Crypto: Not Solving The World’s Problems
“There is nothing new under the Sun.” Powerful and timeless quote. As much as we want to believe new technologies will permanently augment human behavior, our minds and bodies will always gravitate towards meaningful connection, family, and purpose. With the advent of tech and market disruptors, often we feel a revolutionary idea or product is going to upend the way we interact with the world and in the case of this blog, currency. Many technologies do improve our lives and allows us greater abilities. However, in some cases there is a reversion in use or complete failure to adopt. All this applies with regard to behavioral finance. In this respect, no matter what product/service you produce, you can’t change the human spirit.
As an investment, cryptocurrencies make very little rational sense. In fact, most seasoned investors could tell you there’s little reason to believe they are anything more than elaborate ponzi schemes. What they do offer, however, is a strong sense of community, a feeling of intellectual superiority, hope of an easy path to financial freedom and, perhaps the thrill of casino mimicking wild volatility.
In order for cryptocurrencies, like Bitcoin, to survive hinges on their primary use function: being a currency. There has been a wide adoption of Bitcoin as an investment, yet minimally has it been involved in transactions. It needs to be a currency first, investment second. Major stagnation in transactions involving crypto will occur if people believe there is more value in holding the currency rather than spending it. By definition, crypto will cannibalize itself and lose value if it is not being deployed in transactions and payments. Because the root of its value is currency functionality. If it’s not performing as a currency, then what’s the point? The price of crypto will need show long term stability without major gyrations in price while moving in lockstep with other macro economic events, metrics, and indicators. In American business, one of the least riskiest aspects is accepting payment. Credit cards, banks, and cash are highly stable and offer no risk to accept. Rarely does the retailer lose when accepting cash or credit. The average operating margin for a retailer is around 20% (high estimate). There are many operations that run on slim 3%-5% margin where volume is key. Why would one of these retailer ever consider accepting crypto in the current environment of volatility? There have been many situations whereas if a retailer took payment in crypto, their margins would have been eroded up to 40%!!! That’s insane. Effectively, they are paying people to buy their product in this scenario.
In business, you have to identify products or services that scale in order to achieve a global impact. Costs should reduce with volume. This is a simple business dynamic. My experience in performing a bitcoin transaction was clunky and horrendous. Based upon my experience and if the process I’m about to describe remains ceteris paribus, this climate of buying and using Bitcoin will not scale under this multi-fee, multi-headache structure. In 2019, I was getting some web work done and the developer, who was in Ukraine, only accepted Bitcoin as payment. I initially thought, ok no problem. I set up a Coinbase account and that was probably the easiest part to the whole thing. After that I needed to fund it. Coinbase said it would take 3–5 business days for a bank transfer to hit the account. I didn't have that kind of time since the work was already in progress and he demanded payment. So the developer suggested I find a local Bitcoin ATM and deposit cash in exchange for Bitcoin. I found the closest ATM, took $1000 cash down (this was the amount I owed the individual) and was met with a 15% charge for the exchange. Great. Now I needed more cash to deposit $1000 in my account because after fees, I was only left with $850 in Bitcoin. After rounding up all the cash I made a deposit of around $1400 in Bitcoin (I went over just in case). I was then hit with a transfer fee from Coinbase, then a fee to transact and another fee to convert my bitcoin back to cash so I could transfer the remaining back in my bank account. Fees on top of fees. Then I was met with a different problem, Bitcoin’s price had cratered in the time that I was holding it which eroded about 10% of its value. When you add this plus all the fees, my purchasing power relative to dollars was extremely diminished. How on Earth would anyone see this being efficient? All the work of deposit, fees, loss of value, etc cannot sustain broadly and appeal to ordinary individuals especially in a domestic setting. It's much easier to pay with credit card or Paypal. However, please note, I do believe eventually this will change and become more user focused.
Recently, Warren Buffett made an excellent point about Bitcoin. He referenced “The Greater Fool Theory” in his interview. This theory suggests that one can sometimes make money through the purchase of overvalued assets — items with a purchase price drastically exceeding the intrinsic value — if those assets can later be resold at an even higher price.
In this context, one “fool” might pay for an overpriced asset, hoping that he can sell it to an even “greater fool” and make a profit. This only works as long as there are enough new “greater fools” willing to pay higher and higher prices for the asset. Eventually, investors can no longer deny that the price is out of touch with reality, at which point a sell-off can cause the price to drop significantly until it is closer to its fair value, which in some cases could be zero. Bitcoin, just like gold, doesn’t yield or produce. If someone invests in a farm, theoretically that farm expands (cows give birth, crops continue to grow, etc.). Same with a stock, the company will grow and continue to make money for investors. Bitcoin is just computer code. It does not grow or produce.
One statement I hear quite often that typically walks in as the precursor to debate is the belief that cryptocurrency will circumvent our current banking system. This is just simply not true. The banks ability to create money has long been the cornerstone of America’s growth. This is a banks primary role. Loans to fund farms, fuel expansion of a public traded company, or lead new innovations to fruition through its development has largely been attributed to a bank’s products. I think most people confuse our conventional banking systems (commercial and investment) with a government’s central banking system. Very separate institutions. Even if crypto became widely adopted, banking dynamics would have to exist in order to have a stable and growing economy. What this means is crypto would have to be bankable. Loans would have to be issued against warehoused crypto wallets. Companies would need to issue bonds in the form of crypto to fuel growth. Can you imagine a AAA rated bond yielding a 4% coupon that is met with extremely currency volatility? Yeah, no thanks as investor. A robust economy simply cannot function without the ability to create money set forth by our banking system with a net that includes protection of assets. Banks guarantee safety of deposits (up to $125k) and are constantly improving security measures. For instance, why would I not send a payment through Zelle which will protect my transaction versus Bitcoin, which offers no protection. Even with a public ledger, it does not account for any recourse should the payee commit some type of fraud. Now, crypto fans are adamant about infusing the idea that it is decentralized in the context of it being able to roam free without boundaries, being absolved from outside market forces. Just look at the last few years, this should highlight the delusion that crypto is immune from our financial system. The reality is crypto is already dominated by major wealthy investors, big companies, and large platforms. When something goes wrong, it spreads fast inside this network dragging other coins down.
Another hurdle that is screaming to be overcome is it lacks regulation from government authority as an investment. In fact, the best way to support a higher public interest in crypto, would be the advent of regulation. This will need to happen and an order will need to be ceded. Cryptocurrencies are often presented like an investment, guising as a security, however with no required filings, company information, details, or ability to conduct proper due diligence as an investor, you are limited. American law defines securities to include any “investment contract” that produces an asset for which an owner can expect to accrue returns depending on the effort of a promoter. The SEC recently has suggested Bitcoin does not meet this standard. An entity’s issuance of crypto tokens is strikingly similar to the issuance of equity shares. If the organisation does well, the value of its tokens goes up. This makes it hard to argue they are not securities. All financial securities that are heavily regulated by the SEC. Crypto is technically not a security, yet it functions just like a security. Investor looking to add crypto to their portfolio need to be wary. For instance, there is no law or regulation barring groups to start a cryptocurrency on their own, pump it on social media using athletes social influencers to drive traffic and buyers to run up the price. These groups then down-sell their holdings when the price skyrockets. How is this any different than the pump and dump schemes we saw in the 1980s and 1990s? its functioning exactly like a pump and dump scheme that we saw in the famous movie Wolf of Wall Street. With lack of oversight, these scammers who create these crypto currencies by promoting its “value”, in turn, driving up the price through manipulative tactics and selling their positions. Pocketing a profit, there’s no regulation that exists or any rules governed by the SEC for these people to adhere and be held accountable for, which is a fundamental problem for investors.
Like any new technology, how we see it interacting in our future, often differs tremendously to how its function settles in user application decades to come. Furthermore, most often, it becomes something entirely different. New technologies are often hard to predict how humans will interface and adopt the changing technology. Often times, technologies can become obsoleted in favor of something new and improved. Interesting historical fact, there was a time when Socrates said writing things down would ruin people’s memories. People have been historically consistent at fearing new technologies. Many times we see technology spawn and create bi-products that were not its original intent. This deviation from allows creation of new opportunities and industries. I feel we will witness the same pattern in crypto, decades to come. It may land that it doesn’t function much as a currency however something like the Ethereum blockchain becomes a safe haven for companies to manage and store digital assets. With the rise in cyber attacks, IT security needs an intense approach to combat breaches. Blockchain may be able to solve this problem…or at least mitigate it. One reason why I believe there has been such an increase in ransomware attacks is due to the popularity of Bitcoin. Bitcoin incentivizes black market activity. It's much easier to receive a Bitcoin payment, then it is cash, credit, or Paypal. It simply makes it safer and offers less risk of getting caught for the predators. This was the primary motivation for Ross Ulbricht to start the illegal website, Silk Road, in 2011. The Silk Road was a dark-web marketplace that was only accessible through the Tor browser which sold drugs, guns, and other illegal items/services, only accepting Bitcoin. Ross was eventually caught in 2013 and is serving a life sentence in a Federal prison just outside Tucson, AZ. I believe Bitcoin has given rise to increased black market activity. An appropriate use of blockchain could migrate to storing digital receipts, recording legal documents (deeds, marriage licenses, divorce records,) maintenance records of airplanes, vehicles, bank ledgers, and other important documents that can be subjected to manipulation.
There are 180 currencies issued by central banks and governments all over the world. Yet there are over 19000 cryptocurrencies (and growing by the day). It’s surprising to me how this is never brought up. You remember supply and demand from high school economics? Yeah just like that. If we keep pumping in supply of crypto, the value drops because the supply is high. I want to buy a multi million dollar jet. I just created my own crypto: JJOKERSTCOIN. I’m pricing each coin at $1 and have 100 million coins. I’m rich! Going to go buy that Gulfstream with my newly minted crypto (this is actually what some people believe). Currencies need to be backed by something of value that can be easily accessible. Period. You cannot have a true fiat situation. Now, this is the part where you say “Hey the U.S. Dollar is a fiat currency because we got off the Gold Standard decades ago!”. EGHHHH. WRONG. Most Americans confuse this. Fortunately for us, we DID get off the gold standard and backed our currency up by something much more valuable: Uncle Sam. That’s right, the U.S. Government has done a phenomenal job at protecting, encouraging, and fostering commerce in our nation. Supporting intellectual property rights, trains, networks, bridges, military, loan programs, banking, The Commerce Clause, laws, etc. (You get the idea). These valuable sets of infrastructure is what allows our economy to thrive. The government’s budget isn’t supposed to balance. Our economy is. The budget is just a tool to add or subtract dollars from the rest of us. Expanding the money supply is a perfect legitimate tool for central banks to use in pursuit of low employment. You get jobs at the expense of inflation. However, a certain level of unemployment is necessary to keep inflation stable. If monetary policy induces greater inflation, then workers real income diminishes. The government’s role is to constantly balance and rebalance effective monetary and fiscal policy to reduce fear and encourage spending and investment. This secures our dollar’s value in perpetuity. In addition, the dollar is highly sought out globally and continues to be extremely valuable. Back to money creation, if we were still backed by gold, we’d be in a world of hurt. We would not be able to properly maximize the complex platform the government has built in order to create money which in turns fuels the velocity of transactions, which in turn fuels a competitive market, which in turn fuels cheaper prices and job growth. This comprehensive approach to a backed and stable currency far surpasses anything computer code money will likely ever be able to do in the near future.
Now, I’ve been doing tremendous amount of criticizing of crypto. Let's talk about one good thing it can provide: balance in emerging, developing, struggling, or war torn countries. In February of 2022, Vladimir Putin invaded Ukraine. Immediately, Russian citizens experienced hyperinflation of the Ruble. Citizens were desperately trying to withdrawal rubles from banks and institutions. Crypto was able to insulate those citizens that transferred their cash into crypto protecting them from major devalue of their cash assets due to war. A much more positive approach is crypto’s ability to challenge central banks. For instance, if you have a government or central bank that is behaving badly, disregarding the interest of citizens and commerce by lack of or extreme policies that is devaluing its currencies. Citizens have the discretion to choose to transact with Bitcoin amongst each other to circumvent their country’s highly unstable currency. This provides a balance of power against governments and central bank and in theory, could be recognized as a threat thus keeping bad groups in governments in check from igniting extended periods of hyperinflation. In addition, the community surrounding the crypto environment is fascinating. Bitcoin enjoys an unprecedented network effect in its community. The network effect is a phenomenon whereby increased numbers of people or participants improve the value of the goods or services. In the case of Bitcoin, you have many participants involved verifying transactions and increasing the value of its strong network. The greater the value of the network, the gravity of attraction to new users becomes. Thus, exponentially increasing widespread user adoption.
I think crypto, as an investment, has a long way to go before it can be a safe investment, if at all. Technology should focus more on improving the blockchain to be more efficient, secure, and reducing energy consumption. I am excited to see where blockchain goes in our society and how future generations will one day benefit from it.
