Crypto’s Value Comes From Crypto’s Volatility

One of the most difficult challenges in finance is how to price crypto assets. Bonds pay interest. Stocks pay dividends. What exactly do crypto assets pay? Well, other people value them too, but what does that depend upon? How can crypto valuations be connected to something real?

The executive summary of my current thinking goes something like this: The value of crypto assets comes from a few core uses — plus, and this is crucial, how much investors value the volatility of crypto assets. It is this latter feature which explains much of the day-to-day price shifts of crypto.

Start with the core uses. Some of these are already established, others are more speculative. One well-founded core use is that you can use crypto assets to pay off your blackmailer or data thief. (Crypto proponents hate this example, but when it comes to a core use, it is the closest thing crypto has to a “sure thing.”) Whether this is socially desirable is another matter, but it is privately beneficial to hold some crypto in order to pay ransoms.

Other core uses could involve crypto assets as “digital gold,” crypto assets in gaming environments, crypto assets in the metaverse, crypto assets as a means of paying off “smart contracts,” and crypto assets as underpinning decentralized finance, or DeFi. These uses vary in their degree of acceptance and their likelihood of success, but all of them are possibilities.

Crypto prices are in part a moving bet on how much the demand for crypto will increase to satisfy these varied uses. For my purposes it suffices that some core demands exist, and so the value of more useful crypto assets will not fall to zero. What I am most interested in is which forces might operate on top of these relatively well-understood factors.