Jan 2022
“I really like Bitcoin. I own Bitcoins. It’s a store of value, a distributed ledger. It’s a great place to put assets, especially in places like Argentina with 40 percent inflation, where $1 today is worth 60 cents in a year, and a government’s currency does not hold value. It’s also a good investment vehicle if you have an appetite for risk. But it won’t be a currency until volatility slows down.”
― David Marcus, CEO of Paypal
“Of course I hate the success of bitcoin. I don’t welcome a currency that’s so useful to kidnappers and extortionists, nor do I like just shoveling out a few extra billions and billions of dollars to somebody who just invented a new financial product out of thin air. I think I should say modestly that I think the whole damned development is disgusting and contrary to the interests of civilization.”
― Charlie Munger, Berkshire Hathaway
About a decade ago I made a bet with a close friend of mine about cryptocurrency. He firmly believed that Bitcoin would go mainstream and be accepted everywhere as a payment method and I firmly believed that it would not. Essentially, would this become a competitive digital currency or not?
So to determine who wins, we decided that in 10 years time if you could use a Bitcoin at a major local grocery store, as blue chip as it gets, then he would win; and if you couldn’t then I would win. At the time we made this bet each Bitcoin was worth $20. Here we are 10 years later and you can’t use a Bitcoin at the local grocery store. But a Bitcoin is today worth $50,000 instead of $20 when we made this bet.
What I should have done if I was smarter is buy Bitcoin as well as bet for it to fail thereby hedging the bet. But I didn’t do that. I generally find it hard to make internally non-aligned investment decisions. I like to have internal alignment before I invest in something which is perhaps a personal flaw.
But the thing is, the price of a Bitcoin isn’t the point of a Bitcoin. But most discussions about it are dominated by arbitrary price speculation. Will it be $1,000 or $10,000 or $100,000 or $100 or $1,000,000? All of these numbers are essentially people guessing at what a digital token is worth.
Which is trying to guess at what something is worth if everyone believes something is worth that much. It’s not inherent to the thing itself. There’s no business or productive use of it by which to value it with which you would use for a stock. It’s just speculation about how much are large groups of people willing to pay for this thing.
This reminds me very much of discussions in history about what a Tulip or an Ostrich are worth? How do they determine it’s worth? Well other people are prepared to pay X, so it must be worth that right? Which starts this entire philosophical discussion about what is value and what is control. Who determines value and control, is it individuals or networks of people or is it governments and institutions. The truth is there’s no real answer to any of that.
What is interesting to me is that in that 10 years since the bet, something weird happened. It used to be that Bitcoin was a new currency and will replace money. Now it’s turned into a type of digital gold and is an inflation hedge. And then definitionally it became a transaction payments protocol that you could run payments infrastructure on. And then it became a foreign exchange (FOREX) system to send money overseas into other currencies with less fees. And then you could securitise it to the stock of your company and do an Initial Coin Offering which is similar to selling shares. Then it became an inflation hedge and a type of digital gold used as a store of value etc etc.
Even though there is literally a white paper by the creator of Bitcoin that describes exactly how it works and what it is used for. Everyone seems to have a different opinion and even most believers of cryptocurrencies disagree with or append additional utility to what was described in the white paper. Such that it has morphed into a sort of multi headed Hydra of what it was first designed as. Every time you realise it’s not good at one thing, it seems to develop a new thing it’s good for and so on.
What exactly it is and it’s utility is something no-one can seem to agree on and keeps changing after every cycle of speculation and debate. It could be all of those things or it could be none of those things. It could be the most useful thing in the world or it could be entirely useless and a bad use case for everything.
Two funny anecdotes I’ve enjoyed that I read somewhere were “the biggest marketing tactic ever pulled was rebranding MYSQL databases as Blockchain.” or it’s opposite “Blockchains are like Manhattan real estate, they’re never going to make more land and then what you want to build is up to you.” I don’t know where I read each but I really enjoyed and agree with both.
I’m going to stay away from the philosophical side of things and instead talk about what are some basic observations and things I’ve noticed that I dislike about cryptocurrency generally. Some things that really bother me and prevent me from jumping in as a true believer and definitely leave me on the sceptical side.
It’s a Security not a Currency
I’m not 100% sure on the use case for much of what you can do with cryptocurrencies. But most people are not using it for all those things. What most people are definitely using cryptocurrency for is investment speculation. They are treating these digital tokens like securities that are not regulated and trading them as such.
Why are securities regulated in the first place? It’s to avoid market manipulation by participants. This is what happens in crypto. There is massive amounts of market manipulation occurring. Pump and dump schemes, insider trading, coordinated buying pools, wash trades, price fixing, insiders lying about it et al are just some of what happens regularly every day.
But they’re not illegal to do in cryptocurrency markets the way they are in stock markets. Because a currency market doesn’t normally behave like a securities market, until now. Even the word use implies people within Crypto are talking about it like a stock or security. They say things like the market capitalisation of Bitcoin or Ethereum. But strictly market cap doesn’t apply to currency.
Market capitalisation is a term that comes from the capitalisation table of companies which are tables of all their shares and securities issued. You don’t use market cap for measuring how much money there is, like nobody says the market cap of the US dollar when they’re referring to how many US dollars there are. How much of a currency there is is measured by things like Gross Domestic Product (GDP) or CPI (Consumer Price Index), it’s not measured by how much money exists, but by how much of something can be bought with that currency.
You can see this when crypto is discussed, it’s always in relation to the US dollar. That means it’s not a currency. People don’t say they spent 1 Bitcoin to buy a car, they say they spent $20k dollars worth of Bitcoin. Things are not measured in their Bitcoin denominations. But if it was a currency, then it should be. You would say this house is 100 Bitcoins and so on. But that’s not how people measure expenditure.
Plus how much someone pays today for something doesn’t price every single thing in existence. With a share of a company, the price someone does pay today places a value on every share that exists. But with say a $1 USD physical coin, if someone paid me $1,000 USD for a $1 USD coin of money, it doesn’t suddenly mean every $1 coin is worth $1,000 and there is 1000X more money in the system. You’d just think that person is an idiot.
But with Bitcoin, if someone pays $50,000 for a Bitcoin, the market is saying every Bitcoin is now worth that. But that’s how securities behave, not currencies. Then you have media saying look how much “digital money” is “in circulation.” Even though very few people are using that currency to transact anything with. At some point someone will pay a sum like $1 million dollars or $10 million dollars or more for a Bitcoin, does that mean that there’s more Bitcoin than all money in existence?
The other thing about securities is they are tied to some sort of income or cashflow producing entity like a business or company. So there’s a valuation mechanism by which to understand its underlying value. This doesn’t exist in crypto. There is no valuation mechanism, what people are essentially saying with their investment decision is they think someone else will come along and pay more for it later.
There’s nothing inherently wrong with this. Many things work like that, but you know that with say baseball cards, it works like that. But with crypto I think many investors think they’re buying into something stable because the price is high but it inherently isn’t. Market participants are using price to confer legitimacy but that’s not how it works. How much a person paid for a security doesn’t make the security any more legitimate than if it was a low priced security. What matters in a security is the underlying asset.
Creators Giving Themselves Much of the Money
Imagine if the US government created a new form of money tomorrow and then the first thing they did was give the President 20% of all the money in existence. Then fixed the amount of money that was ever going to be created so no more money could ever be made for the general population. There would be riots in the street. As the value of that currency would skyrocket, since no one could get any of it. The President would own 20% of all the money that his government created.
That’s kind of what happened with crypto. 1 million Bitcoins are owned by Satoshi, the creator of Bitcoin. Over 10% of all Ethereum in existence is owned by Vitalik Buterin, the creator of Ethereum. Charles Hoskinson the creator of Cardano owns a large amount of Cardano. And so on and so on. Yes they were the early people mining it which is why they earned so much, but it’s also easy to mine a lot of something if you’re the inventor of it and nobody knows it exists yet. A small number of people own most of it that exists.
When a founder starts a company, yes they receive a large amount of shares in that company. But that’s not how money works. When a person starts a new form of money, should they receive a large amount of that money in existence? You can literally create billions of dollars, say it’s super useful and then give a lot of it to yourself? That doesn’t sound like a healthy soil for an ecosystem to develop out of. It’s like many of the mental models from corporations were ported to the cryptocurrency world but got lost in translation.
This is where really sketchy but interesting things happen. For example Ethereum is explicitly burning off supply of their tokens to further reduce the amount of supply of their tokens, making it harder to use and access. This is like if the government burned more money they had to further reduce the amount of money it’s population could have, while the President kept owning their 20% of all the money. Who got in at the beginning and owned much of it? Well, they did, the creators of the currencies. I’m routinely shocked that the people within the crypto world are ok with all of this.
What is quite ironic to me is that one of the ideological principles was to reduce the amount of control over the supply of money and move it from governments to individuals. But then now the organisations that operate cryptocurrencies have a lot of in fighting and a small number of individuals control the supply of all the money. Essentially creating more influence over the money by a smaller number of people. The antithesis of the original ideological principles.
Price Fluctuations and Stability
Imagine if you bought a coffee for $5 but by that evening, the same $5 you spent was worth $7. A week later that $7 is worth $10 and it just kept increasing from there. Why did it increase? Well people stopped spending the $5 to buy coffees because they thought it would increase and instead spent much of their money to buy more of the currency and not the coffees. The lack of price stability prevented it from having utility as a means of payment to buy things with. Because every time you spent it, that was potential increases in value that you were missing out on by not holding it instead.
Suddenly there is no incentive to spend any money anymore. Every dollar spent is harming you versus helping you. Is my coffee worth more to me now than potential increases in value of the amount I spent on that coffee? One of the biggest reasons people spend money is that they know the value of that money is relatively fixed and stable, it is backed by the government of their area. If you expand that to the world, one of the reason commerce works is because the price they are paying for goods and services is comparable and transactable in other parts of the world.
It’s hard to use something when it’s price is continuously fluctuating and unstable without also being backed by anything. There is nothing underwriting the value of a cryptocurrency other than will other people believe it has value? Except there are now more cryptocurrencies in existence than there are fiat currencies in existence, with more springing up everyday. Do you accept all of them? Plus many of them are explicitly jokes.
Here are a few of my favourites. Mimble Wimble Dimble Coin. Mario Shrooms Coin. Baby Shark Token. When we get to the dogs, we have Dogecoin, Shiba Inu Coin, Floki Inu Coin. You can make a new cryptocurrency and release it and trade it within a couple hours of work. So people are able to mint securities and then trade them on an exchange instantly. Quite literally printing money, then the next step is how many people can you convince to buy it so the price increases. But remember to give yourself a large chunk of it to start with.
It would be like making a company who’s stock is trading on the NASDAQ, except the stock has no utility and doesn’t do anything, but you own 20% of the stock, so you have a large incentive to get other people to buy into it. As a case in point, the joke crypto Shiba Inu coin has posted a return of 590,000% in the last 10 months. Does it have any utility? No, all it has behind it is marketing and bad incentives. People that own it naturally want more people to buy into it so the value of what they have increases. That sort of spruiking is illegal in most public markets but is commonplace in crypto.
But these sorts of returns are why this exists. For a lot of people, why invest in a stock market index fund of public companies that returns 8%-10% per year when you can speculate and buy a useless dog token and make 590,000% returns? Bubble returns are intoxicating especially if you’re indifferent to where the returns come from and can time it right. But how are you supposed to spend those coins on anything when they can explode or collapse like that?
The first Bitcoin transaction for physical goods is supposed to have taken place in 2010 when Laszlo Hanyecz paid Jeremy Sturdivant 10,000 Bitcoins for 2 large pizza’s delivered from Papa John’s. At the time this was $41 USD worth of Bitcoin but today that would be almost a billion dollars worth of Bitcoin. The finance community mock this as the worst investment in history. But he was doing exactly what Bitcoin was intended for. Buying and selling goods with this digital money. Something doesn’t have utility for payments if buying 2 pizzas can cost someone a billion dollars.
By investing in something that isn’t tied to anything, implicitly what the investors are doing is just speculating on the value of something whose value is determined by people speculating on its value. This reminds me of this story I read once about the dot com bubble in the 90s where people’s expectations of the companies influenced the value of the shares more than the underlying businesses did.
It is the cautionary tale of Yahoo which was the biggest site in the world at that time. Venture capital firms made a fortune from Yahoo stock. They would then invest in startups who spent their marketing dollars advertising on Yahoo. Those increasing revenues would inflate the stock of Yahoo, making those venture firms more money on Yahoo stock which they would sell to invest more money in startups. This cycle lasted years until one day it burst and Yahoo stock lost 97% of its value overnight.
This circular model very much seems from the outside how the crypto markets works. Where holders of cryptocurrency then invest in other cryptocurrencies where each one is tied to the values of each other, pumping up the value of the next cryptocurrency with the last one and so on. In the Ethereum presale when it was first released, you would buy the Ethereum tokens with Bitcoin. Shiba Inus are bought with Ethereum and so on.
I honestly think what attracts most people to the field isn’t the utility they could derive from using it, it is the speculative bubble like returns they see early adopters getting and hope they can emulate those returns for themselves. All the mainstream advertising about it are about the potential returns that can be gained. They’re unregulated securities that are being marketed to the public.
Intertwined with Crime and Fraud
Back in 2008 when it was created it’s first major usecase was as the official currency of Silk Road, an illegal marketplace for drugs, weapons and other contraband. Eventually when Silk Road was shut down, almost everyone that had their Bitcoins in that exchange lost everything. This happened again with Mt Gox, the next biggest exchange. Then again with Tradehill, then the number 2 exchange in the world. Then Bitfinex and so on. This pattern played out literally dozens of times with many exchanges being shut down and clients losing everything.
The lucky few who’s cryptocurrency survived these repeated exchange platforms shutting down or getting hacked. Why did they have so much crypto? Well they were participating in illegal activity on a lot of these platforms. If you were lucky enough to hold onto it and not sell it, you made a fortune but most of that crypto were directly proceeds of crime. The only reason you had any was to buy or sell something illegal on the internet.
I’m not saying that buying drugs online is wrong or casting any judgement, I’m just using a strict legal definition here. Much of the history of crypto is intertwined with crime on the internet. Part of the ethos of a cryptocurrency is it is anonymous, usually untraceable and exists outside the control of the government but what that creates is the perfect currency to facilitate illegal transactions. Money launderers, terrorists, drug dealers et al – Bitcoin and other cryptos solve a huge problem for them. That of transporting large amounts of capital undetected by governments.
If you add to that the number of hacks and theft and fraud that occurs. It is a weekly occurrence for people to lose hundreds of millions of dollars worth of cryptocurrency. When it comes to much of this fraud and theft there’s no consumer protections available because it’s explicitly unregulated. If someone steals your coins, there is no legal framework or apparatus within which you can get it back.
The United States alone reports 80,000 cases of crypto fraud in 2020 but I suspect the real number is an order of magnitude higher as most people would never report their cases because there’s no one with any real power to report it too. Even the most devout believers acknowledge the rampant amounts of theft and fraud that occurs. My favourite example of this is the Africrypt founders who were in their early 20s and fled in June of 2021 with US$3.6 billion worth of Bitcoin.
Anecdotally, if I polled my friends that knew about and owned Bitcoins circa 2012. Of the 20 that did, 5 ended up millionaires, 5 sold for a small profit and 10 lost it all or had their Bitcoins seized or stolen. Since then much of these markets have matured and more legitimate platforms like Coinbase, Etoro or Robinhood have emerged where it’s harder to lose your capital. But the fact a lot of people that owned it at the beginning had theirs stolen doesn’t fill me with confidence.
According to commonly cited data it’s estimated 30% of all crypto is either lost or stolen. But if it is the future of all money and 30% of it is stolen, it means that some huge number of it is owned by people who stole it right? As that’s the estimate of how much has been stolen. So almost 1/3rd of the assets you’re transacting in is with a criminal or in something that was stolen. I would be very nervous participating in an ecosystem where double digit percentages of everything in it has been stolen. I wouldn’t buy a house from someone who stole that house or fraudulently obtained it.
Adding to that, every single bad actor I know from the startup and finance community that I caution people to avoid working with, has moved onto cryptocurrency. I don’t know if that says anything but it feels like it does. Bad actors are attracted to fields where their bad behaviour can go undetected while achieving the most gains while receiving the lease amount of punishment.
Lost, Stolen and Nascent Technology
It’s estimated that 30% of all Bitcoin in existence is lost or stolen. I believe that statistic because I had a friend who lost 100,000 Bitcoins which is like 0.5% of all the Bitcoins. He used to be a drug dealer on the internet and then eventually all of his laptops, cash and items were seized and wiped by the police when he was arrested. At the time he didn’t even believe that Bitcoins had a lot of value as an investment beyond buying and selling psychedelics online. At the time it wasn’t worth a huge amount but today that’s a fortune in Bitcoin that was just erased from all existence.
It wasn’t strictly erased, they still exist. He just has no way to get any of it back. Another story I like is this, of a guy with nearly 10,000 Bitcoins on a hard drive that he threw out years before he thought it had any value. There are hundreds of thousands of stories of people who owned cryptocurrency and then something as simple as forgetting a password locked them out of the accounts that owned it so their money became inaccessible. Functionally lost and disappeared.
There’s a funny analogy I read once. Ancient Egyptian tombs were sometimes so secure that you could never get anything back from within them as they were impossible to enter again. Thinking it was very secure, people would then store many of their valuables within them only for them to be robbed anyway years later by tomb robbers. It was a double problem of it being too secure for laymens but also not secure enough to prevent thieves. I think that’s a good analogy for cryptocurrency too.
If it is a replacement for money or a digital investment asset, it will be really unfortunate if a grandma invests her retirement savings into it but then can’t access it because she forgot her password. Or that you can accidentally lose all your money by making a mistake. Even as a store of value it’s kind of amusing to me that forgetting a password can be enough to lock you out of accessing all of your money. That doesn’t seem like it’s very usable by regular people.
The other thing people forget is that it isn’t really a new technology. Blockchain technology was first outlined in 1991 by Stuart Haber and W. Scott Stornetta. It was first applied into digital money in 2008 by the anonymous Satoshi Nakamoto. The blockchain has now been around for almost 14 years. Which is a very long time in the internet. 14 years ago the iPhone hadn’t even come out.
Usually after a groundbreaking new technology has been around for 14 years, it’s everywhere. 14 years into the internet, it was very clear how much of an impact it would have, as everyone from the local grocery store to your grandmother was using it. 14 years into smart phones and almost everyone has one. But blockchain isn’t a nascent technology, it’s an old technology now and the verdict is still out on whether it will have any impact whatsoever. The fact that it isn’t already everywhere says to me that it doesn’t have anywhere near the amount of utility as those who believe in it wish it did. The concencus among most of the finance world seems to be that it’s just a scam.
NFTs Are Barcodes
There’s a great video here about a tangentially related thing to cryptocurrency which are Non-Fungible Tokens (NFTs). Basically they are a type of barcode hosted on the blockchain that proves ownership over an item which could be a picture, an artwork or anything really. They’re a complicated receipt of purchase and have a comparison in the world of art investing. Speculating on the worth of images.
These have all the same issues already discussed above but with the added axiom of it not really solving any problem and of many people being able to recreate the same ownership NFT barcode in many different blockchains. Similarly people generally buy an NFT hoping that the price of it will go up due to artificial scarcity and someone else will come along and pay more for it as opposed to based on the items underlying or intrinsic value.
Conclusion
I have no idea what is going to happen in the future. But these are a few of the things that make me really nervous and I don’t like. Personally I hope there are solutions that emerge to all of it. But I believe there won’t be. My honest opinion is that crypto will go the way of other speculative investment manias in history in that there will be a lot of optimism and hope for the future of something, while some people will make fortunes but most people will lose money and little of that optimism will eventuate.
In fact, currently most investors in crypto do lose money. Which probably brings it into line with the broader stock market anyway. This brings up the most obvious counterpoint to all of this. Doesn’t actual fiat currency have all the same problems that crypto does?
Regular fiat money facilitates most of the crime in the world. Regular money is frequently lost or stolen and fraud happens in it. I don’t have a good answer to that besides Governments usually try their best to stop any bad behaviour and provide some semblance of a safety net for people. They’re also a place you can go to for help and law enforcement if something does go wrong. Which may only happen to a satisfactory degree in some of the western parts of the world.
But I’m reminded of something that happened to me recently. I was in a bar in a prominent hotel in New York with a friend. We started talking to one of the waiters who started telling us about how his life savings were invested in a crypto portfolio and explaining how to trade it and the ins and outs of the crypto world. He was part of a group that would all buy and sell tokens together at the same time. I asked him if he could really afford to lose it and he said that he couldn’t but was doing it anyway.
This resonated deeply with a story I once read about JFK senior. That when taxi drivers, shoe shiners and regular professionals start thinking themselves adept at the stock market, then it’s time to get out.