Last year might as well have been dubbed "the year of the cryptocurrency." Having started the year with a combined market cap of less than $18 billion, digital currencies soared throughout the year to end with an aggregate market cap of nearly $613 billion. Even taking into account the hundreds of new virtual currencies that hit the market, this was an astounding year of gains for cryptocurrencies.
Putting crypto's record 2017 into context
Though there have been no shortage of catalysts behind the rapid ascent of virtual currencies, none stands out more than the rise of blockchain technology. Blockchain is the digital, distributed, and decentralized ledger that underlies most cryptocurrencies and is responsible for logging data and/or processing transactions in a transparent and immutable manner, without the aid of a third party. Or in a more layman's definition, it's a brand-new way to quickly transfer money without using traditional banking networks, as well as a means to store data in order to more efficiently and safely use that data. This means blockchain has currency and non-currency applications.
Investors also have been enamored with the sheer volume of partnerships and projects that digital currencies have undertaken. The financially focused blockchain network developer Ripple has added a small army of financial institutions to its RippleNet with the hope of expediting money flows from one party to another. Meanwhile, more than 500 members have now joined the Enterprise Ethereum Alliance, which, as the name implies, develops blockchain solutions for a variety of industries using Ethereum's network and built-in smart contract protocols.
Even something as simple as institutional investors remaining on the sidelines has been pivotal in pushing cryptocurrency valuations higher. With Wall Street generally unwilling to put its money to work in decentralized crypto exchanges, retail investors have been left in charge of the day-to-day trading activity in digital currencies. With much smaller pockets than Wall Street firms, these retail investors often have little or no means to bet against cryptocurrencies, leading to something of a "buy bias" that's continually buoyed and lifted virtual currencies.
But for as many catalysts as there have been, practically all cryptocurrencies share one deficiency: they lack genuine purpose.
Nearly all cryptocurrencies lack purpose
Take bitcoin as an example. Bitcoin is the world's largest virtual currency by market cap and happens to be accepted by more merchants than any other digital currency that's being used as a medium of exchange. But just because bitcoin is the world's most valuable crypto by market cap doesn't mean that it carries a specific purpose.
The closest "purpose" bitcoin serves is as a medium-of-exchange when investors purchase a not-so-commonly held cryptocurrency. In order to facilitate transactions on decentralized exchanges where less common digital currencies are bought, investors usually first have to buy bitcoin or Ether (the Ethereum network coin) to exchange into whatever other digital currency they want to own. Beyond this "purpose," there's no overwhelming need for users to use bitcoin to buy goods and services.
A similar tale can be told with Ripple's XRP coin. Ripple has three products that it offers -- xCurrent, xRapid, and xVia -- and its XRP coin is only involved in one of them (xRapid). The xRapid product is designed to improve on-demand liquidity solutions for payment providers and transfer services and at this point is mostly in the test phase by the likes of MoneyGram International. Meanwhile, the blockchain software that banks are expected to lean on to expedite the validation and settlement of payments (xCurrent) relies on a ledger that doesn't include XRP. Ripple's coin serves virtually no purpose for the time being.
Even coins with a purpose can lack broad-scale utility
Even when there appears to be a sense of purpose associated with a digital currency, that purpose often is very narrow in scope. As an example, users are encouraged to buy and use Binance Coin, which is the official currency of the Binance cryptocurrency exchange, to pay for crypto transactions on Binance's exchange. Users who choose to pay their transaction fees in Binance Coin are eligible for reduced transactions fees for the first four years (they stagger to a smaller reduction in each successive year). This dangling carrot, along with coin burn, has created demand for Binance Coin and pushed its value higher.
While Binance Coin serves a purpose on the Binance exchange, it has limited utility beyond this. In other words, it's not as if users can take their Binance Coin and use it to pay for goods and services with other merchants.
This is a bigger problem than investors probably realize. If a token has no genuine utility and there's no purpose behind its use, then it's probably only a matter of time before cooler heads prevail and common sense catches up to these lofty valuations. Until there's a genuine reason for consumers to begin using cryptocurrencies, there's no reason for investors to sink their hard-earned money into virtual currencies.
Sean Williams has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool has a disclosure policy.