If you’re a digital startup hoping to be the next Google, crypto assets might be for you. If you’re a flower shop hoping to be the next Inter Flora, maybe not so much
About 541 million years ago, in the space of just 20 to 25 million years, life on Earth went through a sudden and remarkable change. In what became known as the Cambrian Explosion a few simple organisms were replaced by a huge variety of more complex life forms with compound eyes, multiple legs, and sharp teeth. Most of the Cambrian life forms went extinct, but pretty much all animals and plants living today started their evolutionary journey at that time.
Expected return, of course, is an economic and statistical construct
It has been argued that a rise in the level of free oxygen above a certain threshold enabled complex life forms to develop. These complex creatures used their eyes, legs and teeth to prey on other organisms, which had to quickly learn how to hide or grow shields lest they be consumed as food. The rest is history.
We’ve seen a similar explosion in crypto assets over the last 10 years: it started with Bitcoin, evolved to a more complex form with Ethereum, had a separate line with Ripple, and then gave birth to tens of thousands of crypto tokens in the last two years or so.
Like the rising level of oxygen for early life forms, the crypto explosion may have been made possible by Moore’s Law, an observation that over time, ever more computational power is available for the same amount of money. Due to Moore’s Law, sometime in the early 2000s, computing power seems to have reached a critical threshold: it became possible to solve complex calculations on standalone personal computers, and communicate the solutions to other computers over the Internet.
The result was a decentralised, self-sustaining, computational ecosystem governed by a protocol that issued assets to those who let their computers be used for number-crunching. These assets could be thought of as crypto life forms, and pretty soon they began feeding on each other, just as Mummy and Daddy arthropods did way back when.
And as before, many crypto assets will not survive. By some estimates, around two-thirds of crypto assets offered through an initial coin offering failed to survive 120 days. However, the ones that do will give rise to financial assets more suitable to the digital era than the ones we have now.
The key to the survival of a crypto asset is the probability of its adoption for some form of use. To get adopted as quickly as possible, crypto assets have to offer expected return. Expected return, of course, is an economic and statistical construct – it is a sum of payoffs weighted by their perceived probabilities. Whether those payoffs actually materialise and whether those perceived probabilities match anything deemed rational is a big and, at times, very technical part of the research agenda in financial economics and should not in any way, be viewed as investment advice.
A risk-return taxonomy of crypto assets
By plotting the expected return of crypto assets against the risk of their not being adopted, we’re able to organise them into four large groups: central bank issued digital currencies (CBDCs), stable coins, cryptocurrencies, and (an awful lot of) crypto tokens.