In the past month Bitcoin and other cryptocurrencies saw a sharp decline in value. It caused its criticasters to repeat their mantras. Again we heard about the comparable bubbles from the past (tulip bulb) (Internet year 2000), the comparison to pyramid or ponzi schemes.
Cryptocurrency contained in their opinion no intrinsic value and there was no other way than the cryptocurrency market ending in a bloodbath of epic proportions. The price of cryptocurrencies would ultimately dwindle to zero. The sharp decline witnessed in January 2018 was of course the definitive proof of the pudding of their argumentation. If we dive deeper in these sound bytes we can learn that their argumentation is at least very arguable and suspicious. It could as well be that their argumentation is intensely tightened to an agenda of different proportions.
‘It’s a bubble!”
Comparing the January 2018 events to any previous bubble is for a number of reasons difficult. First of all, because in January there was a sharp decline in prices and market capitalisation (from its top at 800 billion in December 2017 to around 400 Billion in early February) but this market capitalisation is still very substantial (it is half of the market value of Apple, one of the largest companies in the world). From this perspective it is impossible to state now that “the bubble has burst“. You can only make such claims in hindsight long after the market really collapsed and no significant ‘signs of life’ are visible or measurable. Looking at following table we can see that the price increase has only a very recently start and therefor it is too early to draw any conclusions.
We can not neglect the fact that the enormous rise in pricing in the second half of 2017 gave people ideas on how to cash in on this new phenomenon. There have been ICO’s (new initiatives within the cryptocurrency space) that were aimed at obtaining a maximum revenue from the token or currency issuing. After the launch these currencies would very soon become irrelevant as an impressive white paper could not be substantiated in delivering a valuable product. This is however a rather typical sign of a new and booming industry. The road to maturity will be paved with ‘accidents’ as can be seen in any new disruptive industry. The internet bubble of 2000 saw the down fall of many .com companies, but also ignited the spectacular rise of companies like Google and Amazon.
‘It’s a fraud, a plain right scam!’
This is the collection of same type arguments when it comes to the accusation of cryptocurrencies being a ponzi scheme, pyramid scheme or scam. These arguments have in common that there is some sinister complot involved by luring people into spending their money into something that thrives on ever increasing higher prices. These higher prices need the attraction of ever new ‘victims’ until the system fails to do so and the system collapses when people who want to get out and get -at least- their invested money back. It is very curious and remarkable how this argumentation is made over an over again in respect to cryptocurrencies even by people who supposed to have the brightest minds concerning economic matters.
First of all, there is a simple deal if you get into cryptocurrencies. Mostly you sell fiat currency and in return you get (part of) a cryptocurrency: you sell 9.000 dollars, you get 1 Bitcoin (considering February 2018 prices). There is no one who has knowledge about what you will receive in fiat currency, might you decide at a later point in time to convert your cryptocurrencies back into fiat currency. Over the past 10 years the only fact that can be proven is that if you are wiling enough to hold on to your Bitcoin long enough, there is a high probability that the Bitcoin has reached a higher level of pricing compared to when you bought your Bitcoin. But there is not an single guarantee that this will be the case when you decide to buy or sell your cryptocurrencies.
This is fundamentally different from pyramid and ponzi schemes where investors are lured with attractive future prognoses of returned values of their investments. In these schemes there is usually also an ‘evil’ initiator who has thought out the scheme, has knowledge about its practices and will keep the scheme in place as long as possible.
There are people who do make claims about future prices and those people might even have a cult following who will act in accordance to these price predictions. For smaller cryptocurrencies it could be possible to manipulate the market through a so called pump-and-dump. A strong party in the market buys a big stake of a certain currency inflating the price, usually in combination with the spread of fake news to promote the currency and its associated products or services. This attracts new buyers willing to invest. When the price reaches a high level, the strong party suddenly dumps its cryptocurrencies leading to a sharp decline in price because of the distorted supply and demand balance.
There are two aspects to be recognised. The first being that the pricing is always in relation to the conversion of fiat currency. The new buyers may have a bad feeling about the situation but they still hold the intrinsic value of their cryptocurrencies. Secondly with a cryptocurrency like Bitcoin having a market capitalisation of around 150 billion (in February 2018), it is difficult to manipulate the market by a pump-and-dump.
Actually the fact that when you bought a Bitcoin in 2013, forgot about it and decide to look up its status in 2018, you will find that it is still there. This may sound like a simple fact, but that we as humans have been able to set up a system of value with no central (physical) guard where you currency is parked safely is actually pretty amazing.
‘There is no intrinsic value, it’s just ones and zeroes and the final outcome is that the price will be zero!’
The intrinsic value argument in combination with the digital one/zero argument can be applied to lots of things and situations. You can take for example the intrinsic value of an Apple iPhone, mainly consisting of materials like a screen, memory, processor etc. with software running on top of it. Individuals could decide to obtain the materials by themselves and to assemble their own phone with their own operating system. They could create their own social media platform like Facebook and write applications to facilitate that.
Yet people are prepared to pay a price buying the iPhone or think of Facebook as one of the most valuable companies in the world and are prepared to use the platform, being aware and take for granted that they themselves become the product for Facebook. So there is an intrinsic value in an iPhone or social media platform like Facebook. The intrinsic value of cryptocurrencies can be reasoned along similar lines.
The value is that cryptocurrencies represent state-of-the-art technology that has been developed over the past decades (amongst them using public key cryptography, proof of work, digital cash) and the culmination of these independent technologies have been applied to set up a working digital, peer to peer cash system that is safe and has no central authority or trust. So instead of making the same invention over and over again, people rather rely on using an existing product that has proven to be trustful and working and therefor to be valuable.
So why these heavy attacks against cryptocurrencies?
There are a number of reasons why there is heavy opposition to the use of cryptocurrencies that have nothing to do with the previous arguments. First of all there is the matter of control. If a government and its central bank do not have absolute control over the monetary system that means there is a direct threat concerning the regulation of (international) transactions and tax collection in particular. It becomes more difficult to determine someone’s taxable wealth. Actually, cryptocurrencies give the ‘normal’ citizens a level of self determination spending their incomes and saving, comparable to the evasion routes that the high an mighty are using to store their wealth in tax free havens.
Secondly there is a more psychological element in play where economists and politicians simply can not think in terms of a construct that is now on the rise where money can be stored and spent without a central and physical guard. And of all this happens in a fast, secure and cheap way (certainly in comparison to the private banks that have missed the capability to innovate along these lines).
It is almost a certainty that many nations will put heavy sanctions on the use of cryptocurrencies in months and years to come. They will make it difficult to transfer fiat currencies into crypto currencies, they will heavily regulate or even ban ICO’s and maybe go as far as ban mining, the processing power behind cryptocurrencies. This will at the same time open great windows of opportunities to countries who embrace these innovations instead of banning them. Which in the end will be a much better approach as it will certainly lead to mighty economic stimuli.
After all radios did not disappear when televisions were introduced and televisions did not disappear when the internet appeared. Cryptocurrencies can and will exist in coexistence with more traditional forms of monetary systems and regulations.
Ewald Kegel, Nootdorp, February 2018