Press Release

Investigating the Bear Case of the Cryptocurrency Bubble: CurrencyTimes

Is This a Revolution, or Snake Oil?

CurrencyTimes: Cryptoenthusiasts, myself included, have a tendency to start discussing cryptocurrencies at any given opportunity. Once our audience starts to concede that they have some viability, we then begin to explain elaborate theories about how the world may look in 50 years’ time after they change everything. To quote Chris DeRose, “You’ll see a lot of rampant idealism in the movement, which is a little bit dangerous.” Since that 2015 claim, calling the space’s rampant idealism “a little bit dangerous” has proven to be an understatement. In a podcast earlier this year, DeRose offered a solution to this danger:

“I am striving to be a secular Bitcoiner. I wish to be not a pumper. I wish to be an independent evaluator of these technologies. I think that our greed is going to make us as willfully ignorant as it is pronounced, so you constantly have to fight it. I think that I am adding more value in skepticism and rationalism.”

As someone with 50% of their net worth in cryptocurrencies, DeRose’s quote provided the genesis for my article: to provide some skepticism and rationalism to the current cryptocurrency craze. The big issue as far as I can see is that hyperbitcoinization (a “Bitcoin future”) is seen as an inevitability by many crypto-enthusiasts. This, I argue, is the catalyst for the current speculative bubble of cryptocurrencies—and make no mistake about it, we are in a Bitcoin bubble:

The Lifecycle of a Bubble vs. 5-year Historic Bitcoin Price (USD)

Nobel prize winner Richard Shiller, who predicted the Dotcom Bubble shortly before its crash in 2001 and then the mid-2000s Housing Bubble five years before it burst, says that what is driving Bitcoin at the moment, like other examples of bubbles, is a story:

“And it’s the quality of the story that’s attracting all of this interest. And it’s not necessarily sustainable. What is the story? Satoshi Nakamoto had this brilliant paper, and then disappeared. Where is this guy? And then we have a new form of money that replaces [everything]. It sounds extremely revolutionary… And the story has inspired young people and active people, and that’s what’s driving the market.”

I have come to this conclusion from my own observations and through interactions at cryptocurrency meetups all over the world. I listen to the newcomer pitch and cannot help but think, “This isn’t a balanced discussion about the technology and economics of blockchain technology—it’s a timeshare sales pitch.” I watch people with no technical or economic background talk about cryptocurrencies with little more than a surface-level understanding. This, in turn, leads to a confused audience, who are spun with an argument of “Smart people understand it. People who don’t understand it are not smart enough to get it.” People see others getting involved and they want to follow this “smart money.” But this is a fallacy; I ask very basic questions to these speakers regarding the technology and economics, and they’re at a total loss for answers.

Therefore, to better inform the community as a whole, over the course of this article I will attack the bull case of cryptocurrencies from multiple angles. First, let’s start with regulation.

The Regulatory Vacuum Cannot Last Forever

Cryptocurrencies in their current state are outperforming traditional financial assets primarily because of their regulatory arbitrage ability. The largest six banks in the US alone pay approximately $70 billion to meet regulatory compliance standards—at the time of writing, that’s around 73% of the entire market capitalization of the largest cryptocurrency, Bitcoin. Citigroup alone has 30,000 employees in its compliance department, a figure that vastly outnumbers the total number of blockchain developers in the world. Indeed as of mid-2016, William Mougayar claims that there are only 5,000 such developers globally. Simply put, blockchains are thriving in large part due to a lack of a regulatory sandbox, and that cannot last forever.

The common refrain you hear from cryptocurrency thought leaders when this argument is made is, “It’s censorship resistant because of its decentralization. You can’t regulate cryptocurrencies. You can’t force the protocols to change!” They send you down the thought path of, “How could regulators shut down the network?” but this is the wrong line of thought to take. The more important question is, “How can regulators make cryptocurrencies irrelevant even if the networks themselves stay up?” I argue that while regulatory bodies would have a hard time completely killing cryptocurrencies, they could regulate a blockchain future into insignificance. Here are some examples of how they could do this:

  • Mandating that businesses cannot accept cryptocurrency as payment and enforcing this with spot-checks and severe penalties, including the closing of businesses.
  • Controlling the on- and off-ramps to crypto. In order to obtain cryptocurrency, one must exchange fiat money for it, and for any significant amount of money, this will go via an online exchange. These exchanges need to be able to handle this fiat money, which necessitates that they operate bank accounts, mechanisms that be closed on a whim by an overzealous bank or its federal regulator. Even outside of electronic audit trails, local in-person bitcoin exchanges can be cracked down on with undercover agents. This may sound exaggerated, but it is plausible. A currency is the manifestation of the direct faith placed in a government (via its central bank); if it is seen that citizens are circumnavigating this, it can be in a government’s best interests to close the loophole.
  • Banning the import of blockchain-related technology hardware, such as ASICs, to hinder the growth of the network.
  • Banning large Virtual Private Server (VPS) providers from allowing blockchain technology to run in their data centers.
  • Continually enforcing that all taxes be paid in fiat, and then expanding that so that all heavily-regulated industries (such as healthcare) must transact solely in fiat.
  • Increasing the sophistication of tax investigations into people who appear to have more money than they claim. If somebody is reporting minimum income on their tax return but living a jet-set lifestyle, they could be flagged to prove their source of funding.
  • Restricting money tied up in the highly-regulated, quadrillion-dollar derivatives market from entering into the cryptocurrency space.

Will Derivatives Be the Bargaining Chip?

The last point of the previous section is particularly pertinent, regarding how the huge derivatives market interacts with the cryptoeconomy. A large argument for hyperbitcoinization is that Wall Street hasn’t entered the crypto space yet. It is cognitive dissonance to think that Wall Street will enter the market en masse while also thinking that regulation cannot prevent cryptocurrencies’ expansion. How could all of that regulated money supposedly move into the cryptoeconomy in the first place? To show the size of the stakes at play here, the visualization below shows the comparative size of the global derivatives market relative to the popular assets that we use to store money.

Proportionate Representation of Global Asset Values (October 2017)

The retort from cryptoenthusiasts when I present this argument is, “Yes, but that’s just one country. Regulation would require the coordination of all the governments in the world because if one allows it, all of the money will go there and that economy will flourish.” While it is true that the SEC cannot regulate the entire world, they can regulate a significant portion of the world’s liquidity. Cryptocurrencies’ values are directly related to the amount of liquidity that they have, and the SEC, the regulator of the world’s largest economy, has the power to turn the screws on this.

The next response I get is usually, “Why has this not happened yet?” The reason for that is twofold.

  1. Regulatory bodies responsible for trillions of dollars of wealth tend to move slowly and cautiously. They must consult with a range of stakeholders, both up and down their chains.
  2. Cryptocurrencies have not been a big enough target until recently. The risk of this ratchets up as prices climb; the higher the price, the sooner that regulation will occur.

When cryptoenthusiasts talk about regulators, they commonly have the idea that regulatory bodies only exist to make the barriers to entry high in order to keep banks rich. While there are certainly flaws to many regulatory agencies’ policies, they exist for good reasons and stamp out problems, some that are particularly rife in the cryptocurrency world: market manipulations and scams.

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