Exploring Cryptocurrencies: The History, the Hype, and the Future

Abstract

We attempt to explain cryptocurrencies, their evolution and variety, and their potential place in portfolios. For many, cryptocurrency has become synonymous with Bitcoin, but there is a great variety of cryptocurrencies, all unified by distributed ledger technology—typically blockchain—whose mechanism, theoretical strengths, and practical weaknesses we describe. We also explore where blockchain can have applications beyond cryptocurrencies. In our view, cryptocurrencies are not intended to function only as private digital currencies. We explore them as investable assets that may be fit into portfolios, and evaluate several attempts at valuing them. We also analyze the correlation of cryptos with other asset classes, concluding that their severe drawdowns make cryptos far riskier than equities, and observing that as their market capitalization increases, major cryptos are expected to behave more in line with traditional risk assets. We distinguish cryptocurrencies from the technology that enables them and highlight the potentially transformative implications of so-called atomic settlement (the simultaneous, instantaneous transfer of assets) and how it may translate to assets more generally. Cryptos’ uncertain and rapidly evolving future includes the likelihood of central bank digital currencies (CBDCs) issued by central banks as legal tender. We conclude by discussing exposure methods to cryptocurrencies and (in our view) their highly promising blockchain technology, from direct ownership to broader market approaches.