What Is The Basis Of Value?

basis-of-money.png

Monday, 8.53pm

Sheffield, U.K.

A billion here, a billion there, and pretty soon you’re talking about real money. – Everett Dirksen

I’ve been reading Terry Pratchett’s “Making Money” one more time. It’s about the introduction of paper money to the city of Ankh-Morpork and how everyone responds and it has lessons for us when we try to think about what value really is and how we can hold on to it.

Last week the Financial Times had a piece on NFTs – non-fungible tokens and whether they had a place in your investment portfolio. An NFT, as you’re probably aware, is a way to create a token that represents a piece of digital art, an image, a song, a tweet. These tokens are unique and can be used to prove ownership and they’ve recently been changing hands at astronomical valuations. The very first tweet, for example, was sold for nearly $3 million. In Ether.

Which brings us to Ethereum and the idea of cryptocurrencies. NFTs are typically paid for using new digital currencies. $3 million was, at the time of the trade, equivalent to around 1630 ETH. Ethereum has surged in value in the last month or so – my paltry holding that I picked up as an experiment is up around ten times. Perhaps I should have bought more. Then again – why would I, what is the basis of believing that this thing has any value?

The story of how value is created is the story of “Making Money”. It goes something like this. Once upon a time people believed in gold and they made money that was backed by gold. If you held a paper note that meant you had a claim on gold from the bank that issued the note. You weren’t ever expected to go into the bank and demand to get the amount of gold that the note backed but in theory, if you wanted to, you could. This meant that the amount of money in circulation was tied to the amount of gold you had and this was a little inconvenient.

What people realised was that the gold wasn’t the important bit. What was important was the reputation of the people who backed the gold. Did you believe in the country, the government that issued the paper money? The US dollar is backed by the US government as is the British Pound. As long as you believe in those governments you believe that their money has worth. And if you stop believing in a government the value of its currency crashes too – as we’ve seen happen several times.

When it comes to digital currencies you have no equivalent of a government backer. These are distributed currencies created using algorithms. Part of their appeal is getting away from the control of governments and their ability to create new money as it suits them. Bitcoin, for example, was created as a sort of digital gold. It needs to be mined, the total amount that can be mined is, in theory, fixed and you might think that it would have the stabilising properties of a monetary system anchored to gold as a store of value.

But these are early days so the main thing that holds up the value of digital currencies is the belief that they have value to someone else. So the price keeps rising because people buy it hoping that the price will rise.

So, we should probably go back to the basis of valuations – why does something have value?

The first way to think about value is as the net present value of future cashflows. Something is worth the money it will make for you now and in the future. If you buy a share of a business you will be rewarded with earnings. And the net present value of those future earnings is the value you’re willing to pay.

Of course, those earnings are in money and you have to believe in the value of the money you are getting. A company that earns in dollars is probably worth more than one that earns in a less tradeable currency. Would you be happy owning a company that derives the majority of its revenue in Bitcoin? You might if you’re Elon Musk – Tesla will accept payment in Bitcoin for its cars now.

The short-term view is that cryptocurrencies are dangerous because no one backs them – there is no government that you can turn to and demand they show value. The long-term view might be that cryptocurrencies are backed by all of us. We can all mine them, have digital wallets and inspect the ledgers. It means that distributed currencies are backed by all those who choose to engage with them.

What history teaches us is that things change. I’m sceptical about most things and the majority of my investments are in safe, traditional businesses. There is a small chance, however, that all the safe, traditional stuff will be wiped out by the new at some point. The only rational thing to do is have some of the new stuff in your portfolio as well as a hedge against the inevitable changes that the future will bring.

Now, how do I make an NFT from my picture and sell it?

Cheers,

Karthik Suresh

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s