I’m still dismayed at the number of people I meet or hear about asking if cryptocurrency is a good investment. How can they even think it is an investment? Of course it isn’t an investment at all. Time for a rant. I know this has all been said before elsewhere but ….
It’s really very simple. Before you invest in any asset class you must ask how will you get a return on your investment. If you “invest” in crypto, then how will you get your money back? Where will the profits come from? With crypto, the only answer is by selling it on to someone else. The only possible return will be from new entrants buying in to the currency, which by definition makes it a Ponzi scheme.
I’m obviously a “no coiner”. I have never owned and never will own any crypto. To me, the concept of cryptocurrency has flaws but more importantly, the way people are trading them shows they don’t understood what it is. The transaction mechanism, blockchain, is also flawed and has some really fundamental problems. Rather than dispelling the myths over and over, I’m going to write them down why so I can just post a link to this text instead.
Crypto is an investment
I think fundamentally people just don’t understand cryptocurrency. Which is a shame. The technology isn’t that complicated. Using the term “investing” in crypto underscores that they don’t understand what crypto actually is. If crypto is meant to be a currency then how can it also be an asset that you invest in? If you want to invest in dollars you don’t go to an ATM machine, withdraw lots of cash, and stuff it in your mattress. You may invest in assets that are denominated in a currency, like government bonds, or property in the country that issued the currency, but you don’t “invest” in the currency itself. You may speculate against movements in currencies, but this is really speculation against the underlying assets or the stability of the central bank or economy of the country that has issued the currency. The currency itself is not an asset and not even currency speculators will hold it for long.
The term investment implies buying an asset that will yield a return. It seems that crypto traders see investing in crypto the same as investing in property or a company and that it is a way to speculate that cryptocurrencies will become a standard way to buy goods in the future. But crypto isn’t a share in a company. It doesn’t entitle you to ownership of anything (other than the coin itself) and doesn’t yield any return. Buying shares in a company, say Apple, is fundamentally different. If I buy shares in Apple then I am buying an actual share of the company and I become a part-owner of Apple. I own part of their brands, intellectual property, sales pipelines and of their good chunk of cash in the bank as well. I get a return on my investment in a number of different ways. I get paid a dividend, I benefit from future profits on sales of Apple products and I get growth in value as the company increases its sales and product lines. Cashflows generated by sales of products can be used by Apple to invest in further product development or to buy back shares on the market, increasing the size of my share by reducing the float. My investment has the potential to grow in value as the company’s revenues grow. The value of my share is based on earnings, which I expect to increase. I can sell my share in the future to another investor who has calculated the value of the share from earnings, earnings growth, future cash flows, company balance sheet and other tangible values. If I buy crypto I get none of those. I get no dividend, no share in any future use of crypto or crypto-currencies, no growth in value, nothing. The value of crypto is completely arbitrary, apart from an expectation of recovering the cost of the ridiculous amount of energy that was used to “mine” the coin in the first place. The only way I have to get my investment back is to find another “investor” to sell my coin to. Eventually, the final investor loses everything – it’s a a zero-sum game. For every winner, there is a loser (and like with any investment, the winners are loud and the losers keep quiet). There is no way to win except for someone else to lose. It’s a classic “bigger fool” investment. I’m a fool to buy and can only get my money back by finding a bigger fool to sell to.
It doesn’t help when blog posts like this make claims such as “you own a portion of this technology that allows you to access the benefits”. This is such an outright lie. Nobody owns the technology. Anyone, even a central bank, can clone the code and create their own coins. Owning crypto currency does not convey any intellectual property rights whatsoever.
Cryptocurrencies will become the defacto payment method in the future
They won’t. But even if cryptocurrencies did become a defacto payment system this will have no bearing on the value of any specific coin. The technology may get reused, the coins will not. Owing coins does not entitle you to a share of anything. People think they are investing in a new technology that has the potential to revolutionise banking, but they’re not. Given the very serious drawbacks in using cryptocurrency for payment (lack of protection against loss or fraud, inefficient transaction ledger, lack of scalability…) it is almost guaranteed it will never become a mainstream currency (certainly not as the tech exists today anyway). But ironically, if it did, the whole reason people currently buy crypto would actually disappear. If many goods and services were priced in crypto the currency would stabilise and we wouldn’t see the huge swings in value that we see today. The huge potential gains that crypto traders are chasing would disappear. And the whole notion of “HODL”ing crypto would disappear as traders move to assets with an actual return.
Blockchain will revolutionise payments
The underlying payment technology, blockchain, is a decentralised and anonymous way to transfer cryptocurrency from one party to another. It is in fact an extremely inefficient and slow mechanism for conducting transactions. Bruce Schneier, who literally wrote the books we use as crypto texts, sum it up well here.
Blockchain can accomplish a maximum of 4.6 transactions per second, it uses huge amounts of energy to record transactions and the transaction ledger is only updated every 10 minutes. It just doesn’t scale. If every transaction in the world that is currently done with a credit card was instead done on blockchain, the population of the world could only perform one transaction per year.
The advantages of blockchain are often claimed to be that transactions are anonymous, decentralised and immutable. These are actually serious shortcomings that will prevent it from ever becoming a mainstream transaction record. Being anonymous means blockchain is attractive to criminal activities including money laundering, illegal drug trades, ransomware, etc. Most people do not need to hide their transactions from their government. There is no reason for people who don’t need to hide the source of their money not to use Euros or Dollars to make the same transaction. The idea that governments are prying and you should hide your dealings from them is flawed. Democracies around the world have elected governments who have implemented anti-money laundering legislation with the full support of their voters, who know it reduces criminality. Circumventing those restrictions enables and even encourages those criminal activities.
Being decentralised means there is no one entity that controls blockchain. This means there is no dispute mechanism, no anti-fraud protection and no way to recover lost coins. It is estimated that at least 4 million bitcoin have already been lost forever but this figure is probably underestimated. If someone who held BTC dies then there is no way to pass it on or even to tell if they ever owned it. If someone loses the password for their wallet, the coins are gone. If they are defrauded, scammed or transfer to the wrong person or just lose their password, their bitcoin is gone forever. If they die and haven’t shared their password, the bitcoin is lost forever. Many of the bitcoins that exist have been irrevocably lost already and as time goes on, more will be. If someone steals coin or commits a fraudulent transaction then there is no way to recover the coin. Most of us like the reassurance of using a bank to provide all those facilities and the lack of them will prevent cryptocurrency from ever becoming the default payment method.
Bitcoin is a store of value
The value of crypto has no basis in the real world, except maybe the cost of the electricity required to mine a coin. The theory goes that one coin will never be with less than the cost of the energy needed to find it, but that theory doesn’t stack up. The value of one coin can certainly go below the cost of mining and when this happens mining will just stop. It is estimated that the last coin will be mined before 2040 but the value of crypto most likely have collapsed long before then. The only real feature underpinning the value of crypto is belief. It is the belief that the value of a crypto-coin, essentially a random number, has value because you can buy or sell with others who also think these random numbers have value. Imagine I set up a ledger tomorrow recording ownership of prime numbers. The first prime numbers would be quickly taken but soon it would become more and more difficult to find unique prime numbers. When eventually prime numbers take substantial effort to find would you pay me a premium for the number 2 or 3 which I found first?
What is the long term outlook for bitcoin or any other cryptocurrency? No sane central bank would ever adopt them when they can just clone the code and create their own. They will invariably become worthless at some point. SHA-256 is still considered secure for now, but then so were SHA-1 and MD5 once. At some point SHA-256 will be broken. When that happens, or probably well before it, banks and other institutions will have upgraded to a stronger hash. But bitcoin holders will be left no way to upgrade, no way to exchange for a new type of coing, just nothing.
The basic concept of a cryptocurrency is in itself not a completely terrible idea. There are advantages in being able to seamlessly conduct transactions from anywhere simply by exchanging digital tokens certainly does have some merits. But buying and selling coins that are not backed by anything is certain to come to an unhappy ending. The purely illusionary value of the current crypto coins will collapse when the world eventually runs out of greater fools. There is no other possible endgame.