Cryptocurrency: What’s it all about?
Cryptocurrency: What’s it all about?
Introduction Cryptocurrencies. This topic receives a great deal of attention nowadays and has left many people, including myself, with questions, concerns, fears, and ambitions. At the risk of merely restating (or misstating) the obvious, this letter is a bid to describe what seems to be happening, in as plain non-technical jargon as possible. Feel free to reach out to me with any questions.
What are cryptocurrencies? Much of the world uses US dollars to transact business because so many people believe in the dollar’s basic value. US dollars aren’t backed by anything physical. We left the gold standard in the 1970s. Dollars are backed by our collective faith in their utility, and by the US government. Also, money is already mostly “digital.” Much of how we interact with money is through online computer applications like bill pay features, smart phone payment apps, credit cards, or through institutional processes such as wire transfers and ACH.
A cryptocurrency is completely digital in that there is no physical version like a paper bill or metal coin (a “token”) that you can hold in your hand. It’s all online. A digital token gains value if people want it and seek to buy it. How much value depends upon supply and demand for that type of token at that point in time.
If this seems abstract, consider that there are a lot of things that have value that is not inherent to the specific object. Sports memorabilia is a good example. Which item has more value: a baseball sitting in the toy bin of your six-year-old neighbor? Or the ball that was hit for the winning home run in last year’s World Series? Which would you rather own?
Value can be nothing more than the sentiment we assign to something, whether physical or digital. So long as there are people willing to buy at a certain price, then there’s value. Of course, sentiment can lead people to overreact. And consensus can evaporate.
The technologies underlying these digital tokens are important to understand. “Blockchain” technology is like a big online ledger or database that shows who owns what for a particular digital token. It is updated whenever someone sells something to someone else. If I sold my friend a crypto token, my crypto account (my “wallet”) would go down by one token and his/hers would go up by one token. This transaction is (apparently) not hackable, verifiable, and real time. It’s also unregulated and the owners of wallets can be hidden so you might not know who you’re doing business with. Potential for risk? You bet. 2 Draft prepared by Larson Gunness, CFP® November 1, 2021
What problem is this looking to solve? So why does this even exist? To think about the possible uses for this, answer first whether you’re thinking about cryptocurrencies (tokens) or blockchain (the technology infrastructure), and then what population uses each.
A currency is defined as a medium of exchange: something that is used to make transactions. It is also helpful if it can retain its relative value so that tomorrow it isn’t worth half, or double, what it is worth today. The wild volatility of cryptocurrencies undermines their case as a replacement for something like the US dollar. But in places like Vietnam, Argentina, or Nigeria, where the local sovereign “fiat” currencies have been fiascos with hyperinflation and all sorts of government shenanigans, an alternate way to deal with money is welcome. In the US, many people are concerned that the massive stimulus and quantitative easing programs from 2020 will be inflationary.
Another group that has dark incentive to find alternatives to the traditional monetary system has been criminals. Drug running, money laundering, ransomware payments have all apparently used the cryptocurrency system of exchange. So, as a currency, the case for crypto is fraught for sure… but the demand is there.
There is also a frenzy of speculative excitement about this new new thing. Throughout the world, day traders, hedge fund managers, major institutions, gamers, and teenagers on smartphones are all engaged in speculative action around crypto. I’ve heard so many people talk about crypto prices – even a sixth grader on our local track team was knowledgeable.
Blockchain, the underlying tech, is for many the most interesting and potentially transformational part of all of this. Let’s consider.
What might the future of this look like? For the myriad of different cryptocurrencies, no one knows where this all will lead. It seems to have become more than a fad that can be readily dismissed. But will there be hundreds to thousands of individual digital currencies in the future, each readily acceptable as means of exchange, with values rocketing skyward for years to come? It seems unlikely. Probably some small number of cryptocurrencies will exist for the long run and the majority will see their value drop to zero. For those that remain, there are many questions around taxation, uses, regulation, acceptance, and so on. Also, the amount of energy needed to power the computer mining of cryptocurrencies is mind boggling: as much energy is used to mine cypto as used by countries the size of Sweden. This seems unsustainable to say the least.
The technology infrastructure being developed is a different story. Blockchain-based technologies could be very beneficial for many uses and users in the future. Anyone who could benefit from a superior means of transmitting and storing digital data could benefit. This technology could reduce costs, improve reconciliation, make transaction time almost immediate, and store data securely. For the intermediaries who have built their businesses by 3 Draft prepared by Larson Gunness, CFP® November 1, 2021
charging fees to control access and flow of money and information, the adjustment might be rough. But the benefits for users could be substantial.
A good example would be ticket sales for large events like professional sports or concerts. Right now, if you want to buy a ticket to a big concert featuring your favorite musician, the process is controlled by big ticket brokers. This technology could undermine the power of the middleman or intermediary. What if the musician could sell tickets directly to his/her fan base and then pay the venue directly? This, as they say, would be transformative.
Conclusion. Much like the late nineties, there appears to be a growing fear out there of missing out on the supposedly easy gains to be made overnight in this new asset class. Stories of fabulous and easy riches seem to abound. In times like these, we have to ask whether things are different this time or only a little different. Truisms like: if it sounds too good to be true, it probably is can seem stale and inapplicable, especially to those who have stuck it rich.
As you think about your own way forward, I’d advise you to go back to the basic fundamentals of what you hope to achieve with your wealth, however great or small it might be. Are you looking to turn your nest egg into a fabulous fortune, risking boom or bust? Or would you prefer to follow a high probability of moderate returns over a long period of time? Some combination of different strategies?
Only you can answer these questions for yourself. But once you have answers, stick to them. Don’t be swayed and seduced by the newer, better thing. If your strategy is achieving what you’d set out to achieve, then stick to your guns. Be flexible, embrace change, but don’t be flippant. If you achieved your return targets, shouldn’t you be satisfied?
There’s much to learn as the world evolves. Smart contracts, NFTs, tokenization, defi, DAXes, and so on are the HTML, .com, smartphones, and IPs of tomorrow. Take time to learn. Companies involved in the emerging sector of decentralized finance is something that I recommend investors should seek to understand. Look to history and think about companies that survived from the late 1990s through the crash during the dot com era.
And in the end, remember we’re still human beings inhabiting human bodies with needs that go beyond what can be found in a gamer’s chair. We’re prone to great creativity, but also to herd behavior. We can collectively gather in euphoria and in panic. Have we seen true investor panic yet in the crypto world? I don’t think so.
Of all the truisms, one of my favorites is: “Don’t confuse brains with a bull market.” Wise words indeed.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, 4 Draft prepared by Larson Gunness, CFP® November 1, 2021
consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Stock investing involves risk including loss of principal.