When I try to make sense of the cacophony preaching cryptocurrencies, I hear at least four “bets” people are making about how the financial world works, especially the economic concept of money, This is my take on those four bets.
I started this year with my overview philosophy of what money really is. In that post I made some hints about cryptocurrency, and in the spirit of this blog I want to expand those rough claims into the shape of getting you to think about what exactly you are betting on, often with probabilistic odds, when you are buying one of the now-many cryptocurrency offerings.
I repeat: Money is primarily denominated choice
Numerous books and academic papers have explored the very notion of money, but my take is that, if you ignore this foundational principle, you are headed for trouble. Humans trade stuff, and money evolved as a reliable counting system for comparing the value of my stuff to your stuff. The first recognizable monies were objects, often of precious metal and usually weight-denominated. The more artificial numbering of choice equivalences really got started when rulers imprinted their icons on small metallic objects.
Gold enthusiasts still cling to the physical object, but by the 20th century the counting system had already become virtual. The ubiquitous U.S. Federal Reserve Note basically just says “Trust us” or (“Trust U.S.”). With the dollar, the U.S. government is endorsing, and at least trying to stabilize, one particular numbering system for our choices. More about that trust thing later.
The next leap of virtuality was the bank deposit, one more step away from the government note, but using the same counting system and still based on trust, now of both the bank itself and the government’s backstopping of that bank.
My British bank account is very similar virtual currency; the major difference between my U.S. and U.K. accounts is different counting systems backed by two different guarantors. The exchange rate between the two is both a conversion factor and a free market test of how much we all collectively trust one of those governments over the other to hold their counting system stable.
Economists call these numbering systems the medium of exchange function of money. There is much more to money than this, and economists argue mightily about all those other aspects. My point here is that if you ignore this basic function of money as a counting system, you do so at your peril. You are ignoring the foundational basis of the first bet, which is the trustworthiness of the count.
Bet #1 – Trusting the count
If you make your cryptocurrency purchase, say Bitcoin, primarily as an alternative medium of exchange in trading for goods and services, then the key bet you are laying down is its reliability as an alternative choice-counting system. The key question here is “Compared to what?” Because I have some continuing financial interaction with Britain, I start out comparing how reliable my U.S. dollar is as a counting system compared to my alternative, the pound sterling. That ratio of price movement over the past year tells me a bit about both counting systems, by the U.S. and the U.K, as the chart below shows in the BLUE line:
GB Pounds and Bitcoin relative to the U.S. dollar
Don’t focus so much yet on where the line starts and ends, rather note how much the blue line moves, which is “not much” in this case. The YELLOW line above is the price of Bitcoin over the last year relative to the dollar. Again, don’t focus on the beginning and end just yet, rather look at the variability. As an exchange medium Bitcoin has, as have other cryptocurrencies, failed so far to provide any usable stability as a medium of exchange, a reliable choice-counting system.
Compare the volatility of Bitcoin to the classic alternative counting method of gold (which is now shown in the BLUE line below). That precious metal, although notoriously variable historically as a counting method relative to the dollar, looks like placid water in comparison to Bitcoin.
Gold and Bitcoin relative to the U.S. dollar
We get similar or greater variability with other cryptocurrencies relative to gold and to the dollar, say, Ethereum (in TURQUOISE below). Again, ignore for now the beginning and ending of each line and instead focus on the variability of Ethereum, which has been even worse than Bitcoin.
Gold, Bitcoin, and Ethereum relative to the U.S. dollar
In short, if you are betting that you can use your cryptocurrency to make mundane financial transactions, you could wind up paying anywhere from 50 cents to 20 dollars for that one Starbucks latte, depending on the “exchange rate” of the day and on when you originally purchased those coins. Good luck with that.
Bet #2 – The investment bet
Now you can look at the beginning and ending points of the charts above. Many crypto investors are buying as an investment, betting that the value of their purchased coins will go up relative to the dollar (and hopefully quickly) from the price at which they were purchased. The operative question here is “Compared to when?”
If you bought Bitcoin in mid-July of 2021, your investment’s value has risen a healthy 30%, although it has been on quite the ride in the meantime. If, on the other hand, if you stuck your money in early last November, your Bitcoin investment has lost 70% of its value. Since there is zero intrinsic value in a cryptocurrency as compared with, say, buying the S&P 500 (from dividends paid on corporate earnings and partial ownership of tangible assets), you are totally dependent on Bitcoin price movements for your return, or in the old investment language, hoping for a “bigger fool” to buy your coins back at a higher value than what you paid. Sometimes, you are the bigger fool.
Remember that, at any one time, half of the “marginal investors” are buying, while half are bailing out at the price of the day. You are starting with a 50-50 bet here, and betting that you are in the smarter half. Good luck with that. So far, it has been a very bad, “high Beta” bet.
Bet #3 – The Crisis Safe Harbor bet
Like gold, cryptocurrencies have attracted a lot of buyers and press from the apocalyptic community. Yes, the dollar is stable today, but what if the world goes to hell via economic collapse, world war, asteroid strike, or environmental disaster? Your bet here is that my chosen money form will have more value than the U.S. dollar when the smoke clears.
And when that smoke clears, go ahead and fire up your fully-charged cell phone and bring up the app from your internet provider so that you can purchase some food…or guns, using your crypto. And buying from someone similarly equipped while using your preferred currency. Good luck with that.
Bet #4 – Privacy, anonymity, and security
Many cryptocurrency purchasers have been attracted to a perception that this form of money is private and untraceable. Some of these folks are up to no good or avoiding taxes, but we will assume that you are just seeking a bit of privacy with your financial transactions. Unfortunately, this aspect of crypto has been grossly over-hyped.
Indeed, every transaction you make with your cryptocurrency becomes a public record in the blockchain, the key transaction technology undergirding all cryptocurrencies. The anonymous part has come so far in being able to keep your ownership of a particular “wallet” less visible than, say, if the money were in a conventional stock trading account. To some extent this has been true, but as soon as you try to use an online commercial portal to manage your holdings, which is a practical requirement for most investors, you become “just another customer” and somebody knows who you are.
Quick in-and-out money transfers across borders are possible with cryptocurrencies, but transactions costs are still high and not as private as you think. If your cash is legal, then a bank transfer is still a much better deal.
Recent news events have highlighted both continuing scams and thefts surrounding portals and new cryptocurrency offerings, as well as the recovery, by the U.S. government, of billions of dollars worth of stolen Bitcoins. You can run, but you can’t hide. Most of us are very small players here in international crypto-bazaars where cyber-pickpockets are everywhere. “There be dragons!”
It is so much easier, I have found, just living a personal and taxpayer life where I have nothing to hide. Anonymity is often a bad bet.
Those are the bets. You have been warned.
For an update and deep dive into the pricing of goods and services using crypto, see this more recent post.
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Great article. Kudos!!!
I agree with everything except the framing of bet #3, which I think is slightly mischaracterising what the true believers would argue. To be maximally charitable to them, their argument seems to be not so much that e.g. Bitcoin would still work after the collapse of complex societies with computers, but that it would be stable (enough) across economic upheaval that might prompt a government to devalue or reform the nation’s currency.
The counter-argument that remains is then the “using your preferred currency” out of all the >20,000 or so currently existing crypto-somethings. Plus the observation that cryptocurrencies don’t have intrinsic value like barter proto-currencies (cigarettes in Germany directly after WW2, the Aztec’s cocoa beans, coca leaves in rural Bolivia), making it much more likely that people would revert to those instead of crypto in a crisis that takes government-backed money out of the running.
I agree with your basic points here. There are multiple arguments about “safe harbor” uses for crypto, but even the more conservative ones, which I would characterize as being closer to the “Gold Standard” school of currency stability, have a hard time coming up with supporting data. Track gold against the big cryptos and gold looks appropriately counter-cyclical, yet positively stable through the recent upheavals compared to cryptos. The cryptos are still all over the place. I’m not a Gold Standard person, admittedly, but gold has been a decent Safe Harbor recently.
