Library/CFA (Chartered Financial Analyst)/JuiceNotes 2024: Alternative Investments - CFA Level I/Introduction to Digital Assets

Introduction to Digital Assets

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Distributed Ledger Technology (DLT) and Blockchain5 min

DLT is the technological infrastructure allowing for the creation and peer-to-peer exchange of financial assets. It relies on a distributed network rather than a central authority. The system comprises a digital ledger, a consensus mechanism for validating updates, and a participant network. Cryptography ensures security and identity. Blockchain is a specific form of DLT where records are stored in sequential, chained blocks. Network participation can be Permissionless (open to all, e.g., Bitcoin) or Permissioned (restricted). Validation occurs via mechanisms like Proof of Work (energy-intensive) or Proof of Stake (capital-based).

Key Points

DLT uses a distributed ledger for peer-to-peer tracking.
Consensus mechanisms ensure transparency and immutability.
Smart contracts are self-executing programs within the ledger.
PoW involves mining; PoS involves staking capital.
Permissionless networks lack a central authority.

Types of Digital Assets5 min

Digital assets are broadly categorized into Cryptocurrencies and Tokens. Cryptocurrencies function similarly to currencies or stores of value and include Bitcoin, Altcoins (alternatives to Bitcoin), Stablecoins (pegged to stable assets), Central Bank Digital Currencies (CBDCs), and Memecoins. Tokens usually represent specific rights or utility within a network. These include Non-Fungible Tokens (NFTs) for unique assets, Security Tokens representing ownership stakes, Utility Tokens for network access, and Governance Tokens for voting rights.

Key Points

Major categories: Cryptocurrencies vs. Tokens.
Stablecoins aim to reduce volatility.
NFTs represent unique, non-interchangeable assets.
Governance tokens grant influence over protocol decisions.

Investment Forms and Risk Characteristics5 min

Investors can access digital assets directly or indirectly. Direct methods involve holding assets in wallets or trading on Centralized (CEX) or Decentralized Exchanges (DEX). Indirect methods include Coin Trusts, Futures contracts, ETFs, and stocks of related companies. The chapter also introduces DeFi (Decentralized Finance) and asset-backed tokens. Regarding risk and return, digital assets are noted for rapid appreciation but high volatility and uncertainty. A key valuation challenge is the lack of underlying cash flows. However, they historically show low correlation with traditional investments, providing diversification benefits.

Key Points

Direct investment uses wallets and exchanges (CEX/DEX).
Indirect investment uses ETFs, futures, and trusts.
Digital assets generally lack underlying cash flows.
Low correlation with traditional assets aids diversification.

Questions

Question 1

Which of the following best defines Distributed Ledger Technology (DLT)?

Introduction to Digital Assets

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