Given last year’s annus horribilis for the digital asset sector, many investors would be forgiven for writing off cryptocurrencies altogether. But the fear of missing out is an underestimated human driver.

In the first half of 2023, Bitcoin and other major cryptocurrencies kicked off the year with a strong performance. But with rising borrowing costs and a slowdown in the global economy have since dampened appetite for the speculative asset.

Continued Regulatory Uncertainty

In July, a decision by the US District Court for the Southern District of New York ruled the XRP token sold by Ripple Labs in secondary markets was not a security, which led to a short-lived bump in cryptocurrency prices.

Many legal observers noted serious flaws in the Ripple Labs decision. Especially in the District Court’s flawed application of the famed Howey test for securities, established by the US Supreme Court.

The US Securities and Exchange Commission (SEC) has announced it intends to appeal the Ripple Labs decision, possibly bringing all token issuances within the ambit of the regulatory agency’s oversight.

Cryptocurrency enthusiasts, eager for the SEC to approve a long-awaited spot-based Bitcoin Exchange-Traded Fund (ETF), also had their hopes dashed when the regulator recently announced a delay in considering all applications. Payment processing giant PayPal announced it would be issuing a stablecoin, only to “pause” the initiative just a week later.

Against this backdrop of continued regulatory uncertainty, investors, both retail and institutional, are understandably standing on the sidelines when it comes to cryptocurrencies and the sector has not seen meaningful inflows.

Yet as investments go, Bitcoin and some other cryptocurrencies, including ether, have had an incredible run this year, with Bitcoin gaining some 75 per cent and Ether up some 55 per cent. And even with the recent pullback in cryptocurrency prices, it seems the human penchant for speculation on a technology simultaneously overhyped and underdeveloped, shows no signs of waning.

Central banks globally have yet to stop exploring the prospect of issuing their own digital currencies, commonly known as “central bank digital currencies” or CBDCs. BlackRock, one of the biggest asset managers globally, has thrown its hat into the ring and applied to list a spot Bitcoin ETF in the US. Meanwhile, Europe saw its first spot Bitcoin ETF listed on the Amsterdam stock exchange.

These activities come against a backdrop of regulatory enforcement actions against some of the biggest names in the digital asset industry. That includes action by the SEC against Binance and Coinbase, two of the world’s largest exchanges.

If financial institutions are skittish about participating in a sector so rife with regulatory challenges, their actions don’t seem to be reflecting that reticence. In some ways, the prospect of enforcement and regulatory action may be a good thing for cryptocurrencies long-term as it would provide the much-needed backdrop of certainty that could move more institutional participation.

Macroeconomics and Cryptocurrency

At just over a trillion dollars in market capitalisation on a good day, cryptocurrencies, to paraphrase a recent decision of the New York District Court for the Southern District of New York, just aren’t that systemically significant.

Yet, an ongoing narrative touted by proponents of cryptocurrency as an investable asset, argues the unprecedented growth in money supply, inflation and an interest rate hiking cycle that looks set to taper, should bolster the attractiveness of deflationary assets such as Bitcoin.

Bitcoin’s deflationary quality (there will only ever be 21 million Bitcoins and the amount that can be mined roughly every four years halves) has long been touted as a reason for its inclusion in an investment portfolio.

Many investors have been seduced by the siren song of the simplicity of Bitcoin’s “deflationary asset quality” as an investment case. But just because an asset is deflationary doesn’t necessarily mean it will retain its value over the long term.

Take gold for instance, which has long been touted as a hedge against inflation given its finite supply.

Yet despite record-high inflation in the US in 2022, the value of gold as an inflation hedge actually decreased because a stronger dollar and higher US Treasury yields made it more attractive for investors to put their dollars into assets which generate yields, which gold does not.

Similarly, with the current risk-free rate of return well over zero, it’s hard to make an investment case for an asset that generates zero yields such as Bitcoin.

Another narrative being touted as supporting the investment case for Bitcoin is that interest rates will soon taper and start to be cut, which will bring increased liquidity and make speculative assets such as cryptocurrencies more attractive. Yet, there is nothing to suggest interest rates won’t simply remain higher for longer.

The US Federal Reserve has not indicated it intends to cut interest rates anytime soon, instead, the overwhelming messaging from members of the Fed has been persistently high inflation and a need to keep rates at their current level or higher for longer.

Historically, central banks have also always acted one step behind market conditions, cutting rates only in the face of a full-blown recession rather than preemptively.

And if a recession is a necessary precursor to rate cuts, it’s difficult to see how dire economic conditions could bolster the investment case for cryptocurrencies.

The elephant in the room of course is Bitcoin can’t be a Chimera, constantly shifting its investment case on the basis of the current macroeconomic climate—Bitcoin can’t be both a speculative asset and a store of value to hedge against inflation depending on who’s asking.

Perhaps, and because, Bitcoin in particular and cryptocurrencies in general are so susceptible to narrative capture, the nascent asset class (if it’s safe to refer to it as that) will almost always find itself an audience, even if the size of that audience may regularly vary.

The Internet of Value

Many cryptocurrency enthusiasts liken the current state of blockchain technology and cryptocurrencies to the early days of the Internet and acknowledge that the propensity to oversell its usefulness was in many ways similar to when the world was first coming to terms with a new means of communication in the form of the Internet.

Today, few, if any, can imagine a life without the Internet, which orders many aspects of modern life. Given how much of our lives are increasingly digital, surely the way we conduct our commerce ought to be as well? But much of commerce already is digital.

Whereas early iterations of the web were ill-suited to supporting financial transactions, digital payments in most of the developed world are taken for granted. Where there remains plenty of room for improvement is in the areas of transparency and access. Although digital payments have become almost ubiquitous, huge swathes of the global population remain unbanked.

Mismanagement and inflation have plagued citizens in certain parts of the world, where it turns out that holding Bitcoin is far more sensible than clutching to pesos and bolívars.

The tokenisation of assets and the analytics and transparency that would afford is attracting greater interest.

Billions of dollars of bonds have already been tokenised, and financial institutions globally are embracing the use of blockchain technology to speed up processes without giving up security.

And finally, to improve access to banking services and speed up transactions while reducing friction, central banks are still open to the idea of issuing their own digital currencies.

The concept of tokenised securities is also taking root, with some pointing to the ability to effect faster and safer trades while receiving real-time information on interested party transactions.

It is difficult to say what cryptocurrencies and the blockchain technology that underpins them, would look like a decade from now; it is unclear at best.

Even in the early days of the Internet, it was impossible to foresee how advancements in bandwidth, mobile technology and rich content would reshape not just our digital experience but our physical lives. Similarly, where blockchain and cryptocurrencies will take us next is less certain.

To be sure, blockchain technology will need to scale significantly while keeping costs low, to constitute a meaningful alternative to current methods of value transfer.

What is clear though is that given the potentially transformative power of both blockchain and cryptocurrencies, there will be more than a handful of investors willing to take a punt on their long-term value, which is all fine and dandy as long as they recognise exactly what they are doing—taking a punt.