Cryptocurrency Demystified

A Q&A with Prof. Christine Parlour

Cryptocurrency Demystified

The surge of bitcoin brought cryptocurrencies from tech-nerd toy to household name, and they’re increasingly showing up in investment portfolios. Yet it’s still a mystery to most people how these digital currencies work. Are they even currency? And do they belong in an everyday person’s portfolio?

BerkeleyHaas sought the wisdom of Prof. Christine Parlour, a leading scholar of financial markets and the banking system. In a recent working paper, she analyzed market pricing on 222 digital coins and examined the initial coin offering market, a new way for startup companies to raise capital. Parlour shared some of her thoughts on the burgeoning cryptocurrency market.

Q: What exactly are cryptocurrencies like bitcoin?

A: Essentially, they’re digital codes that give people the ability to consume and use services. As such, they can be traded, so they do have some sort of transfer-of-value characteristics. But despite the great alliterative mouth-feel of “cryptocurrency,” they’re not really currency. Perhaps a more accurate designation would be “cryptocoupons.”

Q: What can cryptocurrencies be used for?

A: Most cryptocurrencies have a use-value associated with a specific underlying commodity or service. For example, sometimes they’re used to compensate people who are providing some of their cloud storage capacity to other vendors. It’s pretty much anything that you can think of.

Q: How can someone turn cryptocurrency into conventional money?

A: There are many exchanges that allow you to convert cryptocurrencies to U.S. dollars or whatever currency you prefer.

Q: Are they a new asset class?

A: Inasmuch as you can convert any of these cryptocurrencies to fiat money and back again, you can view them as an asset class.

Q: Do they have any advantages as an addition to an investment portfolio?

A: They essentially add an element of diversification to the standard assets that most people have in their 401(k) plans. We know that the returns are pretty much driven by something that’s independent of the standard things we put in portfolios. A well-diversified portfolio should have a little bit of exposure to crypto.

Q: Wouldn’t it be reasonable for investors to be skittish, given the price volatility of these assets and their lack of regulation?

A: Absolutely. But we have a lot of attempts to start exchange-traded funds that track cryptos and these are under the usual regulatory umbrellas.

Q: Isn’t there a concern about buying at the top of the market or buying into a heavily speculative market?

A: Yes, but you can say the same thing about people who bought condominiums in San Francisco.

Q: How does an initial coin offering (ICO), which gives investors digital coins or tokens, differ from a standard initial public offering in which the investor gets stock in the issuing enterprise?

A: ICOs are fundamentally unregulated and the asset that’s issued doesn’t necessarily bear any resemblance to a security. If you’re a smaller investor, only buy a new coin after it has appeared on one of the crypto exchanges–or after the SEC moves forward with more oversight.