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In 2009, a superstar was born.
That superstar was Bitcoin, and in the 12 years since its birth, it has become a pop culture phenomenon and a force that has taken the world of finance and investing by storm. It has since spawned an entire ecosystem of weird and (sometimes) wonderful ideas.
Read on to learn more about the bizarre world of cryptos.
Cryptos, cryptocurrencies, digital tokens etc are all synonyms for the same thing: a small, individual packet of unique data, which exists on a blockchain. These packets of data can be purchased in exchange for fiat currency (eg. US Dollars), accumulated, or exchanged with other parties. They can also be created, more or less, out of thin air.
The better part of the crypto discussion rests with the underlying technology, the blockchain. A blockchain is simply a decentralized ledger; a network in which a large number of participants (nodes) keep a record of all the transactions which have taken place. In this way, not only is there no single ‘middle-man’, but there is also a reasonable level of security, since a transaction hasn’t officially taken place until the nodes of the network have ‘agreed’ that it has.
The removal of the middle-man is the bit which has kept crypto investors in such a frenzy of libertarianism for the past 12 years.
Think of how the conventional payments system works. If you want to send money to someone else, you must first send it to a bank, or some other payment intermediary. That intermediary then forwards it to the intended recipient. Along the way, the intermediary takes a small fee for their trouble. There are two aspects of this which make crypto investors uncomfortable: i) the small fee, ii) the single point of failure represented by the intermediary. Transactions on a blockchain are peer-to-peer; value flows directly from the sending party to the receiving party. There is no middle-man, no small fee (kind of), and no single point of failure.
Blockchain technology has a vast number of applications beyond making payments though. Some securities exchanges are swapping out their legacy clearing houses with blockchain applications. There appear to be a number of promising applications in logistics, finance, healthcare and others too.
A crypto investor may offer a variety of answers if asked this question.
What it all boils down to though is that lots of people, largely without reason, agree. It takes nothing more than the agreement of lots of people for pretty much anything to be worth pretty much anything. It’s just like that time people believed tulip bulbs were worth more than a house.
A crypto investor may make the mistake of saying that fiat currencies (like the US Dollar) derive their value in the same way. The hole in that argument though is that a fiat currency has value because it is backed by the full faith and credit of a nation state; it’s natural resources, it’s warfighting capability, it’s trade relationships etc. Cryptos are typically backed by absolutely nothing whatsoever. Nada.
The other argument that a crypto investor may offer, in the case of Bitcoin in particular, is that of scarcity. This is because Bitcoin’s blockchain is limited to 21 million. In other words, there can never be more then 21 million Bitcoins in existence (there are currently around 19 million). In addition to that, Bitcoin is ‘created’ through a process known as mining. Mining in this instance refers to running a particular algorithm (Secure Hash Algorithm 256) on very powerful computers until a data packet, recognizable as a Bitcoin, is produced. For every Bitcoin that gets mined, it becomes more difficult to mine the next one. It’s true that Bitcoin is ‘scarce’ and has a fixed supply, but it’s an engineered scarcity, in something with no intrinsic value.
Fun fact: Mining cryptos now consumes more electricity than the entire nation of Argentina.
For some, definitely not. There is some genuinely interesting work happening in this space, much of which could have far-reaching benefits for our civilization.
For many others though, the answer is absolutely yes.
Almost every week, we’re regaled with stories of a new crypto which has skyrocketed in value, only to plummet again the following week. This is no accident. These are deliberate (and usually successful) efforts to fleece investors of their money, perpetrated by charlatans who are cashing in on hopes of fast wealth.
Below is one of my favourite charts of all time – and one every investor should familiarize themself with. This chart shows the anatomy of basically every speculative bubble in history, according to famed economists, Charles Kindelberger and Hyman P. Minsky. It is known as the Kindelberger-Minsky Cycle. Let me walk you through it:
1. Stealth Phase: Wise and savvy investors begin entering a new market, seeing much opportunity in the future. The opportunity is not yet widely known, or understood.
2. Awareness Phase: Knowledge of this new market begins to spread. Investors who are highly-skilled, but a bit slower to move, begin entering. Their entry begins to drive prices up further.
3. Mania Phase: This is where the lowest-skilled investors make their move. They’ve seen all the money made by others – and now they want a piece of the action. This final flood of capital begins to drive prices exponentially higher.
4. Blow Off Phase: Reality begins to dawn. Prices tumble! The investors who entered in the Stealth, or Awareness phases have probably already made a timely exit. In fact, their departure is what’s driving the drop in the prices. Everyone else (usually the general public) gets left with severe losses.
If this all sounds familiar, it’s because this is what happens with practically every speculative bubble; it collapses catastrophically and takes the fortunes of a lot of innocent people with it. There are some important differences and unique variations each time, but this general pattern has held true throughout recorded history. The other poignant part of this chart is the very peak of prices, the part labelled “New Paradigm”. Let’s take a look at that in the next section.
I know it’s a bit cheeky, but here’s the price history of Bitcoin/USD for comparison to the Kindelberger-Minsky Cycle above:
Well, it’ll probably be a little of both, but not in the way that Bitcoin’s mysterious creator probably imagined. The problem is this: for Bitcoin, or any other crypto to become a widely adopted means of exchange, it would effectively replace fiat currencies.
That is something I don’t believe any government, or central bank, would be willing to accept.
What is likely though is that governments will start issuing digital versions of their existing currencies. China has already done so with it’s digital Yuan. Interestingly, not too long after China broadened the rollout of the digital Yuan, it’s top regulators banned all crypto transactions and mining.
Would it surprise me if something similar happened elsewhere? Absolutely not, I expect it – and I say that for one simple reason: for non-fiat cryptos to become the primary means of exchange, governments and central banks would need to be willing to take a back seat. I am quite confident that will never happen in a major developed economy.
Frankly, that’s good news for us. Without the active management of money supply and interest rates on the part of central banks in the wake of the Global Financial Crisis in 2008, the global economy would likely have crashed helplessly, perhaps with only a minimal recovery since. If everyone was using Bitcoin, or some other non-fiat digital token, central banks would’ve been basically helpless.
Personally, I’d be uncomfortable living in a world where my quality of life is determined by the same people who were offering up an anonymous means of illegal exchange on the darkweb.
Mercifully, there is almost zero chance that I’ll have to.
It may not surprise you to learn that Afinitiv LLC does not invest in cryptocurrencies.
The gains realized by some investors have been absolutely stellar, but the risks and the volatility involved are well outside the parameters of what we consider reasonable for our clients. We’re opening to changing that policy if a more sensible market dynamic emerges, but we’re nowhere near that right now. If we had to take on anything in this space, we’d likely look for a blockchain stock where there’s a meaningful, real-world application to be had.
Until then, we’ll stick to assets with some real-world fundamentals to analyze – and that fit within our ethical framework. If that sounds more to your liking, we'd be happy to welcome you onboard.
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