The Cryptocurrency Market Isn't Fair, Which Is Exactly Why It's So Successful

Cryptocurrencies absolutely kicked butt last year, leaving traditional equities, like the stock market, eating their dust.

At the very end of 2016, the aggregate value of every cryptocurrency combined was just $17.7 billion. However, when the clock struck midnight on Dec. 31, 2017, the combined market cap of every virtual currency added together had jumped to about $613 billion, representing an impressive increase of more than 3,300%. Comparatively, it would take the broad-based S&P 500 decades to deliver similar returns. What cryptocurrencies did for investors in 2017 might qualify as the greatest year ever for a single asset class.

Accepted reasons why cryptocurrencies had such a phenomenal year

Perhaps the big question is: What drove cryptocurrencies higher in 2017? To that end, there are a number of accepted answers.

To begin with, the proliferation of blockchain is perceived to have played a big role in the ascent of digital currencies. Blockchain is the digital, distributed, and decentralized ledger that underlies virtual currencies and is responsible for recording all transactions without the need for a financial intermediary, such as a bank.

It's believed that blockchain could help solve three of the biggest issues with the way money is transmitted today. First, blockchain is decentralized, which means that information isn't stored in a single data hub. Instead, it's spread all around the world in order to ensure that no single person, group, or company has control over a virtual currency, and to keep cybercriminals from holding a community of virtual currency-holders hostage.

Secondly, since blockchain doesn't need a middleman like a bank, transaction fees could actually be lower than on traditional payment networks.

Finally, blockchain may offer the ability to significantly speed up the rate at which transactions settle. Traditional banks can take days to verify a cross-border payment, and they're only open during "normal" business hours. Meanwhile, transactions are being verified over blockchain 24 hours a day, seven days a week, which may lead to transactions being settled instantly, or at the very least substantially quicker than under the current payment system.

Beyond just blockchain, cryptocurrencies benefited from a falling dollar, which pushed investors into assets that act as a store of value. Virtual currencies like bitcoin and Litecoin have a fixed number of coins that can be mined, offering the perception that they are a finite asset. This allowed some cryptocurrencies consideration as a store of value.

News-driven events played a key role as well. For example, the announcement that bitcoin would be accepted as legal tender in Japan, along with both the CME Group (NASDAQ: CME) and CBOE Global Markets (NASDAQ: CBOE) commencing futures trading for bitcoin in December, helped add legitimacy to this burgeoning asset class.

Here's the real reason why cryptocurrencies keep rising

But what if I told you that these accepted catalysts were merely scapegoats for the real reason why cryptocurrencies have exploded higher in recent months? The real reason virtual currencies can't be stopped is because the cryptocurrency market isn't fair.

What do I mean by "fair?" Let's look at a quick comparison of the choices an investor has with a traditional equity, such as a publicly traded stock, versus a cryptocurrency.

With a publicly traded stock, investors have the opportunity to make money if it goes up, or down. They can buy or sell, as with any equity, in order to take advantage of appreciation in the share price of a stock. But an investor can also short-sell a stock and make money if it goes down, as well as purchase options that bet on a move higher, or lower, in a stock over a defined period of time. Though the odds of turning a profit with options are pretty low, the stock market is "fair" in that money can be made on both sides of a trade.

The cryptocurrency market isn't fair. Investors are essentially limited to buying or selling a virtual coin, with no ability to bet against a virtual coin and make money if it goes down. The one exception here is bitcoin, which does allow retail and institutional investors to place bearish bets via futures contracts on the CME and CBOE platforms. Because there's no money to be made to the downside, moves lower in many cryptocurrencies tend to be swift and short-lived, which are probably a result of stop-losses being hit. Such a market strongly incentivizes buying since downward moves aren't rewarded, resulting in the parabolic moves higher we've witnessed in recent months.

There can be other blatant differences, too, between traditional equity markets and cryptocurrencies that favor cryptocurrency valuation expansion. For example, publicly traded companies are required to comply with listing guidelines and disclose material news events. Meanwhile, the cryptocurrency market is unregulated, meaning rumors and tweets can play a big role in pushing valuations higher.

It remains to be seen if this will change in the year(s) to come, but it serves as a major piece of the puzzle in propping up virtual currency valuations for the time being.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Cboe Global Markets and CME Group. The Motley Fool has a disclosure policy.