Explain what digital assets are and their features as investments
The idea
Digital assets include cryptocurrencies intended as a medium of exchange or store of value, tokens representing a claim on a project or service, and stablecoins pegged to a currency or asset. Most have no cash flows, so conventional discounted cash flow valuation does not apply and prices rest on adoption, scarcity rules and sentiment. Volatility is high, custody introduces a failure mode traditional assets do not have, and regulatory treatment differs across jurisdictions and continues to change. Correlation with equities has proved higher in stress than early advocates expected.
A practice question
Why does conventional discounted cash flow valuation not apply to most cryptocurrencies?
- Because the discount rate cannot be observedWhy not: Discount rates are estimated for every asset; here there is nothing to discount in the first place.
- Because they generate no cash flows to discount — correct
- Because their price history is too shortWhy not: History bears on estimating risk, not on whether a cash flow exists to value.
A discounted cash flow model needs cash flows. Without them, value rests on adoption and scarcity rather than on a stream that can be projected.
A harder one
What is a stablecoin?
- A cryptocurrency whose supply is fixed permanentlyWhy not: A fixed supply describes assets such as bitcoin, whose price is anything but stable.
- A token granting voting rights over a protocolWhy not: That is a governance token, which confers influence rather than a price peg.
- A digital asset designed to maintain a fixed value against a currency or asset — correct
The peg is maintained by reserves or by an algorithm, and the quality of that backing is precisely what an investor must examine, since a failed peg is the characteristic risk.
The hardest tier
Why is custody a distinctive risk for digital assets compared with listed securities?
- Control depends on private keys, and their loss is final — correct
- Because digital assets cannot be held by a third partyWhy not: Custodians exist and are widely used; the risk is what happens to the keys, whoever holds them.
- Because settlement takes longer than for equitiesWhy not: On-chain settlement is often faster, and speed is not what makes custody distinctive.
There is no registrar to restore ownership once a key is lost or stolen. A share register can reissue a lost holding, but a digital asset's ownership is the key itself, so operational failure is terminal rather than recoverable.
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