Virtual asset cap needed to create a sound market

The author is a professor of economics at Seoul National University and a former vice chairman of the Financial Services Commission. Whenever tensions between the United States and Iran have escalated recently, major asset prices, including stock prices, have reacted immediately and shown sharp volatility. Such abrupt price swings had already been common in the virtual asset market long before the Iran war. Bitcoin, which began a bull run after U.S. President Donald Trump returned to office and surged to the 170 million won ($123,000) range in the second half of last year, plunged earlier this year to the 80 million won range — less than half that level — before rebounding to nearly 120 million won as the possibility of an end to the war emerged. In other words, its price halved and then rose 50 percent again within six months. The volatility of virtual assets is far greater than that of stocks. Over the 10 years since 2016, the average standard deviation of daily returns for shares of Samsung Electronics, SK hynix and Hyundai Motor stood at 0.294 percent, 0.414 percent and 0.355 percent, respectively. For Bitcoin, Ethereum and Ripple — with Ethereum and Ripple calculated from Nov. 12, 2017, and converted into Korean won — the figures were much higher, at 0.666 percent, 0.853 percent and 1.065 percent, respectively. Why do virtual asset prices fluctuate more sharply than stock prices? More basically, how are virtual asset prices determined? The defining characteristic of virtual assets is that the fundamentals that determine their prices are unclear. Owning shares of Samsung Electronics is tantamount to owning a stake in the company, and the price will change depending on how well Samsung Electronics performs in the future. But if one owns Bitcoin, what does that mean beyond the fact of holding Bitcoin itself? A common misunderstanding about owning virtual assets is the belief that ownership of a virtual asset means ownership of the technology embedded in it. The technology embedded in a virtual asset belongs to the person or entity that created it. Simply owning the virtual asset does not mean the underlying technology itself belongs to the holder. Where does the value of virtual assets come from? Virtual assets have no intrinsic value, but existing research suggests that value may arise for several reasons. First, although they may be more limited than ordinary currencies, virtual assets can serve as a medium of exchange and may generate utility in that capacity. Second, like other assets, virtual assets can be used as a store of value and as a hedge against inflation. In this sense, they are sometimes called "digital gold." Third, some argue that virtual asset prices depend on production costs and, in particular, converge toward marginal production costs. Fourth, the value of a virtual asset is said to be proportional to the value of the network that holds and uses it. Fifth, virtual assets can be used for money laundering or to bypass capital controls, and value may arise from that function. These are various explanations for how virtual assets may acquire value, but it is not easy to reach a clear conclusion on which explanation is correct. As with other assets, bubbles can also emerge regardless of fundamentals, driven simply by the expectation that prices will rise. Some analyses suggest that virtual assets are especially prone to large bubbles because of the uncertainty surrounding their fundamentals, the absence of circuit breakers, the inelasticity of supply and their stronger sensitivity to popularity and investor attention. In addition to the difficulty of predicting prices and their high volatility due to unclear fundamentals, virtual assets also differ from ordinary financial products in ways that investors should keep in mind. First, transaction costs are higher than in traditional financial markets, meaning frequent short-term trading can cause costs to accumulate and make it difficult to earn profits. The...