Practical analysis for investment professionals
22 June 2021

Down the Rabbit Hole: A Cryptocurrency Primer

This analysis is derived from the PNC research report “Going Down the Cryptocurrency Rabbit Hole.” For more on the cryptocurrency space, we encourage you to read the full report.


When you hear the word “cryptocurrency,” do you immediately think “bitcoin”? If so, you’re not alone.

The cryptocurrency, or crypto, world has evolved dramatically since an anonymous author or authors, writing under the pseudonym Satoshi Nakamoto, published a brief white paper in 2008 detailing the mechanics of what would become known as bitcoin. While bitcoin is still the largest crypto by market capitalization, there are now some 6,000 cryptos in existence.

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For many, the crypto universe has developed beyond its origins as a new payment technology into an investment opportunity. Bitcoin peaked at more than $61,000 on 12 March 2021, achieving a 300% annualized return over the last 10 years. Such impressive performance has naturally increased investor interest. However, in bitcoin’s short history, its price has reached euphoric highs, only to suffer significant pullbacks.

So while many investors may insist that this time really is different, given the extreme volatility and uncertainty in determining appropriate valuations, we still see bitcoin and other cryptos as speculative investments and not suitable for all investors.

But we believe the world of digital assets has reached a critical mass that gives us confidence that it’s more than just a passing fad. Therefore, our aim here is to arm investors with knowledge of the crypto landscape and equip them with the tools to evaluate the myriad crypto options out there.

We also want investors to understand there’s more to the crypto story than just bitcoin. Crypto discussions often ignore the increasing adoption of blockchain technology. Blockchain not only makes crypto possible, but also enables the broader movement towards decentralized finance (DeFi), the secular force that we think is driving the advent of digital currencies. If crypto is to be taken seriously as an asset class and not just a means to speculate on digital art or sports videos, we believe investors should focus on opportunities within DeFi alongside bitcoin.

For investors new to the world of crypto, the scene in Alice’s Adventures in Wonderland in which Alice follows the rabbit down a rabbit hole and into Wonderland is a common analogy. Learning the technological concepts behind crypto can feel like stumbling into an upside-down world of make believe.

Promotional tile for Cryptoassets: The Guide to Bitcoin, Blockchain, and Cryptocurrency for Investment Professionals

Crypto 101: The Abridged Version

Cryptocurrencies emerged in 2008 with Satoshi’s white paper. Like similar breakthroughs, bitcoin was born out of a technological revolution much longer in the making: the internet’s dramatic evolution toward decentralization and blockchain technology applications.

The concept of decentralization is a key differentiator between logging information on a common spreadsheet versus enabling the unique, complex features of crypto. In a decentralized computer network, data is not stored in a central location, and has no central point of control. Any user can tap into the network anywhere, at any time. The idea is similar to Linux open source software or Wikipedia.


Crypto Glossary

The Building Blocks of Crypto

The word blockchain did not appear in the original bitcoin white paper. However, the blockchain concept soon formed the technological backbone of how digital assets work.

What is blockchain? It is a technology that consists of complex cryptography and software that creates an immutable, decentralized database for whatever its application may be. The data stored on the blockchain cannot be changed, and there is no central authority over the records.

The blockchain concept dates back to the early 1990s and the early days of Web 1.0, but it didn’t find a real-world use case until the invention of bitcoin as a peer-to-peer payment network.

Why is blockchain technology essential to crypto? Because it eliminates what’s called the double-spend problem of digital assets. Though physical assets like currency or even an actual gift card can only be spent once, before Satoshi’s white paper, digital information could be duplicated and falsified, so it could potentially be used multiple times. Because blockchain cryptography supports a decentralized and unalterable ledger, once a cryptocurrency transaction is recorded, it cannot be erased. This provides a strong defense against potential double spending.

These building blocks (pun intended) describe the what behind blockchain. But who keeps the decentralized network operational? Since no one is in charge per se, the decentralized system incentivizes users to self-regulate. In short, a crypto network’s security is supported by two critical user groups: miners and node operators. Without these cohorts working as a symbiotic, “trustless” community, a decentralized blockchain’s security could become vulnerable.

  • Crypto miners generate new coins by using high-powered computers to solve complex cryptography problems. By competing to mine coins, they share a direct financial incentive to keep the blockchain functioning and validate existing coins (or blocks) as transactions occur. As the adage goes, “There is no such thing as a free lunch,” and the same applies in crypto transactions: Miners earn transaction fees for validating each transaction on a network.
  • Node operators referee the network, ensuring the accuracy and security of transactions. Most computers have enough power to run a node, but in the upside-down world of decentralization, there is no financial gain for this task. Node operators are incentivized purely by their commitment to the cause.

Illustration of cryptocurrency and blockchain mechanics

To assess the strength of this soft infrastructure, investors should apply a common technology industry measure: network effects. Think about how Facebook surpassed MySpace, or Google replaced Yahoo. Among similar applications, better scalability and stronger network effects determined which would prevail. There are various ways to quantify network effects, including the Lindy Effect, Metcalfe’s Law, and S-curve adoption.1 And, like common software applications, crypto networks can be measured by growth in monthly active users (MAUs).

We believe these concepts form the bedrock of crypto fundamental analysis. Without a committed community of miners and node operators validating transactions, a blockchain network could fall prey to theft or fraud, which could render the cryptocurrency worthless. In fact, a critical differentiator among cryptocurrencies is the perceived strength of their network effect. Therefore, when it comes to the underlying network strength of a blockchain, crypto investors should know what they own. Prices might be rising in the short term, while network activity — the most basic value in crypto — is flashing warnings signs of long-term instability.

Financial Analysts Journal Current Issue Tile

Putting It All into Practice

So how do we evaluate cryptocurrencies throughout our investment process? Though we currently view bitcoin and other cryptos as speculative investments that are not appropriate for all investors and do not recommend crypto for a broad, formal asset allocation, amid increasing adoption of cryptocurrency and DeFi applications, we think it’s worthwhile to examine the crypto world through an investor’s lens.

Given the short time crypto has existed, can we even implement our traditional investment analysis process? In our view, absolutely. Admittedly, some of the approaches may seem unorthodox — our sympathies to students of The Intelligent Investor — but this is the upside-down world of crypto.

Business Cycle Analysis: Where Have We Been, Where Are We Going?

The business cycle has four phases in our traditional investment analysis: slowing expansion, contraction, recovery, and accelerating expansion. How does this apply to crypto? Instead of GDP growth, industrial production, retail sales, and similar metrics, the crypto business cycle is centered on the all-important network effect. Since anyone can observe all transactions on a decentralized blockchain, investors can analyze how long users are holding onto their coins, which is analogous to stock turnover.

Thus, holding period data is one metric to assess the strength of the network, and to potentially gauge trends in a crypto’s value and price. For example, the “HODLers,” or hold-on-for-dear-lifers, are zealous true believers who dominate the early stage of a crypto’s business cycle. The next stage is defined by long-term investors, and the final stage by speculative short-term traders. The increasing influence of speculators tends to signal a weakening network wherein longer-term investors — and potentially miners or node operators — have left for better opportunities elsewhere. This is why network effects are critical to a decentralized blockchain for investors: Growth in the number of long-term users strengthens the network, which should help maintain its value over time.

While crypto follows a business cycle just like any other investment, the available metrics are coincident indicators at best. However, the chart below demonstrates that a relatively strong group of long-term investors maintain most of the bitcoin network.


Chart showing Bitcoin Age Distribution vs. Price

Valuation Analysis: Attractiveness Relative to History and Peers

Crypto’s perceived valuation limitations contribute to investor skepticism. Can an asset that derives value from a network effect really have quantifiable value? While we can’t call up an income statement and plug a few numbers into a spreadsheet, the open-source nature of crypto and DeFi provides a wealth of data that we can submit to traditional valuation analysis, albeit with a little more creativity.

For example, a network’s realized-value-to-transaction-volume (RVT) ratio can offer insight. This ratio simply measures the network’s market capitalization divided by its daily transaction fees much like a price-to-earnings ratio for stocks. Chart 3 depicts bitcoin’s price versus its RVT ratio, which has risen to 6x recently, well above its 1.6x historical average.


Chart showing Bitcoin Price vs. RVT Ratio

The table below illustrates a few other common valuation methods.


Chart showing Select Cryptocurrency Valuation Methods

Technical Analysis: Charting One of the Most Volatile Asset Classes in History

The volatility of crypto markets makes technical analysis challenging. Furthermore, in the crypto space, what traditional technical analysis might interpret as a sell signal can often be an uptrend confirmation and vice versa. For example, “buying the dip” in crypto has been costly for professional traders. The crypto community coined the acronym HODL to describe the rollercoaster of crypto prices. Buy-and-hold HODLers have come to expect high volatility as par for the course. Which is why it is not an appropriate investment for all.

The following table outlines some technical measures that examine transaction activity as a momentum indicator. As an example, Chart 4 shows bitcoin’s relative strength indicator (RSI) has positive momentum.


Chart of Select Cryptocurrency Technical Analysis Metrics

Chart of Bitcoin Price vs. RSI

Key Investment Merits and Risks of Cryptocurrency

With that framework or lens through which to view crypto as a traditional investment process, what are the key merits and risks of investing in the asset class?


Cryptocurrency Merits and Risks Chart

The End of the Rabbit Hole

The digital asset universe passed the $1 trillion threshold in total market cap in 2021, outpacing the S&P 600 Small Cap Index. It is difficult to dismiss digital assets as a flash in the pan. We believe if the internet evolves to Web 3.0, the use of decentralized blockchain technology will increase, so investors should focus on DeFi’s long-term opportunities.

The mainstream narrative may continue to focus on bitcoin because digital gold is easier to explain than a decentralized flash loan smart contract. Yet some of the largest DeFi projects already generate more transaction fees than bitcoin despite a 99% smaller market cap. As NFTs like digital art grow in popularity and users become accustomed to how DeFi works, we expect the use cases for decentralized blockchain technology to continue expanding rapidly. Yet the real-time pricing of these venture-capital-like assets could lead to significant performance volatility, which, again, is why digital assets are just not suitable for all investors.

If by now you’re not sold on the upside-down world of cryptocurrencies, that’s okay. Our goal was to take readers (and maybe some new HODLers?) on a journey down the rabbit hole and to provide an investor’s perspective on crypto. We think that’s of more value than an analysis that is full of FUD or leaves readers asking “when lambo.” Those types of thinking usually end in speculators getting rekt.


1. Lindy Effect theory holds that the longer a technology stays in use, the longer its life cycle is extended. Metcalfe’s Law is a common valuation practice for social media companies in which the value of an internet network is proportional to the square of its number of users. S-curve Adoption is a model for the phases of new technology: research and development, growth, maturity, and decline/obsolescence.


Important Disclosures:

For definitions of indexes used in this publication, please refer to pnc.com/indexdefinitions.

The PNC Financial Services Group, Inc. (“PNC”) uses the marketing name PNC Institutional Asset Management® for the various discretionary and non-discretionary institutional investment, trustee, custody, consulting, and related services provided by PNC Bank, National Association (“PNC Bank”), which is a Member FDIC, and investment management activities conducted by PNC Capital Advisors, LLC, an SEC-registered investment adviser and wholly-owned subsidiary of PNC Bank. PNC does not provide legal, tax, or accounting advice unless, with respect to tax advice, PNC Bank has entered into a written tax services agreement. PNC Bank isnot registered as a municipal advisor under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Investments in cryptocurrencies or digital assets are speculative investments that involve high degrees of risk, including a partial or total loss of invested funds. Investments in this area are not suitable for any investor that cannot afford loss of the entire investment.

DIGITAL ASSET INVESTMENTS SUCH AS DIGITAL CURRENCIES MAY BE SUBJECT TO LEGISLATIVE AND REGULATORY CHANGES OR ACTIONS AT THE STATE,FEDERAL, OR INTERNATIONAL LEVEL WHICH MAY ADVERSELY AFFECT THE USE, TRANSFER, EXCHANGE, AND VALUE OF DIGITAL/CRYPTO ASSETS. Depending on its characteristics, a digital asset may be considered a “security” under the federal securities laws. The test for determining whether a particular digital asset is a “security” is complex and difficult to apply, and the outcome is difficult to predict. Accordingly, digital assets and exchanges are not regulated with the same controls or customer protections available in equity, option, futures, or foreign exchange investing.

Investors should conduct extensive research into the legitimacy of each individual digital asset before investing. The features, functions, characteristics, operation, use and other properties of the specific digital asset may be complex, technical, or difficult to understand or evaluate. The digital asset may be vulnerable to attacks on the security, integrity or operation, including attacks using computing power sufficient to overwhelm the normal operation of the digital asset’s blockchain or other underlying technology.

Blockchain is a nascent and rapidly changing technology and there remains relatively small use of blockchain networks and blockchain assets. The development of blockchain networks is a new and rapidly evolving industry that is subject to a high degree of uncertainty.

Factors affecting the further development of the blockchain industry include: continued worldwide growth in the adoption and use of blockchain networks and assets; the maintenance and development of the open-source software protocol of blockchain networks; changes in consumer demographics and public tastes and preferences; the popularity or acceptance of the Bitcoin or Ethereum networks; the availability and popularity of other forms or methods of buying and selling goods and services, including new means of using fiat currencies; government and quasi-government regulation of blockchain networks and assets, including any restrictions on access, operation and use of blockchain networks and assets.

The application of distributed ledger technology is novel and untested and may contain inherent flaws or limitations. Blockchain is an emerging technology that offers new capabilities which are not fully proven in use. There are limited examples of the application of distributed ledger technology.

The creation and operation of digital platforms for the public trading of blockchain assets will be subject to potential technical, legal and regulatory constraints.

Investments: Not FDIC Insured. No Bank Guarantee. May Lose Value.

“PNC Institutional Asset Management” is a registered mark of The PNC Financial Services Group, Inc.

©2021 The PNC Financial Services Group, Inc. All rights reserved.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images / MR.Cole_Photographer


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About the Author(s)
Amanda Agati, CFA

Amanda Agati, CFA, is the chief investment officer for The PNC Financial Services Group, Inc. In this role, she is responsible for the firm’s overall investment strategy, portfolio and risk management, investment solutions, and the development and execution of investment policies for PNC Wealth Management®, Hawthorn, PNC Family Wealth®, and PNC Institutional Asset Management®. Agati serves as chair of the PNC Investment Policy Committee and is a voting member of the Portfolio Construction Committee. She is also a member of the Investment Committee for PNC's pension fund and also serves on PNC's Corporate Diversity Council and Philadelphia/South Jersey Regional D&I Council and she is a PNC-certified Women’s Business Advocate. Prior to being named to her current position in April 2021, Agati was the Chief Investment Strategist for PNC. Her career began with investment banking, advisory, and equity research positions with Legg Mason and then with PNC. During her tenure at Legg Mason, she actively participated on the firm’s SRI group, focusing on environment, social, and governance issues and the use of fossil-free strategies in portfolios. Additionally, Agati was a member of Legg Mason’s Institutional Investment Committee and led the firm’s annual “Intellectual Capital” investment conference. She rejoined PNC in 2015 as an Institutional Investment Strategist. Agati graduated with a bachelor of science in finance and economics from Penn State University’s Schreyer Honors College. She also holds the Chartered Financial Analyst® (CFA) designation. She is also a member of the CFA Institute and CFA Society of Philadelphia, and sits on the boards of several nonprofit organizations.

Daniel Brady

Dan Brady is the chief investment strategist for the PNC Asset Management Group. In this role, he oversees all investment strategy-related activities for PNC Wealth Management®, Hawthorn, PNC Family Wealth®, and PNC Institutional Asset Management®. In addition, he leads the team that establishes overall strategic and tactical asset allocation guidance of client portfolios, manages the evolution of the investment processes, provides thought leadership on key investment issues, and is the author of numerous publications. He also performs research and analytics that help drive the overall investment recommendations of the firm while also managing the firm’s asset allocation models. Brady serves as a voting member of the Asset Management Group & Institutional Asset Management Investment Policy, and Investment Advisor Research committees. He is also a PNC-certified Women’s Business Advocate. Prior to joining PNC, Brady was a consultant at Clearstead, providing institutional investment advice to endowments, foundations, and retirement plans. During his tenure, he was an active member of the firm’s retirement plan committee and was involved in developing the firm’s pension indicator tool. Before his time at Clearstead, he was a Senior Portfolio Associate at the Glenmede Trust Company where he assisted portfolio managers in a holistic approach to wealth management and financial planning. Brady graduated with a bachelor of arts in economics from The Ohio State University. He is very active in his community and is a member of the Society of American Baseball Research.

Rebekah M. McCahan

Rebekah M. McCahan is an investment and portfolio strategist for the Investment Strategy team. She is responsible for investigating high-potential investment opportunities and conducting research that supports PNC's overall investment recommendations and asset allocation processes. McCahan collaborates with risk, compliance, and portfolio management teams to ensure a professional level of risk management and compliance oversight to the investment process. She is secretary of multiple investment policy and portfolio construction committees, responsible for collaborating with the committee chairs to maintain regulatory and fiduciary responsibilities. In addition, since 1986, McCahan has been delivering the research and analysis for the nationally released PNC Christmas Price Index. She has 40 years of financial industry experience, where she has held several positions, including economist, economic analyst, and investment strategist creating models and conducting macro research and analysis for publications and presentations. Before joining PNC, she was a statistician with Scudder Funds, managing the statistics both internally and externally including the prospectuses and multiple trade publications for all Scudder mutual funds. McCahan graduated with a bachelor of arts in mathematics from Wittenberg University.

Jake Moloznik, CFA

Jake Moloznik, CFA, is a director and client portfolio manager for the Investment Strategy group at PNC. In this role he provides investment and portfolio strategy across PNC Asset Management Group (AMG). Moloznik is responsible for multi-asset class strategy and analysis, including equity, fixed income, and alternative asset classes. Additionally, he co-authors numerous thought leadership publications and delivers presentations on these and other ad hoc topics. Prior to taking on his current role, Moloznik served as regional investment director for PNC Institutional Asset Management® (IAM) clients and prospects. Before joining IAM, he served as a portfolio manager with PNC Capital Advisors, LLC, overseeing the firm’s Target Date and Balanced Allocation mutual funds. He also served on the firm’s Asset Allocation Committee. Moloznik graduated with a bachelor of science in business administration from The University of Delaware. Moloznik also holds the Chartered Financial Analyst® (CFA) and Chartered Alternative Investment Analyst (CAIA) designations.

John Moore

John Moore is an investment and portfolio strategist for the Investment Strategy team. He is responsible for investigating high-potential investment opportunities and conducting research that supports PNC's overall investment recommendations and asset allocation processes. Prior to joining the Investment Strategy team in 2018, Moore served as the analyst to the PNC Capital Advisors (PCA) president and chief investment officer and the PNC Asset Management Group chief investment officer. In this role, he collaborated with PCA portfolio managers, PNC economists, and macroeconomic consulting firms to evaluate investment and fund complex strategies. He also authored weekly and quarterly market commentary for clients and the PCA Funds Board. Moore graduated with a bachelor of arts in economics from The University of Virginia and a master of science in commerce and finance from UVA McIntire School of Commerce.

4 thoughts on “Down the Rabbit Hole: A Cryptocurrency Primer”

  1. At this stage of fossil fuel fuelled climate crisis, it is gratifying to read explainers like this – particularly the rich commentary about proof of work cryptocurrency mining (eg Bitcoin), and the ethical implications for all investors – and especially ESG investors. Oh wait, could I be mistaken? Could it be true that there wasn’t a single mention of this at all? Remarkable. It can’t have been that important then. Climate issues are externalities after all, and we can let future generations deal with that while our higher risk client portfolios absorb the exciting benefits of speculative crypto assets.

  2. Jonathan Harris says:

    This has some interesting perspectives. I wish it covered more of the reasons a range of people consider cryptocurrencies a horrible product.

    Two issues I would like the authors to address:

    1) It is erroneous to apply Metcalf’s law to Bitcoin or most cryptocurrency networks. Larger networks have value because as the number of participants grows, it becomes more likely one will be able to use it to interact (pay, communicate, find) a desired peer. In the case of Bitcoin and cryptocurrency, the network does not provide added value. Crypto is more inefficient for payments, so you don’t get value from the likelihood that a counterparty will be on the network. The only potential value is political power to bring in new buyers, just like in a massive pyramid scheme.

    2) I think people need to investigate the role of misinformation and deception in promoting cryptoassets. I’ll give one of many examples from the CFA Institutes recent “Crypto Assets” Publication. To argue crypto is an efficient cross-border transfer mechanism, they claim a particular $1+B Bitcoin transfer cost $.68 compared with a “1-8%” cost of fiat transactions

    This claim is riddled with errors. 1) The Bitcoin transaction wasn’t even cross border, it was from one account to another at the same exchange. 2) They only account for a portion of the cost paid out of the transaction. They don’t even count the block reward paid to miners or the costs involved outside of the blockchain. 3) They greatly overstate the costs of fiat transactions. Zelle is free to retail customers and costs banks $0.50-$0.75.

    I have watched such gaslighting being used to sell Bitcoin since 2013.

  3. Anthony Deveaux says:

    Thank you for sharing a innovative information about cryptocurrency, Recently I had done a poverty proof cryptocurrency course to learn every thing about crypto. But I learned some interesting things from technical analysis. Informative blog.

  4. Olivia Smith says:

    Interesting..!!

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