Investing in Cryptocurrencies and Digital Assets E-Book

Keith H. Black

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance
• Sprache: Englisch

Seitenzahl: 687

Veröffentlichungsjahr: 2024

Beschreibung

A must-read roadmap to analyzing, valuing, and investing in cryptocurrency and other digital assets

In Investing in Cryptocurrencies and Digital Assets: A Guide to Understanding Technologies, Business Models, Due Diligence, and Valuation, alternative investments expert Dr. Keith Black delivers a compelling and straightforward roadmap for analyzing, valuing, and investing in crypto and other digital assets. You'll learn how to buy crypto directly — and how to keep your new digital assets safe from hacks and fraud — and how to invest indirectly, using stocks, futures, options, and exchange-traded funds.

You'll also discover how to conduct extensive due diligence to reduce technology and compliance risks, as well as how to understand the business models that underlie and power these novel technologies. The book also offers:

• Accessible discussions of and introductions to blockchain and distributed ledger technology, stablecoins, Bitcoin, Ethereum, and other foundational concepts
• Ways to differentiate between investing in digital assets for the long term and risky, short-term speculation

An essential new playbook for institutional, professional, and retail investors involved with digital assets and cryptocurrency, Investing in Cryptocurrencies and Digital Assets is the comprehensive and up-to-date guide to the sector that you've been waiting for.

Leseprobe

Table of Contents

Cover

Table of Contents

Title Page

Copyright

Dedication

Preface

DISCLAIMER

PART One: Defining Cryptocurrencies and Digital Assets

CHAPTER 1: Money, Banking, and Inflation

CHAPTER 2: Centralized Finance (CeFi) and Traditional Finance (TradFi) Markets

CHAPTER 3: Uses of Blockchains and Distributed Ledgers

CHAPTER 4: Bitcoin Mining and Proof-of-Work Protocols

CHAPTER 5: Ethereum Blockchain and Smart Contracts

CHAPTER 6: Proof-of-Stake Protocols and Other Layer 1 Blockchains

CHAPTER 7: Layer 2 Blockchains and Scaling Solutions

CHAPTER 8: Stablecoins, Crypto Yields, and Central Bank Digital Currencies

CHAPTER 9: Oracles and Insurance Tokens

CHAPTER 10: Privacy Tokens

CHAPTER 11: Decentralized Finance (DeFi): Borrowing, Lending, and Decentralized Exchanges

CHAPTER 12: Composability, Stacking DApps, and Bridges

CHAPTER 13: Blockchain Applications Beyond Financial Markets

CHAPTER 14: NFTs, Metaverse, and Web 3.0

CHAPTER 15: Decentralized Autonomous Organizations (DAOs) and Governance

PART Two: Investing in Cryptocurrencies and Digital Assets

CHAPTER 16: Risks, Regulations, and Taxes

CHAPTER 17: Tokenization of Off-Chain Assets

CHAPTER 18: Fundamental Valuation Models

CHAPTER 19: Initial Coin Offerings (ICOs), Security Token Offerings (STOs), and Tokenomics

CHAPTER 20: Trading and Technical Analysis

CHAPTER 21: Investing Directly in Crypto: Wallets, Custody, and Security

CHAPTER 22: Derivative Markets: Futures, Options, and Perpetual Swaps

CHAPTER 23: Building Portfolios of Stocks, Bonds, Crypto Stocks, and ETFs

CHAPTER 24: Investing Through Private Equity and Hedge Funds

CHAPTER 25: Due Diligence and Technology Risks: FTX, Terra Luna, Hacks, and Scams

Notes

CHAPTER 1 Money, Banking, and Inflation

CHAPTER 2 Centralized Finance (CeFi) and Traditional Finance (TradFi) Markets

CHAPTER 4 Bitcoin Mining and Proof-of-Work Protocols

CHAPTER 5 Ethereum Blockchain and Smart Contracts

CHAPTER 6 Proof-of-Stake Protocols and Other Layer 1 Blockchains

CHAPTER 7 Layer 2 Blockchains and Scaling Solutions

CHAPTER 8 Stablecoins, Crypto Yields, and Central Bank Digital Currencies

CHAPTER 9 Oracles and Insurance Tokens

CHAPTER 10 Privacy Tokens

CHAPTER 11 Decentralized Finance (DeFi): Borrowing, Lending, and Decentralized Exchanges

CHAPTER 12 Composability, Stacking DApps, and Bridges

CHAPTER 13 Blockchain Applications Beyond Financial Markets

CHAPTER 14 NFTs, Metaverse, and Web 3.0

CHAPTER 15 Decentralized Autonomous Organizations (DAOs) and Governance

CHAPTER 16 Risks, Regulations, and Taxes

CHAPTER 17 Tokenization of Off-Chain Assets

CHAPTER 18 Fundamental Valuation Models

CHAPTER 19 Initial Coin Offerings (ICOs), Security Token Offerings (STOs), and Tokenomics

CHAPTER 20 Trading and Technical Analysis

CHAPTER 21 Investing Directly in Crypto: Wallets, Custody, and Security

CHAPTER 22 Derivative Markets: Futures, Options, and Perpetual Swaps

CHAPTER 23 Building Portfolios of Stocks, Bonds, Crypto Stocks, and ETFs

CHAPTER 24 Investing Through Private Equity and Hedge Funds

CHAPTER 25 Due Diligence and Technology Risks: FTX, Terra Luna, Hacks, and Scams

About the Author

About the Companion Website

Index

End User License Agreement

Guide

Cover

Table of Contents

Title Page

Copyright

Dedication

Preface

Begin Reading

Notes

About the Author

About the Companion Website

Index

End User License Agreement

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Investing in Cryptocurrencies and Digital Assets

A Guide to Understanding Technologies, Business Models, Due Diligence, and Valuation

KEITH BLACK

Copyright © 2025 by Keith Black. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, [phone], fax [phone], or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, [phone], fax [phone], or online at http://www.wiley.com/go/permission.

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Library of Congress Cataloging-in-Publication Data is Available:

ISBN 9781394268627 (Cloth)ISBN 9781394268641 (ePub)ISBN 9781394268658 (ePDF)

Cover Design: Wiley

Cover Image: © InfiniteStudio/Adobe Stock Photos

Author Photo: Courtesy of Keith Black

For Melissa, Trish, and Parker.

Preface

Cryptocurrencies and digital assets are exciting, innovative, and potentially lucrative investments. Similar to the internet of the late 1990s, blockchain technology may fundamentally transform the ways many industries conduct business. Much of the conversation to date has focused on speculative investments that have provided rags-to-riches and riches-to-rags stories, as well as the potential of crypto-based protocols to upset the current world order of financial markets and sovereign borders.

However, many investors in cryptocurrencies and digital assets may not have explored the characteristics of assets that may rise or decline in value. This book offers a balanced view, embracing the potential to profit and democratize markets while tempering the unbridled optimism that has tempted some to invest their entire net worth in a single, highly speculative crypto asset. While the market capitalization of some crypto protocols may one day exceed the valuation of today’s largest tech stocks, most crypto assets today are likely to lose value in the coming years.

This book provides an in-depth exploration of cryptocurrencies and digital assets from the point of view of experienced investors in traditional financial markets. While the technology backing blockchains and digital assets has developed rapidly since 2008, venture capital and stock market investing can provide important historical precedents on the outlook for digital asset investments. The venture capital model shows us that, while most startup companies never reach critical mass, disciplined investing in a portfolio of companies or digital assets can provide strong long-term profits. That is, a small number of massive winners can more than offset the losses from many unprofitable investments.

This book is designed to benefit readers with various goals. First, undergraduate and graduate students in business and computer science wishing to enter an exciting industry can study this volume to get up to speed quickly, demonstrating a breadth of knowledge derived from a full semester course. Second, this book can assist investors and financial advisors in understanding the investment implications of this new technology, including the asset allocation and portfolio construction implications of adding crypto assets to a traditional portfolio of stock and bond investments. Finally, corporate leaders seeking to future proof their business can search for applications of blockchain technology to their current operations.

Part 1 defines cryptocurrencies and digital assets. Chapters 1 to 15 provide a comprehensive introduction to proof-of-work blockchains, such as Bitcoin, and proof-of-stake blockchains, such as Ethereum. The discussion also delves into the characteristics of centralized finance, making a compelling case for adopting distributed ledgers, which can facilitate more transparent and global transactions.

This book also explores the revolutionary potential of smart contracts, paving the way for groundbreaking applications like decentralized finance and non-fungible tokens. Moreover, it highlights how stablecoins and central bank digital currencies could serve as catalysts for the widespread adoption of digital assets on a global scale, opening up new horizons for investors.

Part 2 provides considerations for investing in cryptocurrencies and digital assets. Chapters 16 to 25 describe ways to access digital asset investments, including holding crypto assets on centralized exchanges or in self-custody wallets, crypto-related stocks, venture capital, hedge funds, and derivative products, including futures, options, and perpetual swaps. The fundamental valuation models and due diligence processes that are discussed can be used to evaluate investment decisions carefully. Lessons learned from previous risk events can help investors keep their holdings safe and avoid losses due to overleverage, custody events, and counterparty and credit risk.

The long-term potential of blockchain technology may be most beneficial in tokenizing assets, using the transparency and security of distributed ledgers to provide ownership records for real-world assets, including automobiles, real estate, and event tickets. Distributed ledger and blockchain technology promise to make the world smaller and more equitable, allowing global peer-to-peer transactions while bringing property rights and financial services to the world’s 1.4 billion unbanked citizens.

DISCLAIMER

This book is for educational purposes only and does not provide legal, tax, regulatory, or investment advice. The author may have an economic interest in the stocks, cryptocurrencies, and digital assets discussed in this book. Efforts were made to ensure this book’s accuracy when the manuscript was drafted. However, taxes, regulations, and the specifics of crypto protocols can and will change over time.

PART OneDefining Cryptocurrencies and Digital Assets

The first 15 chapters define the landscape of cryptocurrencies and digital assets, including the differing technologies and asset types.

Chapter 1 discusses money, banking, and inflation. The rationale for creating the digital assets industry arose from dissatisfaction with current institutions, especially regarding bank failures and the debasement of the value of fiat currencies through inflation.

Chapter 2 explains the institutions involved in the centralized finance (CeFi) and traditional finance (TradFi) markets. The crypto universe seeks to recreate, replace, or disintermediate many traditional institutions, including central banks, securities exchanges, and commercial banks.

Chapter 3 introduces the concepts of blockchains and distributed ledgers. As investors move away from reliance on centralized counterparties, information is securely stored by thousands of global recordkeepers.

Chapter 4 discusses the revolutionary concept of Bitcoin, including the process of mining in a proof-of-work protocol. Miners earn block rewards for approving transactions and securing the Bitcoin blockchain.

Chapter 5 continues with the evolution of digital assets by discussing the 2014 launch of smart contract technology. The Ethereum blockchain remains a leader in smart contract distributed applications to this day.

Chapter 6 provides a list of alternatives to Ethereum-based smart contracts. Proof-of-stake protocols such as Binance, Avalanche, and Solana seek to provide faster and cheaper access to smart contract-based distributed applications.

Chapter 7 discusses the need to increase the scalability of blockchains, especially Ethereum, which relies on layer 2 solutions such as Polygon, Optimism, and Arbitrum to speed transactions and reduce gas fees.

Chapter 8 introduces stablecoins, which seek to provide a store of value linked to the value of gold, euros, or US dollars. Stablecoins issued by governments are termed central bank digital currencies (CBDCs).

Chapter 9 expands on the use cases of digital assets by explaining oracles and insurance. Oracles provide the price and data feeds required for the smooth operation of smart contracts. Smart contract–enabled insurance policies may revolutionize the cost and speed of insurance operations.

Chapter 10 explains that while the Bitcoin and Ethereum blockchains are designed to be transparent, privacy tokens seek to keep transactions private. The regulatory risks of obscuring transactions are also discussed.

Chapter 11 introduces what could be the most important innovation in the digital assets universe: the creation of a parallel financial system in which decentralized finance (DeFi) seeks to replace the role of banks and securities exchanges.

Chapter 12 explains how smart contract ecosystems can be combined using the concepts of composability and the stacking of distributed applications (DApps) to work together like “money Legos” to accomplish DeFi’s goals.

Chapter 13 lists various uses of blockchain applications beyond financial markets, where blockchain technology may revolutionize supply chain management and ticketing for concerts and sporting events.

Chapter 14 explores the exciting impact that blockchain technology may have on popular culture. While initially focused on art, music, and gaming, non-fungible tokens may provide the entry point for consumers to access the metaverse and Web 3.0 using a single wallet as their portable digital identity.

Finally, Chapter 15 explains how the corporate governance structure may be replaced by distributed autonomous organizations (DAOs) that can manage businesses remotely in a much flatter hierarchy than traditional corporations.

CHAPTER 2Centralized Finance (CeFi) and Traditional Finance (TradFi) Markets

In Chapter 1, we explored traditional methods of money and banking and the impact of inflation on the long-term purchasing power of fiat currencies. In this chapter, we will discuss how blockchain-based markets seek to improve on the inefficiencies of the centralized finance (CeFi) and traditional finance (TradFi) markets.

The digital asset market facilitated by blockchain will change many of the industries in today’s economy. One of the first areas of innovation is moving functions from traditional and centralized financial markets into a parallel financial market facilitated by blockchain technology.

Once we understand these different financial systems, we’ll move to the Bitcoin and Ethereum blockchains to see how this new financial technology may one day replace many existing financial systems.

Our financial system has a variety of goals including price discovery, asset liquidity, facilitating payments, and efficiently bringing savers and borrowers together.

Price discovery allows investors to know exactly what an asset is worth at any point in time, while liquidity allows investors to sell an asset quickly for close to the expected price. The insurance industry and derivative products, such as futures and options, are among the largest businesses in the financial sector. Facilitating payments and purchases allows consumers in an economy to efficiently interact without resorting to barter.

Savers have excess capital with a desire to earn a return, ideally a yield that is higher than inflation, so their savings can have greater purchasing power in the future than in the present. There is also a need for individuals and corporations to borrow. In many cases, older individuals are savers and younger individuals are borrowers. Younger companies need to access capital to grow while more mature companies may have excess capital to invest.

Bringing borrowers and savers together allows money to move through the economy, while the capital markets help the economy grow jobs and make investments. An economy can develop a shared prosperity when the savings of the savers are used to lend to the borrowers, and hopefully, the borrowers will put that money to good use, perhaps starting a business, buying a house, or earning a college degree.

Cryptocurrencies, digital assets, and blockchain technology have the ability to transplant or reinvent many of the areas of the CeFi industry. Centralized means that there is one specific institution that’s in charge. It might be a bank, a securities exchange, a governmental regulator, or a central bank. Other centralized counterparties include credit card payment processors, remittance facilitators, and insurance companies. Many of these large financial institutions are now seeing competitors in the blockchain space.

Banks bring together savers and borrowers. Savers deposit their money into the bank to earn a yield to maintain or grow the future purchasing power of their cash. Banks loan those deposits to borrowers who consume or invest today and repay the loans in the future. Ideally, the investments made with the borrowed funds have a higher return than the loan’s interest cost, allowing the borrower’s wealth to grow. Banks allow borrowers to spend now, and savers to store and increase their assets for future spending.

Many institutions have relatively similar functions, such as banks, credit unions, and savings and loans. In the US, deposits are insured up to $250,000 per individual per institution by Federal government institutions such as the Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Administration (NCUA). While US banks insure a portion of deposits, deposit insurance is not available in every country and certainly not widely available in the cryptocurrency and digital asset industry.

It is important to understand the assets and liabilities of these depository institutions. A bank’s assets are the customers’ liabilities, and the bank’s liabilities are the customers’ assets. Banks borrow money from their customers’ deposits into checking accounts, savings accounts, and certificates of deposit. Many of those deposits bear interest, which comprises the bank’s borrowing costs. In addition to customer deposits, banks may borrow money through short-term credit facilities or by issuing long-term bonds.

Assets (Often Long Term)

Liabilities (Often Short Term)

Loans

Checking accounts

Cash

Savings accounts

Central bank reserves

Certificates of deposit

Bonds and investments

Bank borrowings

The liabilities of bank customers, such as loans, are the key assets of a bank. Banks can also keep cash reserves in their vault or on deposit with the central bank. Banks can also purchase bonds and make other investments.

The goal of a bank is to earn a positive net interest margin, which is the income on loans and other assets relative to the costs of the bank’s deposit base and borrowings. For example, if the bank offers a corporate loan at 8% and pays a 3% yield on a checking account, the bank’s net interest margin is 5%. The bank earns a profit when the net interest margin exceeds the cost of their operations, employees, buildings, and losses on loan defaults and bad investments.

The goal is to borrow at a lower rate and lend at a higher rate. The net interest margin is the difference between a lower borrowing rate and a higher lending rate. Banking is difficult when the duration of the assets differs from the duration of the liabilities. An asset-liability mismatch is created when bank deposits can be withdrawn at any time, while the bank uses the volatile deposit base to lend to homeowners in the form of 30-year fixed-rate mortgages. Banks naturally tend to have short-term liabilities and long-term assets. If not carefully managed and hedged, times of rising rates can be especially challenging for banks.

In centralized finance, investors are concerned about the potential failure of a key institution. In the great financial crisis (GFC) of 2008, a number of significant players in the financial industry failed, including Bear Stearns and Lehman Brothers. When banks fail, depositors are concerned about when, and if, they will receive the return of their assets.

There’s a concern that banks exhibit censorship when some types of consumers are denied service. Denials of service may be due to a consumer’s income or credit quality, country of citizenship, or even discrimination based on race or other issues. A key goal of the cryptocurrency industry is to provide a level playing field for consumers around the world. Consumers are free to interact with any blockchain-based protocol as long as they meet the financial requirements.

Many countries, especially those in emerging markets, have strict regulations or a lack of access to financial services. If the services are available, they may be expensive or difficult to access.

Finally, centralized counterparties, whether banks or social media providers, tend to operate as walled gardens. While the assets or social media connections are the consumer’s property, centralized businesses make it difficult to transfer across platforms. In order to transfer an account from one US bank or brokerage firm to another, it may take several days or even weeks to fully close one account, open another account, and transfer assets to the new account. It is even more difficult to transfer US dollar–denominated assets from a US bank to euro-denominated assets at the European bank.

While transferring assets from one firm to another is time-consuming, it is extraordinarily difficult to transfer liabilities, such as a home mortgage, from one bank to another. That process typically involves refinancing, borrowing a new mortgage at today’s current rate, and using the proceeds to retire the original mortgage. This is beneficial during declining interest rates, but infeasible and expensive during times of rising mortgage rates.

Similarly, there is no portability of a user’s followers, friend list, or connections between Twitter/X, Facebook, or LinkedIn platforms.

The goal of the blockchain and cryptocurrency community is to use a decentralized, peer-to-peer system to disintermediate banks, reduce costs, and make it easier for consumers to access financial services worldwide.

Banks fail for a variety of reasons, especially credit losses, investment losses, and asset-liability mismatches. A recipe for bank failure is when the bank’s assets are long term and illiquid, and the liabilities are called immediately. A moral hazard is created if the banks receive the profit or reward for taking risks while the losses from taking those risks are insured by the government or the taxpayers. In fact, taking greater risks by lending to more risky borrowers is expected to have a higher net interest margin, but the riskiest borrowers also have the highest probability of defaulting on the loan and not repaying principal and interest as scheduled.

What are the mechanics of a bank failure? Consider the market in 2021, where savers were earning near-zero interest rates while borrowers were able to lock in 30-year mortgages at 3%. Banks expected to earn a net interest margin of 3%. However, after the Fed tightened rates aggressively in 2022 and 2023, savers sought to earn 5% yields on Treasury bills, money markets, and even checking accounts. Banks paying zero interest rates were forced to either increase the interest rates they offered to maintain their deposit base or see their deposits depart for higher-yielding accounts in other institutions. Banks paying 5% on deposits while earning 3% income on 30-year mortgages face a negative net interest margin that can threaten the profitability and stability of the bank.

In March 2023, Silicon Valley Bank (SVB) experienced the largest bank failure in 15 years and second only to the 2008 demise of Washington Mutual as the largest bank failure in US history. As SVB’s assets increased from $71 billion in 2019 to $211 billion in 2022, the bank was unable to increase loan growth as quickly as asset growth, so a substantial amount of bonds was purchased.

As short-term interest rates increased rapidly, SVB’s portfolio of long-term Treasury bonds was losing value. After mark-to-market losses of more than $15 billion combined with a bank run of rapid customer withdrawals, the bank failed and its operations were sold to First Citizens Bancshares.

SVB noted that its available-for-sale bond portfolio held $21 billion in US Treasury and agency securities, yielding 1.79% with an average duration of 3.6 years.1 As interest rates rise, bond prices decline at a rate of the duration multiplied by the change in yield.

If rates rose to 4.79% during the Fed’s tightening cycle, SVB would lose $2.26 billion, which is the 3% yield change multiplied by the $21 billion position size and the 3.6-year duration of the bond portfolio. Notice that this loss was 10.8% of the bond portfolio’s value or more than 6 years of interest on the portfolio at a yield of 1.79%. With total assets of $211 billion at the end of 2022 and total equity of $16 billion, a loss of just 7.6% of assets was sufficient to wipe out the bank’s equity base. The bank was widely criticized for its lack of interest rate hedges, as a short position in Treasury note futures would have profited from a decline in Treasury prices and a rise in Treasury yields and offset the decline in the value of the bank’s assets caused by a sharp increase in interest rates.

A similar asset-liability mismatch led to the failure of the Federal Savings and Loan Insurance Corporation (FSLIC) in 1989, which could not fully insure the one-third of US savings and loans that failed between 1986 and 1995. As discussed in Chapter 1, inflation exploded after the US abandoned the gold standard in 1971. In August 1971, the US ended backing the US dollar with gold, with the 10-Year Treasury yielding around 6.3%. By September 1981, 10-Year Treasury rates exceeded 15.8%.