just take a look at the milestones and rollbacks that Bitcoin’s US dollar value went through last week. On Sunday November 26, Bitcoin exceeded $9000 for the first ever time. On Tuesday November 28, it broke $10,000. By Wednesday, it had hit above $11,500. On Thursday, it dropped back to almost $9,500 – a loss of more than 17%. As I write this a week on from the $9000 all-time high, Bitcoin is sitting at a new all-time high of $11,800. At the press time Bitcoin is trading at $11,150 level.
It’s clear from this that it’s impossible to know with any certainty what Bitcoin is really worth. In any other market, a 17% drop would trigger panic-selling and a complete collapse in confidence. To put that figure in perspective, Black Monday in 1987 triggered one of the greatest stock market crises in history. The stock market’s value fell 22% in three days and people thought the sky was caving in. If the value of Bitcoin fell 22% tomorrow, it would be considered a minor blip that would be forgotten about a week later.
As the mania and hype of speculation around cryptocurrency gathers pace, it’s tempting to think of this new asset class as being completely immune to the economic maxims that govern other investments. And while it’s true that the speed and volatility of cryptocurrency markets far outstrips any other form of investment, conventional wisdom can still be applied.
Investing in Undervalued Assets
The gulf in opinions on Bitcoin’s true value is enormous. For every economic expert proclaiming Bitcoin a bubble built on nothing but hype, there’s a true believer who sees a revolutionary new technology that is still massively underpriced.
Because cryptocurrency is so new, it’s impossible to know with any certainty which of these groups will eventually be proven correct. However, there are many projects within the cryptocurrency sphere which appear relatively undervalued.
In the stock market, a company is said to be undervalued if its market capitalization is less than the value of its assets. In theory, this is relatively simple to work out. All publicly traded companies are required to publish in-depth financial reports each year. If these reports show that the company’s profit-generating capabilities exceed its market cap, then the company is probably undervalued.
A good practical example of this theory is the fall in BP’s share price following the July 2010 Deepwater Horizon oil spill in the Gulf of Mexico. This catastrophic event was both an environmental and public relations disaster. BP’s share price halved immediately following the oil spill, plummeting from approximately $60 to $30 in a single day. The price has never since surpassed the pre-oil spill highs and BP has suffered seemingly permanent reputational damage, but the market reaction to the oil spill represented a fantastic opportunity for savvy investors.
Despite the reputational hit and the eventual tens of billions BP were forced to pay in fines, its share price a day after the oil spill was massively undervalued. BP was still a global energy giant with a huge amount of infrastructure and profit-generating capabilities. If you’d bought at the bottom of the dip, your $30 BP shares would’ve been worth almost $49 by March 2011. 61% price appreciation over eight months might seem meagre by cryptocurrency’s otherworldly standards, but for most forms of investment, that’s an insane return.
Finding Undervalued Assets in the Cryptocurrency Marketplace
Sifting through the plethora of alt-coins and tokens now available on cryptocurrency exchanges can make playing the stock market look like a breeze. While publicly traded companies issue detailed annual accounts, most cryptocurrencies are backed only by a white paper outlining bold and unproven strategies for future growth. However, the rewards for taking a chance on an undervalued crypto asset can be enormous.
Bitcoin will likely hit $12,000 before 2017 ends and could in all probability climb even higher, marking a roughly 1200% appreciation in value over the course of the year. But there are other players within the cryptocurrency market who’ve experienced even greater growth.
Ethereum is the most prominent, beginning the year at $8 and recently hitting an all-time high just shy of $520, meaning an almost 6500% increase in value.
Neo began 2017 valued at less than 15 cents. In August, its value surpassed $48 – a 32,000% rise. Ripple began the year trading at a fraction of a cent – $0.006396, to be precise. It’s all-time high of a little less than 37 cents in May represents growth of almost 57,700%.
Sorting the Undervalued from the Completely Worthless
Undervalued doesn’t mean ‘cheap’. In fact, the value of a single unit of a cryptocurrency is an almost completely meaningless figure.
Think of the way different fiat currencies are denominated. Ten US dollars is worth roughly the same as a thousand Japanese Yen, which is worth about 10,000 Korean Won.
There are about 16.7 million Bitcoin currently in existence, with a maximum of 21 million that can ever be mined. While the supply of Bitcoin will increase until it hits that 21 million limit, other cryptocurrencies work on the exact opposite principle. Ripple was launched with 100 billion XRP already in existence. Every transaction conducted using Ripple destroys a little XRP and reduces the supply. The relative US dollar value of one unit of BTC and XRP is therefore a completely meaningless metric for comparing the two.
Imagine that Company A’s share price is $100 and Company B’s share price is $10. Its tempting to think Company A is by far the more valuable of the two, but now throw in the consideration that each of Company A’s shares represent 10% of the whole company while Company B’s shares represent 0.01%. Company A therefore has a market capitalization of $1000 while Company B’s market capitalization is $1 million.
Market capitalization is the main metric for determining the worth of a cryptocurrency. A single unit of Dash is currently valued at just over $789 compared to roughly $0.26 for Ripple’s XRP, but Dash has a market cap of around $6 billion while Ripple’s market cap is over $10 billion.
The surest metric of finding an undervalued cryptocurrency is therefore finding a cryptocurrency with an overly low market cap.
As already mentioned, this is difficult in an emerging area where the biggest bargains are those with potentially revolutionary ideas that have yet to establish themselves. This is where hype comes in – projects like Ethereum and Neo generated a lot of buzz before their value went stratospheric. If you find a buzzworthy coin with a $5 million market cap, there’s a chance that coin might be about to go supernova.
A Final Word of Warning
Investing in something that’s as unproven long-term as cryptocurrency is inherently risky. Investing in emerging coins with no track record is potentially far riskier than investing in the volatile established names like Bitcoin.
The less investors backing a coin, the easier it is for its price and market cap to be manipulated. While cryptocurrency exchanges are beginning to make efforts to stamp out pump and dump schemes that send the value and market cap of worthless alt-coins skyrocketing, there are still scores of coins which see a 500% jump in their valuation one day and become completely worthless the next.
At the same time, legitimate projects which are just getting started are far more vulnerable to ‘fear and doubt’ (FUD) campaigns, where alarmist and often groundless articles appear online throwing doubt on the project and suppressing its value.
The truth is that absolutely nothing in the world of cryptocurrency is certain. However, if you’re kicking yourself for missing out on the meteoric rise of Bitcoin and other established cryptocurrencies, you can take solace in the fact that are still a lot more moonshot projects waiting to be explode within the wild and unpredictable cryptocurrency marketplace.