Cryptocurrencies: The Risks of Misunderstood Dollar-Wannabes
A wise man once said, “Don’t invest in things you don’t understand”. Unfortunately, this is not the mantra masses of Bitcoin and other cryptocurrency investors live by. Instead, it’s become one of three primary things: 1) Validation for hipster/millennial/silicon valley-incubated techies to draw from the original 1990s cyberpunk movement, 2) A gambling vehicle, or 3) A quick way for newly emerging hedge funds & ETFs to take a quick buck from unsavvy investors with high fees. However, before you start throwing me in with the majority of Bitcoin naysayers, allow me to make my case for why, in its purest forms, cryptocurrencies are good for the world and why the reality is quite the opposite.
A “Pure” Cryptocurrency
Although I’m using Bitcoin as the primary example in the article due to its mainstream popularity, there were many predecessors I won’t discuss that goes back to the 1990s cyberpunk movement, giving birth to the model created by the ominous Satoshi Nakamoto.
For those who haven’t even taken the time to understand how Bitcoin works, it’s based upon what is called block-chain technology, or simply an algorithm that solves an equation(the block), thereby generating a token (Bitcoin) as a reward. The equation gets more and more complex due to encryption and how many “miners” (problem solvers) are scouring the net running the algorithm. The system is also a closed system, meaning that in order for me to lose (spend) a coin, someone has to gain it through a digital ledger. This leaves it as an unmanipulated, decentralized system, with a maximum amount of coins available for the algorithm to generate. This is a block chain cryptocurrency in its purest form. If you want to read more up on this, here’s a good link to understand this in detail.
The Impure Reality
Although Bitcoin, in it’s purest form, creates an environment where you can potentially change the world by means of electronic transactions directly between one person and another, the reality of how Bitcoin is used is far from this.
The “pure” concept of a cryptocurrency is actually comparable to Karl Marx’s idea on the use of Communism. The basis of the idea working for the betterment of everyone requires a perfect world where everyone subscribes to the foundation of the use of that system. If everyone, including governments, subscribed to the idea that wealth should be absolutely, totally shared at an equal amount, Communism would not be such a bad scenario for the world (other than potentially stifling innovation). Thus, the same analogous comparison with Bitcoin or cryptocurrency in general. I’ll discuss how, because of the way the world currently works, that Bitcoin is truly no better than any other currency currently in existence.
This Point Makes Bitcoin-Believers Angry…
Basically, the staple of what many like to call the term “Value” is based in dollars. Ready for the kicker? Here it is: Bitcoin (and all block chain crytocurrency) is now no better than any other foreign exchange currency on the market. Think about that for a minute…
Okay, so now that statement has likely sunk in, we must go back to the original intention of Bitcoin, and why we as human beings (like everything else in the world that we touch) have proverbially screwed up the concept back to the status quo.
The minute Bitcoin started being exchanged for US Dollars, it became just another foreign exchange currency (FOREX), without the added benefit of earning a potential interest rate dividend return on a daily basis.
An exchange essentially violates the first rule of block-chain technology: No middle man. Essentially, the original owners of Bitcoin bought a lotto ticket and won, mostly without that intention. The very small volume of original owners actually used Bitcoin as a form of currency to make transactions. Just look at the Most expensive pizza in the World article which proves this concept.
Fast forward almost a decade, and now people are buying Bitcoins (or some form of a nebulous Bitcoin ownership contract, which is largely unregulated) in the shape of a Forex market. They have no intention of spending those coins, and instead want the coin for the value that it has in dollars.
Ready for the scary part? Forget manipulation of price for a minute, and just think about that term: value. The minute people begin to distrust Bitcoin, due it’s largely gambling-class volatility or it’s inability to catch on as a mainstream form of transactional currency, the price is going to plummet. The latter is the most glaring issue with the current exchange rate for Bitcoin and other cryptocurrencies. By massive amounts of volume driving that exchange price upwards, the currency has become a self-licking ice-cream cone of exchange in dollars, to the point where nobody is going to spend their coins on an Amazon product, Dominoes Pizza, or whatever.
As a result, I challenge your major papers and online blogs like the Wall St Journal to conduct a poll of the people who “invest” in the Bitcoin craze, and see how many of them even know what a block-chain does or how it works. I’d bet my salary that most people have not one clue. I received this type of insight just from subtly polling my Lyft/Uber drivers for the last month of not having a car in Los Angeles, 85% of whom has put money into the crypto-craze.
Finally, let’s talk about the massive number of cryptocurrencies out there and the manipulative aspects of these relatively new and questionably regulated exchanges for Bitcoin, Ether, Lite, etc. If you do not think it can happen, just go look at the flash-crash to 10 cents on the GDAX data for Etherium to the US dollar. See the huge dip earlier this summer? Now go to another exchange’s chart and see if that same crash exists.
This happens when you have these garage startup exchanges with relatively low volume compared to your major stock, option, and forex exchanges. If Millionaire X uses Etherium Exchange X, and his ownership makes up 2-3% of the daily volume that Etherium Trader X actively trades, and Retail Cryptotrader Y uses Etherium Exchange Y with a different set of lower-value Millionaires, then Millionaire X has the ability to crash his specific exchange’s market due to the market maker (aka the “middle man”) having to execute that astronomic order for the price point. I like to equate this scenario to what would happen if Warren Buffet, Goldman, and JP Morgan were to sell all holdings on one exchange all at once in one day on the S&P 500 ETF.
The other portion of the risks involved is revolved around the fact that, if we were to switch to a cryptocurrency based society from a paper-based, the cybersecurity involved with protecting individual wallets would be paramount (and subsequently I’d invest in whatever company solves that problem). The great thing about having cash is that I can withdraw it at any point, and put it in my safe if I truly felt like my current financial institution wasn’t performing its duties of protecting my money. With cryptocurrency, I have yet to see an insurance policy against having your wallet robbed by a hacker with relatively moderate level of unethical hacking knowledge. By having wallets that are vulnerable, uninsured by organizations like the FDIC, and a currency that only exists in the form of ones and zeros, it become risky from the standpoint of a commodity investment.
I hear bitcoin called the “digital gold”, and in a lot of aspects this is true. But gold, although not a form of transactions since the dropping of the Gold Standard, holds value in the form of a commodity for use as a precious medal. In the near term, I don’t see there becoming a precious jewelry or industrials market for a digital signal produced from solving an algorithm. Bottom line: gold has actual utility, and therefore will maintain some sort of long term value until a new precious medal arises that’s stronger, more durable, more eye catching, lighter, etc etc.
The Positive Upside for Cryptocurrencies
It’s commonly said that bubble-like conditions and subsequent crashes are drivers of major changes in our society. The same conditions apply to Bitcoin. This is what I see happening in the intermediate to long term: Bitcoin to US Dollar will crash when the relative small number of buyers close out their positions to take profits. Your retail traders and uneducated investors will get burned in the process, generating fear amongst those select individuals to pulling out their money. I even bet some of these exchanges will not be able to honor certain orders at the tail end, thus shutting down those particular exchanges into going bankrupt.
Then, one of two things happen. First, Bitcoin or any of the other mainstream cryptocurrencies will slowly gain traction with the main population in the form of how it was meant to be used: as a transactional currency for a product (not for US Dollars). Then, as business begin to further adopt the currency for quicker transactions and contractual obligations, Bitcoin will gain real value to the mainstream.
…Or The Negative Downside
Second, and more negative, is the eventual bubble, whenever it is, will cause any if all cryptocurrency to lose its trust from the public, and die a horrible death in the long run. The US Dollar will continue to be the staple of value to the rest of the world, and US interest rate decisions will continue to have major impact on the world economy at large.
I guess history will determine the outcome. The bottom line of my article is I hear people on mainstream television, on any forex blog, close friends, enemies, and random folks in general talking about the wonderful benefits of cryptocurrency. This is great, and personally, I hope it all comes to a positive outcome to where you don’t have a deflation or inflation aspect, and 1 coin is worth 1 coin; forever. But there’s one fundamental flaw with this hope: greed. We as humans will always be greedy, and this will be the downfall of blockchain cryptocurrencies, because they’ll end up being exchanged for some form of a paper currency backed by an international bank or government system. In the meantime, I’m going to continue to trade or invest in things and companies that actually generate value in the form of the only thing that truly matters to people: Dollars.