As a proponent of blockchain technology this isn’t FUD (Fear, Uncertainty, and Doubt). This is the reality about the dangers of hype, FOMO (Fear of Missing Out), the lack of general understanding on basic economics, and the absence of reasonable conversations in the community.
The First Bubble and Why it Was The Fault of Investors
Even for those unfamiliar with cryptocurrency or blockchain technologies, it would be impressive if you didn’t at least hear of the crash. In late 2017, cryptocurrency prices and more specifically Bitcoin Core (BTC) went on a meteoric rise hitting an all-time high of 19,891 US Dollars per BTC on the Bitfenix exchange.
The market capitalization of cryptocurrency as a whole had been relatively stagnant throughout 2017. However, in late September 2017, there was a steady rise and from this came the hype and FOMO. Bullish investors will attribute this rise to bullish news when it really came down to the sudden burst of publicity and FOMO from new investors.
New investors hopped on the bandwagon hoping to catch the rising wave without any understanding of the technology and its purpose. Buzz words permeated the media and like Tulip Mania everybody was buying.
BTC, being the first cryptocurrency, pulled up the value of other currencies as investors scrambled for easy financial gains. Within days the prices stumbled and began to fall. At its peak, the total market capitalization was over 795 billion US Dollars and at the time of writing it is now just over 210 billion US dollars an approximately 73.5% drop.
The Lack of Responsible Investors
Instead of a sound understanding of the underlying technologies of each project, investors were speculating based on the excitement surrounding the sudden rise of the price. The media began reporting on this same excitement, bringing in hordes of amateur investors. As the entire market rose in tandem with BTC, alternative coins flourished based on the same speculations.
The market was flooded with not only new coins, but also initial coin offerings (ICO) that provided the mirage of easy gains. This lured in investors who expected the market to continue rising, without any precedence or understanding of why that rise should continue.
A lot of this comes from the same issues that I discussed in my post on the Tribalism in Cryptocurrency. Even for those who took the time to do their due diligence, the reality is that every coin at the moment is one of speculation where most discussion happens in echo chambers that ignore many realities of each situation. Financial motivations powered by greed drove the prices to unrealistic and unsustainable levels for cryptocurrency in its current state.
Then and Now – Price Comparisons
Looking at BTC has generally been a relatively good metric in determining the market as a whole. Being the forefather of all other coins currently gives BTC the power at shifting the entire market capitalization. As you can see from the above chart, any investors who decided to buy BTC during the late 2017 rise would have seen losses within months and even further losses if holding until October 2018.
The losses are mostly relative across the board for alternative coins, however, some coins are bigger losers.
Of the major cryptocurrencies, XRP, commonly referred to as Ripple, had seen some of the biggest losses since the bubble and subsequent crash, however Bitcoin Cash (BCH) has now surpassed those losses. At time of writing, XRP is 12.7% of its peak price whereas BCH is 11.6% of its peak price.
Another facet of the crypto bubble were the sudden explosion of popularity for Initial Coin Offerings (ICO). ICOs gave investors the ability to get in early on a new cryptocurrencies project, something many would have liked to do on BTC before its rise. Problems quickly arose as ICOs were unregulated and allowed bad actors to participate.
Luring investors into investing money and then abandoning the project is called an exit scam. There were fake or unsustainable projects that were shut down during this period as well. Here are some notable exit scams or coins that no longer function from ICOs during the 2017-2018 frenzy:
- ACCHAIN, PUYIN, & BIOLIFECHAIN
- Shenzhen Puyin Blockchain company raised funds for these three projects before abandoning the project. Since then China has outlawed ICOs completely and six suspects were arrested for this exit scam that brought them $60M US Dollars.
- With an anonymous dev team, newly minted websites, and fake comments in their forums, this project enticed $12M US Dollars from investors hands before the project’s sites and accounts all shut down.
- Certainly one of the most memeable failed projects, BCC’s market capitalization soared making it one of the best performing cryptocurrencies in 2017 through an aggressive multi-platform marketing campaign. As fast as it rose, it crashed after a strike-off notice from the British Registrar of Companies and a subsequent cease and desist from the Texas Securities Board.
As anybody familiar with the state of cryptocurrency knows, this list is much longer and very likely continually increasing in size.
The Idea of Intrinsic Value in Cryptocurrency
Claims of any cryptocurrency having an intrinsic value are absolutely false. There are arguably few things one could even consider having intrinsic value and those are limited to the absolute necessities for life, such as food, water, air, shelter, and medicine. Anything with a value outside of these four aforementioned essential life necessities is based solely on supply and demand driven by earning potential or perceived value.
Supply & Demand
The value of an object, asset, or service determined by supply and demand has to do with the availability or the supply of said object, asset, or service. If the object, asset, or service has a high demand, but low availability, this can drive up the price. Real world scenarios of manufactured supply shortages creating higher prices provide an easy example for how supply and demand can affect pricing.
The first Beanie Babies© began production in 1993 and by 1995 many of these plush toys began selling for 10 times their initial value. Ty company accomplished this by producing a limited supply for each style of the plush toy it released. This created speculation amongst consumers that due to the retirement of older styles, the value would rise due to the continued demand by those who were unable to procure the plush toys before the supply was depleted. As such, many of the plush toys were purchased for their earning potential and at one point their resale accounted for 10% of eBay’s sales.
Giving a value to something based on its perceived worth is common everywhere. Brand-name drugs, designer brands, and gems are easy targets for perceived value. In regards to drugs for example, the generic versions of a drug have the exact same active ingredient as their brand-name counterpart, yet they are sold at a higher price.
Bitcoin as an Example
First and foremost, ensure you understand the differences between BTC the coin and the blockchain technology that powers it, as this is a very important distinction. BTC in itself is only as revolutionary as the underlying blockchain technology allows it to be.
Charliee Lee, best known for the creation of Litecoin (LTC), has previously stated cryptocurrency and more specifically BTC has an intrinsic value. Lee has made a couple points about the merits of cryptocurrency and why that gives credence to the idea of an intrinsic value.
The problem of course is that Lee is wrong.
As has been said many times and even directly to Lee since his statements at the Coinsbank 2018 blockchain cruise, the cost of production to create cryptocurrency, does not give the currency an intrinsic value.
Cost of Production
If you pay somebody (cost) to make chairs (asset, object, service) and then sell those chairs, the value is not determined by your cost of production, it is determined by the the raw materials and the willingness of the buyer (demand) to pay for that chair when comparing to competitors (supply). Even in this example, there is the potential for the chair to sell at a price below its cost of production.
A chair isn’t a great example, because in a way it does have an intrinsic value through the materials used to create the chair. However, the vast majority of cryptocurrencies are not pegged to a physical asset, removing that potential.
Lee’s other three points as to the intrinsic value of cryptocurrencies were transaction immutability, fixed money supply, and censorship resistance.
Transaction immutability through blockchain is admittedly a potentially revolutionary technology. The technology itself can certainly be valuable based on how it is applied as a real world solution. It certainly does not give intrinsic value to any project.
One of the factors of immutability for BTC also relies on Satoshi Nakamoto’s solution to the Byzantine Generals’ Problem. BTC relies on the majority consensus through proof-of-work hashing. In July 2014, the now defunct Ghash.io mining pool exceeded 50% of the BTC hash rate which lead to the voluntary action of reducing their hash rate. Similarly, in July 2018, Bitmain was dangerously close to controlling the majority consensus as it reached 42% of the BTC hash rate.
The claim of immutability in BTC’s blockchain relies on the fact that controlling the majority consensus is too expensive, yet these near misses exist. Less altruistic players would be able to take advantage of this weakness.
Fixed Money Supply
Anybody who believes BTC has a fixed supply is extraordinarily gullible or purposely naive. Per Satoshi Nakamoto’s original whitepaper describing the technology that gave birth to Bitcoin, BTC does indeed end once all 25 million coins have been mined.
This however is completely irrelevant to the actual supply of a digital currency. The total number of coins in no way determines the total available supply. The supply is actually determined by the lowest recordable unit on the BTC blockchain.
Currently, a Satoshi (0.00000001 BTC) is the smallest unit of BTC that is recordable on the BTC blockchain. There’s also the need to mention such things as the millisatoshi, an even smaller unit, which although is currently not recordable on the main blockchain, has its uses in sidechain projects.
If you can transact at a level of a single Satoshi this makes 25 million become 2.5 quadrillion (2,500,000,000,000,000). This determined value of a Satoshi tells you multiple things. It sets a limit for the value of BTC and if that threshold is ever crossed, there is very much the ability to increase the available supply by allowing a lower unit of measure, such as the millisatoshi to be written onto the blockchain.
The fact that there are sidechain projects already utilizing units smaller than a Satoshi only solidifies this point. You can’t indefinitely limit the supply of a digital currency; especially so when it is not pegged to a physical object or asset.
To say that any cryptocurrencies are censorship resistant is at least dishonest and at worst a pipe dream. Would the majority of investors or businesses adopting crypto payments be doing so if there was not some way to convert that cryptocurrency back into fiat?
Take a look at the reach of US banks when it comes to the IRS and tax evasion. In order to do business with US banks, international banks must divulge account information for their US customers. Many country’s banks also participate as AEOI (Automatic Exchange of Financial Account Information) members for tax evasion purposes. Even now Canadian banks continue to ban cryptocurrency activities for their account holders.
Now imagine the US outlaws cryptocurrencies. All US banks stop cryptocurrency activities and freeze incoming payments from known cryptocurrency sources. International banks that conduct business with US banks are now forced to abide by these same rules. Exchanges with KYC requirements close the accounts of all US citizens.
Although it’s true you can continue to trade and use BTC, it no longer has a legitimate use for you. The local takeout restaurant is not going to accept BTC if it is illegal and their only ability to turn that into fiat is also illegal. Government’s very much have the ability to censor the use of cryptocurrencies using their already existing systems of financial controls.
The True Value of Any Cryptocurrency
Most of those passionate about the future of cryptocurrency will undoubtedly point out this as an unfair representation of BTC. I respect BTC for its potential and as the forefather of the projects that have come in its wake. There are however still many hurdles BTC needs to cross in order to cement itself, which will be increasingly difficult as other projects develop competing technologies.
This is not FUD, this is a request for those investing in any crypto or blockchain projects to understand how to value a project or if a project has value at all.
It is easy for the crypto-centric to dismiss the words of economists, successful investors, or even banks; instead brushing these entities off as dinosaurs that are afraid of the future.
Ironically it it is these dinosaurs and their financial institutions that actually give credence to cryptocurrency now. Even more so is the fact that many in the cryptocurrency world are relying on these prehistoric institutions to give further value to their projects, such as a BTC ETF.
Each projects value needs more than to be based on speculation of a perceived value. Understand not just what your investment means, but also if it is capable of accomplishing its goals and as all investors should know, only invest what you can afford to lose.