Crypto - All or Nothing

Due to my current occupational hazard, the one topic that I am asked most often is for my view on cryptocurrencies. I haven’t written on this before because it's not a topic easily understood or explained. By this point however, I believe most people have an underlying understanding, or at least have soundbite they can repeat so they sound like they know what they're talking about.

Perhaps before getting into what crypto is, it is best to explain what it isn’t. One thing to remember is that crypto currency is virtual, there are no actual physical coins or bills being circulated. When you see an image of Bitcoin (the most popular of the crypto currencies) used in a news story, it is used for visual purposes only - to quote Getrude Stein “there is no there there”. Its value is entirely determined by what investors are willing to pay for it, and the only way to make money is to sell it to someone else at a higher price. If that sounds like any other investment, there are some key differences. For starters, crypto is a currency, not a stock in a corporation with assets. Stocks have book values and price can be tied to at the very least, the value of the company's assets minus any company debts or liabilities. Some stocks also pay dividends, to let owners of them share in the profits of the company. Crypto will pay you nothing to hold it, its entire value is again based on speculated appreciation. This is often used as a knock against crypto as an investment, but it really isn’t an apples to apples comparison. Crypto is a currency and so should be evaluated as such. Many investors have speculated in foreign exchange markets (buying and selling of country currencies) forever. The key differences for crypto and a national currency is its creation and backing.

If we again examine the crypto standard bearer, Bitcoin, it is created by computers mining (solving complicated mathematical equations) for it. Unlike a country’s money supply that is printed by a country’s central bank, Bitcoin has a finite number of coins that can be eventually mined and is capped at 21 million. The value of each coin mined is halved every 4 years and based on current mining success rates of computers there will be no coins left to mine by 2140 approximately. Currently, there are over 19 million virtual coins that have already been mined, leaving all the world’s bitcoin mining computers left to find the remaining. It is this artificially created scarcity that is meant to mimic mining for actual precious metals that also become more difficult to find over time.

So if we compare its value to a country’s currency, Bitcoin supporters will point out that governments are constantly increasing the money supply and thus devaluing their currencies over time. While the finite amount of Bitcoin gives it scarcity and protects its value. The problem with this logic is that the scarcity of something does not guarantee its value. Plant species have become endangered, but they are not necessarily anymore valuable monetarily speaking. What gives a currency its value is confidence. Confidence that it is backed up by something. People have confidence in the U.S. dollar because it is the top economy in the world and is backed by the U.S. government. A national currency is also legal tender, meaning it is backed up by nation’s law and is required to be accepted as a method of payment to settle a debt. Crypto has no backing of a nation and is not legal tender. Again, its entire value is purely speculative.