Their name tells us that cryptocurrencies like bitcoin are meant to be currencies: tokens of exchange used to purchase goods and services.

Yet even a quick glance at the most heavily trafficked cryptocurrency news sources certainly wouldn't give that impression. Instead, their coverage gives you the impression that what people are most interested in is trading cryptocurrencies—trading, the way we trade other securities, especially stocks.

If bitcoin were primarily a currency, the only salient measure of its success would be its adoption by buyers and sellers of products and services. Volatility—whether positive or negative—actively militates against that usage. Volatility makes it dangerous for merchants to use bitcoin, unless they instantly exchange it for national currencies after every transaction, which seems to miss the point of a currency. If a merchant sells $4000 US worth of beer for 1 BTC, and then 1 BTC becomes worth $2000, the merchant has quickly lost $2000. The reverse equation is even more serious for the farmer who invests 1 bitcoin in $4000 worth of grain, planning to sell it for $8000 in the future, only to find that the original 1 bitcoin at harvest time would itself have been worth $16,000. The farmer would have been better off never spending the bitcoin in the first place. This is why deflation frightens economists so much: It's a huge drag on production. So it is no surprise to see merchants running away from bitcoin rather than toward it.

If there is any existing instrument—again from the perspective of a traded security—that cryptocurrencies resemble, it is penny stocks

The fact that cryptocurrencies are for the most part not being used as currencies is relatively easy to see once you look at the universe of other tokens available. For bitcoin, there is at least a coherent story that it is intended to be used for the purchase of goods and services, and it sometimes is, though mostly where other currencies can't be used for legal reasons, such as on darknet markets and for online gambling. Cryptocurrency advocates suggest that they could be useful as currency for the world's poor and disenfranchised who don't have access to banks, but many development experts consider these yet-to-be-proven use cases as hype.

It's true that a relatively small number of popular general-purpose tokens like Litecoin, Dash, and Monero, and a few domain-specific tokens like STEEM (for content creation), NameCoin (for decentralized Domain Name Services), and PotCoin (for… well, that should be obvious) are used at least some of the time for currency-like functions.

Cryptocurrencies are like penny stocks. Image: Shutterstock

But for the many other cryptocurrencies (one leading data service, CoinMarketCap, currently lists over 800, though not all of them are actively traded), virtually nobody uses them for currency-like transactions. They are vehicles for pure speculation, nothing more or less. There might be a vague story about potential use as currency, but the interest in them is almost entirely based on the prospects of getting rich quick.

Even ethereum, the much-touted "blockchain-not-bitcoin" project that is supposed to be about "smart contracts" and "decentralized organizations," seems to attract an inordinate amount of attention relative to the performance of the system's token. In fact, the token is technically called Ether to distinguish it from the ethereum blockchain itself, and the fact that it has instead taken on the same name is also indicative of the main driver of interest in blockchains: wealth accumulation via speculation.

The recent surge in Initial Coin Offerings or ICOs only confirms this. ICOs are designed in certain ways to parallel IPOs, as the name implies. An IPO or Initial Public Offering happens when a company "goes public," typically distributing its ownership over many shares of stock, which are also known as "equities" because they provide a share of ownership in a company. ICOs look as if they do the same thing by distributing tokens, thus bypassing the "financial elites" that cryptocurrency promoters claim to hate. But most ICOs do not provide an ownership stake in the company. If and when they do, in fact, they run into the exact SEC rules they are trying to avoid. ICOs actually end up growing the main speculative bubbles, since the new tokens are funded via sales for bitcoin and ethereum.

Despite these similarities, however, cryptocurrencies are not stocks any more than they are honest-to-goodness currencies. The thing about cryptocurrencies as stock-like investments is that there is no accurate way whatsoever to value them the way we value stocks. Despite the frequent claims of their promoters—often with a deep vested interest in the tokens—there is very little meaningful, long-term correlation between the price of a cryptocurrency and anything else in the world.

Certainly, at a very gross level, the most famous cryptocurrencies tend to be worth more in raw dollar terms than the rest of them, which frequently trade for bare fractions of a penny—but beyond that, there is no anchor whatsoever to explain why 1 bitcoin should trade for $100, $1000, or 10 cents. This leads bitcoin promoters to develop awfully strange and novel arguments to justify its value. Some have suggested that bitcoin's price may in some sense be correlated with the price of the the energy and hardware necessary to mine the coins. This is itself a novel argument, without financial theory to back it up, which does not mean it's incorrect. But even as the power required to mine bitcoins increases, power costs go up and down for any number of reasons. Long-term, it's not clear what this might mean, unlike the long-term prospects for a company whose market share continues to increase.

To be sure, very short-term price movements may occasionally appear to be correlated with events such as new technology developments, investments by major players, media coverage, or other market events; but as with stocks, it is hard to know whether positive or negative news causes will cause an increase or decrease in value.

"Market cap" in cryptocurrency-speak becomes another way of celebrating rising price as though it means the tokens are succeeding, in reasoning that is profoundly circular

Short-term price movements might also well be predictable by technical analysis, a set of methods that has some acceptance among financial professionals. But these are all useful only for those who are trading in and out of securities in hours or days. There is no doubt money to be made in cryptocurrency trading of this sort. But these are all the kinds of short-term movements that ordinary investors are typically advised to ignore. The question for investors is the direction in which the security will tend to move over the long term of months, years, and even decades. It's this long-term frame that bitcoin pundits often talk about when they talk about value. But it's exactly the long-term perspective in which bitcoin has no obvious analogue with other financial instruments, so that predicting what will happen to it has to happen without reference to anything that has happened before.

If there is any existing instrument—again from the perspective of a traded security—that cryptocurrencies resemble, it is penny stocks. Penny stocks, so-called because they often sell at a very low price-per-share (today, categorized by trading at $5 per share or less), are the gross underbelly of Wall Street. They are the stocks of companies that cannot meet the requirements to be listed on one of the regulated exchanges (such as the Nasdaq or New York Stock Exchange), or in other words, in most people's opinion, that have no reasonable ongoing business model. Penny stocks trade on the "OTC Bulletin Board" or the "Pink Sheets," listing services that allow trading without requiring verification of the company's financial information or meeting other regulatory requirements. The world is full of advertisements for penny stocks, but virtually no one with investing experience would tell you to buy them; they are sucker's bets. Someone is hoping you'll buy their shares for more than they paid for them. But hopes for the underlying company to actually sell a product or service are thin to nonexistent.

The parallel between stocks and cryptocurrencies is oddly emphasized by cryptocurrency promoters, in their reference to what they call "market capitalization," a number derived by multiplying the number of tokens in circulation by its current selling price. It's easy to find the current market cap of all cryptocurrencies. Market cap is a familiar concept from stock investing, not currencies. But the familiar idea of market cap in stocks has a definitive purpose: it's a rough measure of the size of a company versus other companies. The S&P 500 is an index of the 500 largest publicly-traded companies when sorted by market cap.

What if one person owned every single bitcoin in existence, or at least every bitcoin that is currently being traded? What would they be able to do? As far as I can tell, absolutely nothing

Market cap has a fundamental role in corporate finance, though. Stocks represent ownership in companies. Market cap gives investors a rough idea of what it will cost to buy a given company. It often provides a direct mechanism with which to do that: buy enough shares of stock and you own the company, through what is called a tender offer. In the simplest kind of tender offer, a majority of shareholders agree to sell the company for a set price. Then the purchaser offers that price to all current shareholders. Technically speaking, shareholders have the right to refuse to sell, but because the company is being acquired it is effectively going out of business, so the shares of its stock will become worthless.

Market cap is a fundamental factor in the price of a stock. If the stock price falls low enough that the company can be purchased by a competitor, it may well be. So everyone in investing pays close attention to the number: it means something.

There is simply no parallel between this phenomenon and "market cap" in cryptocurrencies.

A person could, of course, at least in theory, purchase a huge percentage of a given cryptocurrency. Many observers of the markets think this already happens, especially in the tokens other than the big five or so, but even then. So what? What if one person owned every single bitcoin in existence, or at least every bitcoin that is currently being traded? What would they be able to do? As far as I can tell, absolutely nothing, beyond selling them to other people or crashing the market, thereby losing much of whatever money the person had used to buy up the bitcoin to begin with. That has very little in common with buying a company. So "market cap" in cryptocurrency-speak becomes another way of celebrating rising price as though it means the tokens are succeeding, in reasoning that is profoundly circular.