As an investor with an economics background, I’m fascinated by cryptocurrency. It’s an innovative form of currency that differs from anything the world has seen since the development of modern money. Crypto isn’t tied to a specific country, it’s digital, it’s not easily manipulated, and is backed by complex technology. What’s even more interesting to me is its meteoric rise, and fall, and the willingness of people to invest huge sums of money in it without fully understanding the currency and its risks.
In this post, I’m sharing what you need to know about cryptocurrency (it’s not what you expect!) and guidance for investing in it going forward.
Crypto Currency Is Speculative
Crypto is speculative due to its high volatility. Any investment that can go up that fast can easily come down just as quickly. It’s also speculative due to the hype that surrounds it. Discussions around crypto are consistently filled with unjustified conviction that it’s the best thing since sliced bread. This opinion was reinforced as the price of crypto kept gaining month after month, year after year. It had all the features of a bubble. When crypto was at its peak I stopped preaching to people about the risks as it seemed that no one wanted to hear it. I was that guy at the party who was bumming people out. At that time, there were only a few big holdouts, including Warren Buffett and Charlie Munger of Berkshire Hathaway. Charlie went so far as to call crypto “rat poison”.
One of the reasons crypto became so popular, in my opinion (leaving rising values aside), was that it is an anti-FIAT currency, in other words, crypto is a currency that is not managed and backed by trust in the government. It does its own thing without interference. Today, almost all currencies are backed by nothing more than the trust in government. For those who believe that their national currency is manipulated by an evil government, with absolutely no discipline in spending money, crypto is very appealing. It’s touted as a currency for the people, with no government control or regulation; essentially like crowd-sourced money for the people. It has a cool algorithm that limits the number of coins mathematically and its technology is impressive making it very tamper-proof.
Crypto Currency Likely Can’t be the New US Dollar
Currencies need to be manipulated and regulated. This isn’t a popular opinion but in economics, it is true. The great depression of 1929 was a big turning point in how governments managed economic shock. For the most part, governments do not want to be heavy-handed, they want to keep things stable. During the Great Depression, the government’s laissez-faire approach to managing currencies prolonged a down cycle that lasted a decade, and people suffered. If that’s too ancient history, look to the recent COVID-19 pandemic. Manipulation and intervention was the key strategy to saving the world economies. The current view is that the government (central banks) needs to intervene in situations where the economy cycles down too fast or conversely cycles up too fast. There are a number of ways that the economy can be throttled up or down. Without getting into complex mechanisms, this is mostly accomplished by adjusting interest rates and the money supply. Although not perfect, the economy generally gets pushed or pulled in the right direction.
Why the distrust in governments? That is a complicated issue, but it’s also rooted in history. There are plenty of examples of currencies that died at the hands of greedy businessmen and politicians. The ability to print as much currency as desired, without a limit or tie to something real (like gold or silver) has sometimes resulted in serious abuse. If too much money is printed, it eventually becomes worthless. This happens frequently in other countries. Even in the USA and Canada, crypto fans anticipate the demise of the US dollar, which will usher in a new era for crypto. There is some intuitive validity to the expectation that major currencies will eventually come crashing down because governments have been overspending year after year. It’s an interesting theory and it grabs headlines, but is it true? Not necessarily.
Crypto Currency Vs. Other Currencies
Most people do not realize that money isn’t a physical thing, it’s more like a concept or idea. Prior to money, people raised rabbits, then went to the local market to barter for carrots or fish (for example). The barter system was simple but the world moved very slowly and was for the most part very poor. The move to money was like discovering fire, a huge leap in the history of mankind. Money is a human construct that required the participation of and acceptance by society that money was an acceptable exchange medium. Because it’s a construct and not a physical thing, money can take any form. Throughout history, people have used shells, beads, cigarettes, playing cards, pantyhose, gold, silver, gold certificates, coins, and later paper currencies backed by gold, and finally FIAT currency, which is what we have today and is backed by nothing. It can be backed by nothing because it is ultimately very a powerful concept or idea.
So what currency was ever real? Answer: none of them. They are all human constructs, including gold. They are all based on the idea that as a society, we have valued and accepted (insert money type here) as a store of value, a unit of exchange, a unit of account, with a certain amount of confidence that it will not disappear overnight. But how can gold not be real? It’s shiny and has been around for thousands of years? It’s valuable! Well, it’s only valuable if we all agree that it is. If you think about it, gold is only useful to society to meet a few manufacturing needs – the rest is for jewelry, which is cultural and subject to change. Aluminum is a much more useful product and at one time more valuable than gold because of how difficult it was to produce (scarcity).
What you should take away from this article is that no currency, whether it’s gold, your bank account, or crypto, is real. Even if your favorite currency is backed by something (gold), it does not mean it’s more real. The system works on confidence and nothing more. It’s truly amazing. The existing monetary system has evolved over the last few centuries to become very complex and few people truly understand how it all works. It does not however stop everyone from having all kinds of opinions about how it should be managed. Central banks can make some dumb decisions about the system, mostly because it’s so complex, even with all their experts at their disposal, but they for the most part generally try and keep things stable by doing very little.
How does crypto fit into the monetary system? People have given it value, but stability is something it has never had. So it competes against other unstable currencies of the world with one big difference, it is not associated with a country. From an economist’s perspective, it’s genuinely fascinating. Crypto is much more comparable to gold except it’s electronic, it does not need to be mined or physically stored. The environmental aspects of mining crypto aside (it uses a huge amount of electricity to mine), it’s a much better version of gold.
Guidance for Investing in Crypto Currency
Investing in crypto has always been a bet that the existing reserve currency (the US Dollar) would fail and be replaced by crypto. Or at the very least crypto’s adoption would continue to grow and become one of the few major accepted currencies. It’s possible, but is it probable? No one knows if the US dollar will fail, and even if it does, why would it be replaced by crypto? Why not a new US Dollar, the Euro, the Chinese Wan, a US government digital dollar, or a multi-country led cryptocurrency? How likely is it that the powers competing for the reserve currency of the world would back crypto? They would have to give up the ability to manipulate the currency for good reasons (or for those conspiracy theorists for bad reasons). Like many things, it is possible that crypto does succeed and just like winning a lottery, if you are right, you win big. But even if this scenario plays out, you still have to figure out which cryptocurrency will be the winner. There are the obvious big players, but there are thousands to choose from and the majority of these will fail and fall into obscurity.
As long as investors understand that crypto replacing major currencies is a low-probability scenario, with a potentially high payout, there’s no harm in speculating. I would love to have held some crypto early on as a 1-2% weighted speculative bet. However, I was likely betting on something just as speculative at the time, which did not fair as well. That’s the way the investment cookie crumbles sometimes and that is ok.
I don’t think crypto is going away anytime soon, but it sure has lost some confidence. Will it shine again? Maybe, but the probabilities are not good. In any case, there is much to learn by following the cryptocurrency story.
Money with Marc 