“It’s difficult to get a man to understand something when his salary depends on not understanding it.” -Upton Sinclair
A range of businesses and careers have popped around cryptocurrency and, thus, have to defend its place in society. While I believe that blockchain and decentralized finance (“DeFi”) are wonderful innovations and will likely play a growing part in the global economy’s future, I think the current iteration that is considered the “cryptocurrency asset class” will not.
Consider that Windows was not the first operating system, Google was not the first search engine, and Facebook was not the first social media site.
What does this imply?
In most sectors and industries, you get a “first-mover advantage”. Yet in many cutting-edge parts of the tech you, paradoxically, get something called “last-mover advantage” (sometimes, “second-mover advantage”). Those who create the first-generation technology go on to create the market. Unfortunately, they often do so with a flawed technology and these flaws only get exposed once the tech is at scale. It is these flaws that ultimately lead first-generation (“1st-gen”) tech to fail. But, in the wake of this failure, those who come second (or later) get the unique, retrospective opportunity to fix whatever the critical flaw(s) was(/is) in the f1st-gen” tech and have an existing market vacuum waiting to be filled with their solution.
Hence, Windows solved for usability, Google solved for search and online advertising, and so on.
Thus–and ignoring blockchain and DeFi as valid concepts–a decade after launch and 1st-gen cryptocurrency has failed to become what it set out to be: a currency.
I will explain my view below, but it is important to note that highly-invested characters keep “inventing” reasons why 1st-gen crypto should remain relevant. These subjective people are pivoting philosophies and 1st-gen’s raison d’etre from that of cryptocurrency (i.e. being a currency) to a selection of other utilities (store of value, hedge against inflation and, the worst, digital gold). I will touch on these arguments for relevance later too.
Why 1st-gen crypto has failed as a currency
A medium of exchange has the following characteristics:
- Durability – 1st-gen cyrpto succeeds: In the absence of data loss, hacking, the apocalypse and the like, cryptocurrency is more or less durable. There is the problem that in an energy scarce world, crypto uses vast amounts of energy to power itself. This energy could be used more productively, but this is a resource allocation argument and not based on durability. If we focus only on durability, then crypo ticks the box of “durability”, but then so do seashells, trading cards and sneakers, and we certainly do not view those as currencies.
- Portability – 1st-gen cyrpto succeeds: You carry any amount of cryptocurrency in your eWallet and send cryptocurrency around the world through various (arguably sketchy and opaque) networks, exchanges and wallets. It isn’t very efficient to do so and sometimes the transaction fees can be really high, but it is still possible. Thus, I’d argue that cryptocurrency is portable, but then so are many digital items from WhatsApp messages to NFTs to Netflix shows to my holiday photos sitting on Facebook.
- Uniformity – 1st-gen cyrpto only partially succeeds: This is where 1st-gen crypto begins breaking down… While each individual crypto coin may be homogeneous amongst itself, there are so very, very many and they are made so very, very easily to create more types of coins that the asset class has diluted itself into a heterogeneous collage of different coins. Currency.com reckons that there are 9,900 of these things while Investing.com’s listing of major ones runs into the 100’s of coins. Sure, the real-world has different currencies and that doesn’t invalidate them, but in a world where each coin is unique and, thus, needs its own tech, resources and community to support it, this endless copy-paste proliferation arguably dilutes the space. It is no ones fault but it is a major problem. Still, let’s be kind and say that within each cryptocurrency coin, the coins are all the same and, thus, uniform.
- Limited supply – 1st-gen cyrpto fails: This leads to my view of why there is not a limited supply of cryptocurrencies. Believers (always a worrying sign in finance and investing when we need to use the word “believer”) will argue that Bitcoin can only ever have 21 million coins and, thus, has a limited supply. Well, you–yes, literally anyone–can fork Bitcoin, which is really just a copy-paste where you get to change some rules. Each time Bitcoin is forked, it doubles the number out there. And you can fork it infinite times. Yes, that does kind of fork up the limited supply argument! But, more subtly, it is so easy just to make a brand-new crypto that (see point #3 above) these things are endlessly multiplying. Especially if one wants it to be universally adopted as a currency, then perhaps 9,900 of the things kind of dilutes the asset class! (Let me phrase it this way, would you pay money for a house if we had technology whereby we could click a button and instantly create a brand-new house at basically zero cost? In a world with infinite houses (even if they look different to each other), the price of houses is basically zero.) So, no, cryptocurrency does not have a limited supply. Quite the opposite is true.
- Acceptability – 1st-gen cyrpto absolutely & completely fails: Even if you disagree with my arguments against (#3) Uniformity and (#4) Limited Supply, acceptability is where cryptocurrency crashes and burns. I will not go esoteric here, but rather be intuitive. When was the last time you saw paid for anything in any cryptocurrency, other than another currency? Do you know anyone else who has? The answer is almost certainly “no”. Even the HOLDers, ironically, do not use their crypto as a currency (they refuse to sell and, thus, do not transact in it)! Depending on where you look, somewhere between 33% (feels way too high & comes from a bias crypto site) to 1% of transactions flowing through the blockchain of Bitcoin are actually for anything other than speculation. Indeed, I would argue the vast majority of these “transactions” are just money laundering (if your “use case” for crypto is crime, then you have a problem). If a currency is not being used to pay for goods and services, and it is only (ignoring crime) being used for speculation, then it is not a currency at all.
Thus, over a decade later and 1st-gen cryptocurrency has failed as a currency.
Oh, but, “crypto” is a store value, hedge against inflation and digital gold some many cry…! No. No it is not any of these.
Let me elaborate…
Store of Value & Hedge against inflation
Both of these terms revolve around protecting your capital against the ravages of inflation.
(Interestingly, “inflation” is a monetary phenomenon and, thus, stores of value and hedges against inflation tend to be “non-monetary” in nature. I.e. These tend not to be currency! Thus, if anyone is using this argument for cryptocurrency, they have basically admitted that cryptocurrency is not a currency.)
This is an easy test: in periods of high inflation, has the asset at least maintained its spending power.
Let us use Bitcoin (as the largest, 1st-gen crypto) and the USA (as the USD remains the global reserve currency):
- In the last twelve months, the US inflation rate has hit 9.1% y/y (link)
- In the last twelve months, Bitcoin’s USD price has collapsed from a little over $32,000 to currently around $23,000.
In other words, in a period of high inflation, Bitcoin has lost a little under a third of its spending power.
This is not what a “store of value” or “hedge against inflation” asset does to earn its name! And, indeed, most other cryptocurrencies have performed worse than Bitcoin.
Thus, 1st-gen crypto is neither a store of value nor a hedge against inflation.
This is a more colourful way of illustrating “store of value” and “hedge against inflation” and, indeed, equally as easy to test.
- In the last twelve months, gold has fallen from c.$1803/oz to its current $1708/oz. About a -5% fall in its USD value.
- As mentioned above, in the last twelve months, Bitcoin’s USD price has collapsed from a little over $32,000 to currently around $23,000. A lost of nearly a third in its value.
- Most other crypto’s have done even worse…
I cannot fork gold, copy-paste gold or launch a new gold, yet I can do so with 1st-gen crypto. Thus, gold has held its value in the face of tightening liquidity, rising interest rates & high inflation. 1st-gen crypto has not and, as highlighted above, it is highly misleading to try market it as “digital gold”.
But you used such short time periods in your arguments!
Cryptocurrency has not been through many Fed hiking cycles, periods of high inflation and truly widespread bear markets. Hence, realistically, there is very limited data to work with and, ce la vie, we must use what we can to extrapolate views.
But, my argument is simple, an asset class’s true characteristics are not shown in bullish periods when the stars are aligned but, rather, in periods of stress, worry and widespread panic. People’s true character tends to be revealed in tough times and, I believe, the same should be applied to testing the characteristics of an asset class.
We have come off an historic period of falling interest rates, super-low inflation, booming markets and endlessly hotter and hotter money seeking higher and higher risk assets. Indeed, cryptocurrency was born out the worry about the end-point of these monetary excesses and, ironically, was then carried to bubble proportions based on this self-same monetary jet fuel.
Well, this period is over and, so far, 1st-gen cryptocurrency has proven itself largely worthless. With its strongest correlations being towards the Fed’s balance sheet (now shrinking) and the Nasdaq lost-making stonks (DotCom Bubble 2.0), 1st-gen crypto has failed to be a currency and, indeed, has become a solution desperately looking for a problem to solve.
“You don’t understand. These are not eating sardines, they are trading sardines.” -Anon (& probably broke shortly afterwards)