The Bitcoin BubbleJay Adkisson
An entire industry exists to take advantage of cryptocurrencies. From the creators of individual cryptocurrencies, to folks who sell software apps such as wallets, to companies that are attracting venture capital for vaguely-described synergies involving the retail use of cryptocurrency, to hedge funds that invest directly in cryptocurrency to those who put on conferences on how to get rich on cryptocurrency, literally billions of dollars worldwide have poured into crypto.
Yet, cryptocurrency is failing, badly. The vast majority of cryptocurrency have already ended up listed at http://www.deadcoins.com and even the flagship best-of-class Bitcoin as of this writing has lost 80% of its value in the last year. Despite the continuing hype for crypto, seemingly every day makes it look worse as both an idea and an investment.
To understand why crypto is failing, it is necessary to understand what crypto isn’t and is.
Cryptocurrency Is Not A Revenue-Producing Asset. Unlike a stock whose value can be determined by earnings, cryptocurrency provides no income stream to its owner. While some owners like to think of themselves as “owning the technology”, nothing could be further from the truth since they earn no royalties if somebody else is using that technology. Because crypto has no earnings, that means it has no P/E ratio by which a rational price can be established. Crypto isn’t even as good as a zero-coupon bond, however, since it has no maturity date when principal will be returned.
Cryptocurrency Is Not A Commodity. A commodity is usually something that is consumed, leading to demand for more. Oil and wheat are examples; once a stock of those is consumed, another must be supplied. Cryptocurrency is not a commodity. There is no demand for cryptocurrency in the consumption sense, and an individual unit of cryptocurrency is not destroyed by a transaction but can be reused over and over such that most demand can be met by existing stocks.
Cryptocurrency Is Not A Store Of Value. Some pundits have claimed that crypto is a “store of value”, meaning that if you put $1,000 of value into crypto today, then in the future you will be able to get your $1,000 of value back by selling the crypto. That’s not the way it works in reality, however, because cryptocurrency is so volatile. As mentioned, the flagship Bitcoin has lost 80% of its value in a year, which in retrospect doesn’t seem like a particularly good way to store value.
Cryptocurrency Is A Currency . . . Crypto is currency, meaning a mechanism of exchange. In the past, humankind has used everything from pretty seashells to beaver pelts to rare metal coins to (now) little pieces of paper with uninteresting pictures on them as units of exchange. At the end of the day, this is all that crypto is — a unit of exchange that does not exist in the material world but instead exists only in binary code on computer ledgers somewhere. If this sounds high-tech and really innovative, then you’d better consider that we’ve had such payment systems for years in the form of debit and credit cards, wire-transfers, and services such as PayPal.
The difference is that those older systems dealt in the local governmental currency, such that a Nebraskan buying beer with a credit card did it with dollars, or if there was an international wire-transfer from Moscow there was a conversion from rubles to dollars, etc. With cryptocurrency, the currency itself is predominantly used so long as the user can find a seller who takes that cryptocurrency, although it should be noted that Bitcoin ATMs dispense cash in the local currency. The point being that cryptocurrency, as its name suggests, is in fact currency and not something else.
. . . But An Unprotected Currency. There is a reason that some nations have relatively stable currencies such as those found in the industrialized nations: The governments of those nations have strong central banks (in the U.S., the Federal Reserve Bank for example) which keep those currencies stable by variously expanding or contracting the money supply, guiding government economic policy decisions, and using a variety of methods — including criminal prosecution — to prevent currency manipulation.
By contrast, nations such as Venezuela, the Sudan, etc., have no meaningful central banks and thus their currencies are extremely volatile, sometimes changing their value relative to the stable currencies by the hour. These nations are subject to what amounts to “currency anarchy” and have no effective weapons in their financial arsenals to combat price manipulation.
Cryptocurrency falls into this later category. With cryptocurrency, there is no governing body to expand or limit the money supply to meet changing events, and utterly no mechanism to prevent widespread price manipulation. This is the primary reason why cryptocurrencies are so volatile — like a nuclear reactor without control rods, once a cryptocurrency is launched there is no way to control it until it finally burns itself out.
This is also why cryptocurrency adoption by merchants has dramatically lagged predictions: What merchant wants to accept much of a currency that is like a Venezuelan bolivar that can go down in minutes? Oh sure, a few merchants have thought that it is neat to hang a sign on their window that says “We accept Bitcoin!” because that sounds kind of hip, and, who knows, maybe somebody will make a large purchase someday with crypto. But taking in a bunch of it everyday and risk losing a bunch of money on wild price swings? No way.
Cryptocurrency As A Speculative Investment
By far the most purchases of cryptocurrency have been raw speculation; investors buying particular cryptos in the hope that they would dramatically appreciate in value. This phenomena was illustrated in the Great Crypto Boom of December, 2018, when Bitcoin shot up in value from $1,000 per Bitcoin on January 1, 2017 to $19,783.06 in mid-December of that year.
During the 2017 bubble, many ordinary folks who were smart enough to sell became instant multi-millionaires and, just like the gold-rush days of old, many other ordinary folks started taking second mortgages on their houses and cashing out their credit cards and IRAs to spin the Wheel of Crypto Fortune and buy in, which further accelerated the price until that bubble finally burst and those belated investors were wiped out.
The point being that few, if any, of those investors bought into Bitcoin because they had faith that it would be the “currency of tomorrow”, but rather they just wanted to get rich, and quick. But even as the Bitcoin bubble was building, other promoters of their own cryptocurrencies were out pitching their deal as the next big thing. It is these other currencies — nearly all of which eventually failed entirely — ended up on deadcoins.com where you can read their obituaries. The other cyptos (called “altcoins”) often lacked any usage whatsoever and had no merchants that would accept them in payment. But folks bought in because they were speculating on their values rapidly appreciating just as Bitcoin had done. But this is not to overlook that Bitcoin itself has value only because of the promise of future appreciation, i.e., the price of Bitcoin is driven primarily by speculation.
The Cryptocurrency Paradox
All this now brings us to The Cryptocurrency Paradox:
Crypto has value based on its usage to buy things; because of that value, most owners of crypto do not want to use it to buy things; therefore, crypto is not widely used to buy things and thus has no value other than related to relatively minimal usage.
In other words, the sine qua non of a particular cryptocurrency is based on the mutual concepts of “acceptance” (how many merchants will take the crypto in exchange for goods or services) and “usage” (how many owners are spending their crypto in exchange for goods or services).
Whatever the rates of acceptance, the problem is that because crypto owners expect their crypto to appreciate in value, they are holding it as an investment and not using it. This is supported, among other things, by a study reported in Reuters that usage of Bitcoin had gone down approximately 80% in January to September, 2018.
Thus, the paradox: Crypto investors buy and hold crypto because they want their crypto to appreciate in value, but unless they use their crypto the value will not go up. To the contrary, unless the crypto is used, the value of the crypto will keep falling, and investors will start unloading their investment to avoid further losses. Repeating this cycle leads to the inevitable “death cycle” that is so common to finance, and ends badly for the crypto and any remaining investors. This seems to be what is happening to Bitcoin now.
Because of this paradox, no cryptocurrency is likely to be successful until investors can be persuaded to actively use their crypto, and not simply hold on to it and speculate that it goes up in value.
But, again, there are significant barriers to increasing usage not the least of which is crypto’s high volatility, and the possibility (if not likelihood) of widespread price manipulation. Here, acceptance plays a role: What large company wants to hold on its books an asset that can fluctuate by 10% in an hour, or which can be pumped-and-dumped by bad actors? But even beyond this, the fundamental problem is that there is no means available (such as taxes) to incentivize investors to quit holding for speculation and actually use large amounts of crypto for mercantile activities.
It is largely because of this paradox that leading economists such as Nouriel Roubini and many others have predicted that Bitcoin and other cryptocurrencies will sooner or later return to a value near zero. With Bitcoin in a long slide, and the handful of remaining altcoins having one foot already in the grave, it is probably more likely than not that such will be end result for all cryptocurrencies unless some really bright person can figure out how to solve this paradox.
In the meantime, there will certainly be peaks and valleys in the price of Bitcoin, and the volatility is likely to get even worse which will drive down usage as a currency even further. But something quite spectacular will have to occur to break the paradox and stop Bitcoin and the remaining altcoins from entering the death cycle. One this is absolutely certain, however, which is that for the next few months investing in cryptocurrency should be strictly limited to those willing and able to lose the totality of their investment because that is exactly what will be at risk.
As things go now, it is looking more and more like the final procession of crypto funerals will occur in 2019. In that case, the epitaph written on the tombstone of Bitcoin and the altcoins might well be that phrase by which Jefferson Davis in his later years characterized the failure of the Confederacy: “Died of a Theory.”
This article at XXX