Demystifying the link between VDAs and blockchains

Virtual digital assets (‘VDAs’) are becoming increasingly mainstream. With recent amendments to the Prevention of Money Laundering Act, India has taken a substantial step towards governing this space. The conversation has also received global traction as it features as a key agenda item in India’s ongoing G-20 Presidency.

While there is increasing acceptance around the untenable value of VDAs, the topic is still riddled with jargon and is somewhat inaccessible to the larger public. There also still exist critics who often deem VDAs as ponzi schemes with no underlying value. This article seeks to break down the true value of VDAs in simple terms.

How are VDAs and Blockchains Linked
In order to understand the value of VDAs, it is first important to understand what a blockchain is. One can think of public blockchains as digital ledgers, similar to online spreadsheets, shared across and maintained by a network of participants who view and validate the stored data.

Such blockchains enable participants to transact with one another on the network without the involvement of a central server and all these transactions are recorded on the database in a distributed manner by multiple network computers. These computers are called nodes. They initiate transactions on the request of network participants and verify transactions initiated by other nodes.

VDAs play a fundamental role in the functioning of public blockchains. They create incentives and disincentives for nodes and other network participants to engage with the blockchain, productively.

For example, on the Polygon network, MATIC is used to pay nodes for services like sending transactions or running smart contracts. Without MATIC, the whole system wouldn’t work as nodes would not have any incentives to engage with the network. In the same vein, to discourage malpractices, blockchain networks leverage mechanisms such as “proof of stake”.

Nodes that validate a transaction need to “stake” their VDAs and risk losing some or all of them if they conduct fraud. Many blockchains actually destroy one’s stake as a penalty for some provable attempt at corrupting consensus data.Ascertaining the Value of VDAs
It is clear that VDAs are fundamental to the functioning of any public blockchain. No transaction can be initiated on such blockchains without VDAs. At their core, VDAs enable the transfer of value digitally without the involvement of a third party, with assets native to the internet. This is something that thus far, has been impossible. Therefore, the fact that VDAs have value is clear beyond doubt. Given their novelty, however, the process of ascertaining this value is slightly different from that of traditional assets as their cash flows are not as predictable. Like any other asset, the underlying value of VDAs depends on several factors such as its core characteristics, demand, supply, network effects, and utility.

The importance of Scarcity, Fungibility and Durability in VDAs
The core characteristics of VDAs are essential in determining their value. These characteristics include scarcity, fungibility, durability, portability, security, decentralization, programmability, and the use case of the underlying blockchain. Each of these characteristics plays a crucial role in determining the value of a VDA. For instance, scarcity is an essential feature that makes Bitcoin valuable. It has a limited supply of 21 million coins, which ensures that it maintains its value over time.

The Role of Network Effects and Utility in VDA Valuation
Another factor that is key to the value of crypto-assets is the network effect and the utility it offers on the blockchain. Crypto assets are the key mechanism through which blockchains incentivise players to engage constructively with the network and build on it. The more developed the use cases and network effects of a particular blockchain, the more valuable its native token will be, resulting in higher earnings for participants who hold it. This drives participants to bolster the robustness and value proposition of the blockchain they’re invested in. If participants do not see any value in obtaining the token, there is no reason for them to be part of the blockchain and such a network would cease to exist. As a natural corollary, if the network is robust and the blockchain has a sound value proposition, its native token will have value. The transfer of tokens in the secondary market also ties in here and contributes to the value of the token, as a consequence bolstering the blockchain.

How Demand and Institutional Adoption Impact VDA Valuation
The demand for VDAs is another important factor in determining the value of crypto assets. On-chain metrics such as active addresses, exchange wallet flows, adjusted trade volumes, hash rates, and funding rates can be used to measure demand. Institutional adoption is also reflective of the value of a crypto-asset. If a crypto-asset is widely adopted by institutions, it is likely to have a higher value than one that is not.

Transparent Supply: A Unique Feature of Crypto-Assets
While some factors that impact valuation are seemingly harder to ascertain in the crypto- ecosystem, other factors like supply are more transparent in this space as compared to other traditional assets. Most crypto-assets have defined and open policies regarding their supply. In the case of Bitcoin for instance, based on consensus rules, new supply is created as miners receive block rewards, with a gradually decreasing amount of Bitcoin added to the total supply and distributed to a miner approximately every ten minutes. Block rewards are halved approximately every four years, and supply is capped at 21mm bitcoin in total. After 21mm bitcoin have been mined, miners are expected to continue to validate transactions on the network in exchange for a portion of network fees.

Conclusion: The Future of VDAs and Blockchain
VDAs are a transformative technology that enables never seen before-use cases. They have intrinsic value and it is both in India and Indians’ benefit to engage in them as they form the foundation for public blockchains. By working together, we can ensure that this technology is used to its full potential to create a better financial future for all.

(The author is Chief Public Policy Officer, CoinDCX)