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The Worst Narrative In Cryptocurrencies

Summary:
Successful investing is often more so about how to avoid bad ideas than it is about finding the right ideas.¹ In the last year there has been no place worse to be than cryptocurrencies with most of them down 85%+. Despite this I still see lots of optimists pushing cryptos based on narratives that are fundamentally wrong. For instance, here’s one I see all the time: “Governments are big bad terrible entities that will print money and ruin society and we can create a better form of decentralized money that won’t inflate our living standards away.” That’s not an exact quote and I don’t want to blow anyone up, but I’m sure you’ve read something like that somewhere. Now, I am not here to imply there are no good narratives for owning crypto. But this one is particularly bad. Fixed money

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Successful investing is often more so about how to avoid bad ideas than it is about finding the right ideas.¹ In the last year there has been no place worse to be than cryptocurrencies with most of them down 85%+. Despite this I still see lots of optimists pushing cryptos based on narratives that are fundamentally wrong. For instance, here’s one I see all the time:

“Governments are big bad terrible entities that will print money and ruin society and we can create a better form of decentralized money that won’t inflate our living standards away.”

That’s not an exact quote and I don’t want to blow anyone up, but I’m sure you’ve read something like that somewhere. Now, I am not here to imply there are no good narratives for owning crypto. But this one is particularly bad. Fixed money supplies without counterparty-based credit markets do not work. They have never worked. So, here’s why this narrative doesn’t make sense:

  1. “Money” needs to be elastic. We need money to be somewhat elastic so that its supply can change over time with its demand. For instance, if we have a fixed amount of dollars in the economy and rich people decide to hold all those dollars then there’s no dollars for the rest of us to spend. This is why most money has evolved as credit or debt. We can create money when we need it by borrowing it into existence to make a market where money is needed instead of having to find a market where money exists (and might not be readily supplied). This is an imperfect system (as we learn during financial panics), but it has many more upsides than downsides because the alternative is a deflationary form of money that always leads to a paradox of thrift (ie, not enough money to meet the demands of consumption, investment, saving etc) and the inevitability of resource scarcity. (Related: see, “Elasticity of Money is a Feature, not a Bug”)
  2. Governments have less control than we think. The common narrative about money creation is that the government “prints money” and the Federal Reserve in particular, is this big bad entity out to destroy the value of money. This is misleading in any Democratic Capitalist economy because the private competitive banking system mostly controls the quantity of money that exists. Governments can change interest rates on certain forms of money, they can implement QE (which is just an asset swap), they can print physical money (which is then used by bank depositors to swap an existing form of money into a physical form of money), and they can print bonds when they deficit spend, but governments have less control over the quantity of money and the rate of inflation than we tend to think. (Related: see, “Where Does Money Come From?”)
  3. Par conversion is Remarkably Difficult in Crypto. In order for money to be useful it needs to have a stable nominal value. That is, I need to know that, even if my currency is eroding in real terms it is still worth $1 in nominal terms. This is why people don’t use stocks to go shopping. You could have $100 one day and $90 the next. Par conversion, maintaining a price of 100 cents on the dollar, requires a counterparty who is willing to always convert your money at a specific value. This doesn’t just require a complex counterparty arrangement, but it requires a network of trust that can only be maintained by the rule of law. And the rule of law requires…centralized court systems so that, if someone owes me $100 I can force them to uphold that contractual obligation. And this gets at the heart of the problem with crypto and par convertibility. As long as there are huge liquid trustworthy centralized markets in money (like the USD) inferior forms of money are always going to be volatile compared to those forms of money. And that instability will always be a problem since money needs to be nominally stable. Can stability with par convertibility be achieved? I am extremely skeptical of any cryptocurrency overtaking a large centralized currency with a reliable court system.

The kicker here is that crypto doesn’t fix any of this. So, the next time you hear this narrative be very skeptical that buying cryptocurrencies gives you access to an asset that is an improvement over existing forms of centralized money.

¹ – This is kind of a version of Warren Buffett’s “only invest in things you understand”. Sticking to things we understand helps us avoid mistakes based on unforeseen risks.

Cullen Roche
Former mail delivery boy turned multi-asset investment manager, author, Ironman & chicken farmer. Probably should have stayed with mail delivery....

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