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    Digital Asset Valuation and Cyber Risk Measurement: Principles of Cybernomics
    Digital Asset Valuation and Cyber Risk Measurement: Principles of Cybernomics
    Digital Asset Valuation and Cyber Risk Measurement: Principles of Cybernomics
    Ebook630 pages9 hours

    Digital Asset Valuation and Cyber Risk Measurement: Principles of Cybernomics

    By Keyun Ruan

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    About this ebook

    Digital Asset Valuation and Cyber Risk Measurement: Principles of Cybernomics is a book about the future of risk and the future of value. It examines the indispensable role of economic modeling in the future of digitization, thus providing industry professionals with the tools they need to optimize the management of financial risks associated with this megatrend. The book addresses three problem areas: the valuation of digital assets, measurement of risk exposures of digital valuables, and economic modeling for the management of such risks. Employing a pair of novel cyber risk measurement units, bitmort and hekla, the book covers areas of value, risk, control, and return, each of which are viewed from the perspective of entity (e.g., individual, organization, business), portfolio (e.g., industry sector, nation-state), and global ramifications. Establishing adequate, holistic, and statistically robust data points on the entity, portfolio, and global levels for the development of a cybernomics databank is essential for the resilience of our shared digital future. This book also argues existing economic value theories no longer apply to the digital era due to the unique characteristics of digital assets. It introduces six laws of digital theory of value, with the aim to adapt economic value theories to the digital and machine era.
    • Comprehensive literature review on existing digital asset valuation models, cyber risk management methods, security control frameworks, and economics of information security
    • Discusses the implication of classical economic theories under the context of digitization, as well as the impact of rapid digitization on the future of value
    • Analyzes the fundamental attributes and measurable characteristics of digital assets as economic goods
    • Discusses the scope and measurement of digital economy
    • Highlights cutting-edge risk measurement practices regarding cybersecurity risk management
    • Introduces novel concepts, models, and theories, including opportunity value, Digital Valuation Model, six laws of digital theory of value, Cyber Risk Quadrant, and most importantly, cyber risk measures hekla and bitmort
    • Introduces cybernomics, that is, the integration of cyber risk management and economics to study the requirements of a databank in order to improve risk analytics solutions for (1) the valuation of digital assets, (2) the measurement of risk exposure of digital assets, and (3) the capital optimization for managing residual cyber risK
    • Provides a case study on cyber insurance
    LanguageEnglish
    PublisherAcademic Press
    Release dateMay 29, 2019
    ISBN9780128123287
    Digital Asset Valuation and Cyber Risk Measurement: Principles of Cybernomics
    Author

    Keyun Ruan

    Keyun Ruan is a computer scientist and author. Coined the term “cloud forensics” in 2009 during her Ph.D. in cybercrime investigation, Keyun pioneered the field with foundational publications, talks, and edited the world’s first academic reference book, making her one of the most cited scholars on the topic. She led and contributed to working groups commissioned by the U.S. government and European Commission to advance industry standards of cloud computing and the future of digital infrastructure. She has advised large telecommunications companies, fast growing risk analytics and Fintech start-ups, as well as global financial services companies on cloud security and risk management. She has been involved in cyber risk measurement and economic modelling for leading insurers and reinsurers since 2012.

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      Book preview

      Digital Asset Valuation and Cyber Risk Measurement - Keyun Ruan

      cybernomics.ruankeyun.com.

      Chapter 1

      Digital Assets as Economic Goods

      Abstract

      This chapter first looks at the origins and philosophical concept of value, the different schools of thoughts from the subjective and objective views of value, the differences between intrinsic and extrinsic value, the definition of traditional assets, the definition of economic goods, and current asset valuation methods. Then, five unique characteristics of digital assets distinct from traditional assets are outlined. For example, the most fundamental assumptions of the discipline of economics are that: (1) the amount of resources available for a society is limited; and (2) the market exists as a measure of substitutability of those limited resources. To find optimal distribution of resources by means of free competition under these assumptions has always been thought to be the fundamental purpose of economics. Today, some argue limitless computing has arrived, making digital value theory inherently unique from past theories. This chapter then defines intrinsic digital value, extrinsic digital value, and a digital value matrix for categorizing digital assets according to their economic functions, this is, core value versus supporting value, digitized versus digital native, rather than technical functions, for example, software, hardware, etc. Attributes of digital assets that contribute to intrinsic and extrinsic value creation are then discussed along with measurement methods. This chapter closes with a review of current methods used for digital asset valuation.

      Keywords

      Intrinsic digital value; extrinsic digital value; digital asset valuation; digital value matrix; characteristics of digital assets

      Chapter Outline

      1.1 Origins and Philosophical Concepts of Value 2

      1.1.1 Subjective View Versus Objective View 2

      1.1.2 Intrinsic Value Versus Extrinsic Value 4

      1.2 What Is an Economic Good? 4

      1.3 What Is an Asset? 5

      1.3.1 Definition of Asset 5

      1.3.2 Current Asset Valuation Methods 5

      1.4 What Are Digital Assets? 6

      1.4.1 Categorization of Digital Assets 7

      1.4.1.1 (Networked) System Assets 7

      1.4.1.2 Software Assets 7

      1.4.1.3 Hardware Assets 7

      1.4.1.4 Service Assets 7

      1.4.1.5 Robotic Assets 8

      1.4.1.6 Data Assets 8

      1.4.1.7 Metadata Assets 8

      1.4.1.8 Digitally Enabled Devices 8

      1.4.2 Managing Digital Assets in an Organization 8

      1.4.2.1 Information Resource Management 9

      1.4.2.2 Digital Assets Management 9

      1.5 Unique Attributes of Digital Assets 9

      1.5.1 Characteristic 1: Digital Value Creation Does Not Decrease but Increases Through Usage 10

      1.5.2 Characteristic 2: Duplication Does Not Increase Digital Value 10

      1.5.3 Characteristic 3: Digital Value Production and Distribution Entails Higher Fixed Costs and Lower Variable Costs 10

      1.5.4 Characteristic 4: Digital Value Can Be Distributed via Multi-Sided Markets 10

      1.5.5 Characteristic 5: Digital Value Is Limitless 11

      1.5.5.1 Characteristic 5a: Digital Value Has Limitless Utility to the Owner 11

      1.5.5.2 Characteristic 5b: There Are Limitless Opportunities to Distribute and Consume Digital Value 11

      1.6 Digital Value Matrix: Categorization of Digital Assets Based on Their Economic Functions 11

      1.6.1 Digital Asset on an Individual Level 13

      1.6.2 Digital Asset on an Organizational Level 13

      1.6.3 Digital Asset on a National Level 14

      1.6.4 Digital Asset on the Global Level 14

      1.7 Valuation of Digital Assets as Economic Goods 14

      1.7.1 Attributes of Digital Assets Contributing to Intrinsic Digital Value Creation 14

      1.7.1.1 Data Quality 14

      1.7.1.2 Risk Exposure 15

      1.7.1.3 Age 15

      1.7.1.4 Data Volume 18

      1.7.1.5 System Quality 19

      1.7.1.6 Production Cost 19

      1.7.2 Attributes of Digital Assets Contributing to Extrinsic Digital Value Creation 19

      1.7.2.1 Exclusivity 19

      1.7.2.2 Network Connectivity 20

      1.7.2.3 Accessibility 20

      1.7.2.4 Reproduction Cost 21

      1.7.2.5 Economies of Scale 21

      1.7.2.6 Data Format 21

      1.7.2.7 Level of Structure 22

      1.7.2.8 Delivery Cadence 22

      1.7.2.9 Power Supplies 22

      1.8 Existing Challenges for Digital Asset Valuation 23

      1.8.1 Inherent Challenges 23

      1.8.2 Market Challenges 23

      1.8.3 Taxation Challenges 23

      1.8.4 Regulatory and Standardization Challenges 23

      1.9 Current Methods for Digital Asset Valuation 23

      1.9.1 Intrinsic Value 24

      1.9.2 Direct Conversion of Financial Value 24

      1.9.3 Business and Performance Value 24

      1.9.4 Cost-Based Models 25

      1.9.5 Market-Based Models 26

      1.9.6 Income-Based Models 27

      1.9.7 Option Models 27

      What you risk reveals what you value.

      Jeanette Winterson

      1.1 Origins and Philosophical Concepts of Value

      The concept of value lies at the core of the economic adjustment process, which organized the economic life of society as the basis for deciding what to produce, how to produce, and who gets it. The debate of how value itself was formed has lasted for millennia, dating back to pre-Christian times, when Aristotle (384 BC–322 BC) famously argued that value is based on the need of exchange (Aristotle, 350 BC). It is a fundamental subject of study in philosophy, economics, finance, and risk management (Fogarty, 1996). Theory of value is a generic term that encompasses all the theories within economics that attempt to explain the exchange value or price of goods and services. Key questions in economic theory include why goods and services are priced as they are, how the value of goods and services are determined, and how to calculate the correct prices of goods and services. Value theory is the major intersection between economics and philosophy. The search for a theory of value is really a search for a consistent foundation for economic theory (Taylor, 1996).

      1.1.1 Subjective View Versus Objective View

      The historical evolution of the value debate has been locked into centuries of old dialectical conflict between objective and subjective approaches, which focus, respectively, on the conditions of production and on the preferences of consumers.

      The objective approach is taken primarily in classical political economy, the labor theory of value and the Sraffian revival of classical value theory in the 20th century. Intrinsic theories hold that the price of goods and services is objectively determined by labor, cost of production, etc., and is not a function of subjective judgment (Smith, 1776; Marx, 1867). The cost of production theory of value is the theory that the price of an object or condition is determined by the sum of the cost of the resources that went into making it. The cost can comprise any of the factors of production (including labor, capital, and land) or taxation. Historically, the best-known proponent of this theory is Adam Smith (1723–90), who also developed the Water–Diamond Paradox:

      The things which have the greatest value in use have frequently little or no value in exchange; and on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.

      Smith (1776)

      The labor theory of value argues that the economic value of a good or service is determined by the total amount of socially necessary labor required to produce it. It is central to Marxist theory, Karl Marx (1818–83) took the labor theory developed by David Ricardo (1772–1823) and constructed it in a societal manner. Marxist theory holds that the working class is exploited under capitalism, and dissociates price and value (Marx, 1867). Ricardo was also searching for a measure of value, which he found to be truly impossible as the technology of production of a good or service changes or advances, so does its value. The forces that determine the distribution of income also varies with technological change (Ricardo, 1817).

      The subjective approach is taken primarily in neoclassical economics, with an emphasis on marginal utility, productivity, equilibrium, and enhancements to utility analysis developed in the late-19th and early 20th centuries. Subjective theories hold that an item’s value depends on the consumer, and it must be useful in satisfying human wants and must be in limited supply (Stigler, 1950). The utility theory of value was the belief that price and value were solely based on how much use an individual received from a commodity. Pioneered by William Stanley Jevons (1835–82), Carl Menger (1840–1921) (Menger, 1871), and Marie-Esprit-Léon Walra (1834–1910) (Walras, 1874), and then further developed by Alfred Marshall (1842–1924), marginal theory of value focuses on the determination of goods, outputs, and income distributions in markets through supply and demand. This determination is often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits by firms facing production costs and employing available information and factors of production, in accordance with rational choice theory (Marshall, 1890). Today neoclassical economics is usually used to refer to mainstream economics, which rests on three assumptions (Fogarty, 1996; King and McLure, 2014):

      1. People have rational preferences between outcomes that can be identified and associated with values.

      2. Individuals maximize utility and firms maximize profits.

      3. People act independently on the basis of full and relevant information.

      From these three assumptions, neoclassical economists have built a structure to understand the allocation of scarce resources among alternative ends. The problem of economics was presented by William Stanley Jevons as:

      Given, a certain population, with various needs and powers of production, in possession of certain lands and other sources of material: required, the mode of employing their labour which will maximize the utility of their product.

      Jevons (1871)

      Below are some fundamental definitions central to economics and the concept of value:

      • Cost: the amount incurred in the production of goods and services.

      • Price: the financial reward for providing a good or service including the cost and profit margin, charged by the seller.

      • Money: a current medium of exchange in the form of coins and banknotes. Money is used to pay the price of a good or service.

      • Trading: trading is the action or activity of buying and selling goods and

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