The Cryptocurrency Debate

Last week I read an excellent investor letter written by Mark Yusko of Chapel Hill NC firm Morgan Creek Capital on how the current cryptocurrency investment opportunity could be likened to the gold rush of 1849 in California. Today, I wanted to explore some of my own thoughts around Cryptos. 

To start, let's get some facts out in the open. Satoshi Nakamoto released his Bitcoin paper in 2008, and since the creation of Bitcoin in 2009, it has increased in price from $.10 to a current price (as of 9/15/18) per BTC of $6,523.99. This represents a remarkable ~240% annualized return over the past 9 years. This includes, by the way, a 60+% decline from the 2017 high of ~$19,000. It was originally intended to be a peer to peer medium of exchange whereby people could send payments to one another without a financial intermediary (an ideal not lost on those who witnessed how much havoc could be wreaked by overleveraged financial institutions during the great recession). 

So what's the best long term use case of cryptocurrencies? From what I have read and listened to over the last year, it seems that the best case for cryptos is as a permanent store of value that allows 'the people' to control their own currency via a truly open and free market pricing mechanism. In contrast to fiat currencies which are backed by nothing more than the full faith and credit of whichever government issues them, cryptocurrencies are driven by underlying demand for ownership and transaction. Cryptos simply shift the value of currency to a demand dynamic rather than simply supply driven (fiat currencies are controlled by each respective central bank by increasing or decreasing money supply and base discount rates in an economy). Ultimately, cryptos are about giving the power of exchanging value and valuing that medium of exchange (currency) back to the people. 

Crypto enthusiasts make the case that since they have a limited supply written directly into their code, they are more of a permanent store of value versus fiat currencies (essentially rehashing the traditional gold standard currency argument). They argue further that since fiat currencies tend to depreciate over time as governments print more fiat money over time (either slowly or very quickly depending on the government policies used), that cryptos would allow the people to control their own supply of currency rather than letting a centralized (dictatorship?) government control the value of their currency. Some even think central banks could use cryptos as a reserve in addition to traditional fiat currencies to blend their currency risk between fiat currency and digital cryptoreserves.

Now for the other side. To begin, cryptos are not productive assets like real estate, farmland, or businesses that produce goods and services. So, to 'invest' in these is more like 'to speculate' because if you are buying in hoping to sell them at a higher price, you may just be playing the greater fool's game (listen to Buffett's interview for a simple explanation). Though traditional fiat currencies are not productive assets either, cryptos are being pitched as 'investments' which, in my humble opinion, is incorrect. They should be viewed rather as substitutes or competitive alternatives to present currencies - not productive investments.  Jim Rickards, in his interviews (parts one and two) on The Investors Podcast, on why he doesn't believe BTC will be the dominant crypto of the future, notes that 

- the power consumption for mining BTC in the future is too great to support utility as a transaction based currency and only increasing

- the transaction speed vs. traditional networks' speeds (Mastercard) is simply too slow and needs to be sped up by orders of magnitude to compete

- there are better alternatives that significantly improve on BTC's shortcomings in these two key areas. 

Charlie Munger , in an interview with Warren Buffett and Bill Gates, took a stance that Bitcoin is worthless digital gold. Buffett has a magnificent quote along the lines of: "if you criticize someone who owns Bitcoin and they get mad, that just means they are gambling. If someone criticizes the fact we own Apple, we don't care because we'd buy more if the stock went down." In the same interview, Gates goes on record saying he'd short Bitcoin if he could because as an asset class, it does not produce anything.

Gates, however does acknowledge that the technology behind cryptos (blockchain) is cutting edge and will be helpful in the future.  While I am not as bullish on cryptocurrencies, it is imperative that we separate the underlying blockchain technology from the cryptocurrencies which are built on top of the blockchain digital ledger technology. Blockchain is simply the technology that allows users to exchange value or data or ownership anonymously in a decentralized, secure, and seamless manner without a trusted third party intermediary.

For those who are more technologically inclined, I'd recommend this primer on blockchain technology by Deloitte. It has an excellent chart that shows how blockchain could potentially be integrated in new industries beyond its original use for cryptocurrency ledgers.  There have been articles by several news outlets lamenting the tougher-than-predicted road for blockchain applications within industries, but just two weeks ago, the World Bank announced the world's first blockchain based bond issue (keep in mind the world bond market is over $100 Trillion - the opportunity to disrupt traditional financial institutions here is incredible).

Could it be that the underlying blockchain technology is the real game-changer?  Will other 'systems of trust' be disrupted (think about the data we inadvertently share with tech companies, trust we place in consumer brands, trust we place in transportation services, and the list goes on)? For that matter, couldn't any system that tracks ownership (bonds, real estate, stocks, copyrighted material, patented products/systems) potentially be moved to a blockchain ledger? The possibilities in my mind are endless.

Ultimately, cryptos could be an alternative way to exchange value in competition with traditional fiat currencies, but I am not holding out for crypto global dominance. In my opinion, they will not replace fiat currency globally but could potentially be a store of value for citizens in nations whose governments do not manage their national finances in a productive fashion (Venezuela, Argentina, The Weimar Republic in the 1920's, People's Republic of China in 1940's, etc.).  However, the underlying blockchain technology's future is what truly gets me excited. I believe that it has the potential to disrupt many industries that are centered around fee based intermediaries. Whether reality will match the hype is what will define its legacy.