Some cryptocurrencies have experienced a surge in value (and interest) since the pandemic. However, there’s a long way to go before it becomes clear how to determine their fundamental value.

Even the Reserve Bank is talking about cryptocurrency, having announced late last year it is exploring the potential use and implications of a wholesale form of central bank digital currency.

This came as popular cryptocurrencies, like Bitcoin, experienced huge surges in value in 2020. This may have been spurred on by fears of a drop in the value of traditional currencies if inflation picks up and then the sheer force of momentum as more and more buyers jumped on the bandwagon.

Some of the figures related to cryptocurrency are stunning – both the gains and losses – and some investors have seen very good gains after buying in early on. However, there remain some fundamental risks and considerations:

Value: This is the thing which, in our view, remains a biting issue for cryptocurrency: it’s very hard to value. It’s not like shares, like copper, like cash – we still don’t wholly know what drives its value over a long period of time.

Income: Although some may claim otherwise with the use of a bit of fancy financial engineering, Bitcoin and other cryptocurrencies do not generate income directly. That also makes it hard to value them and adds to the potential for speculative booms and busts.

Supply: When taken together, the supply of cryptocurrencies is unlimited. This makes them less reliable than traditional paper money in advanced nations, where supply is managed.

Stability: We can be reasonably confident that the A$50 we carry in our wallet or purse today will roughly hold its value by the time we spend it. So far, the same can’t be said of some popular cryptocurrencies which go up with gusto but also come down sharply at times making it very hard to know what buying power they have.

That said, it’s clear digital currency does have a future, especially when you start to see central banks and major financial institutions taking an interest. However, it’s hard to know what form that will take.

As with everything related to markets, we think it remains important to turn down the noise, consider the investment fundamentals and make sure you fully understand what you are getting into before joining a growing investment crowd.

Source: Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist, AMP Capital