Over the last month, the value of Bitcoin has fallen by nearly 30%. As is always the case, other smaller cryptocurrencies like Ethereum have fallen suit as well. While the fall on its own isn’t necessarily remarkable – the reasons in this instance revolving around the tensions in Ukraine along with the US Fed being expected to drain liquidity from the economy – it might be a good time to talk about what cryptocurrencies really are, or at least what they have become.
The journey that cryptocurrencies have made, starting with Bitcoin in 2009, has been extraordinary. At first, just an obscure technological innovation not taken seriously, it has now grown to become a part of our consciousness, something that the average person is aware of and even believes is important and has value, though they may not be able to explain why. Around November of 2021, the price of a single Bitcoin reached its highest value ever which was just shy of $70,000.
To truly understand the world of cryptocurrencies, we need to look at it from a certain historical perspective. 2009, the year Bitcoin was first introduced, was in the immediate aftermath of the global financial crisis. In fact, the crisis was still ongoing, with governments trying to figure out how to clean up the mess and how it had gotten so bad in the first place. In short, a small group of bankers decided to try and make money off mortgages by clubbing them in with other investment packages. Investors could buy mortgages without buying the house itself. They were investing in the mortgage owners ability to pay off the mortgage over time. On the ground, real estate agencies were aggressively selling these mortgages to prospective homebuyers who also had access to cheap credit and at first, everything was going according to plan but as soon the credit dried out and the homebuyers stopped being able to afford the mortgage payments, the whole thing collapsed.
In the aftermath, those responsible weren’t punished and millions of people lost life-changing sums of money for which they had spent years working. Such an occurrence would naturally lead to an extreme reaction. The movements that received the most coverage, the ones that we know of are the likes of ‘Occupy Wall Street’ and the ‘May Day Protests’. They are staunchly anti-capitalistic and believe that the entire system needs to be rethought and restructured so that a crisis like the one in 2008 may never be repeated. Similarly, another school of thought emerged. The central tenet of this school, however, was hyper-capitalism. They didn’t think that the crisis was the result of capitalism itself, but that it was due to the government’s involvement. Whatever the government tried to do, be it in the form of regulation or giving in to the demands of lobbyists, was the cause of the crisis. They believe that if the market was left alone and functioned without a centralised power then the market would have regulated itself. The involvement of a regulatory authority interfered with the natural process of market economics, and this was why the crisis occurred in the first place.
This anti-government ideology formed the basis for Bitcoin, which then lead to what cryptocurrencies are today. What is the main point in any cryptocurrency pitch that a person has ever encountered? It is the fact that it is a decentralised platform free of government interferences. It is a truly democratised system where each individual has power and control over their own affairs and therefore cannot be a victim of the government’s incompetency. Yes, it has other selling points that have to do with the potential of the underlying technology i.e, blockchain. We have written about this in a separate report. However, it has now been well over a decade since its inception and the potential of that technology still remains as just potential.
At first, Bitcoin promised a new world order. It could function as a currency and blockchain could be used to revolutionise every industry that was digital. Blockchain was prophesied as being this utopian place where no fraud was possible because the owners and the users were one of the same. No central authority has absolute power and any change has to be ratified by the participants. This sounds amazing, doesn’t it? So what is the problem, then? Well, ask yourself, has blockchain delivered on any of the promises that it came with? It is certainly not a substitute for any real currency. It has not revolutionised any industry. Its transaction time and cost is so high that it is highly inefficient and what’s more, it uses the same energy as that of a small industrialised nation to even function. Traditional banking, while far from perfect, does not use up nearly as many resources. To put this into context, Visa can conduct 15 million transactions with the same amount of energy that Bitcoin needs to execute just one singular transaction. The scale of inefficiency boggles the mind.
Bitcoin, and for that matter, every other cryptocurrency’s main use case today is simply that of a speculative financial asset. Yet, even as a speculative asset, it has a number of issues.
Since the cost and time associated with transacting cryptocurrencies are so high, and the prices are as volatile as they are, tokens known as ‘stable coins’ were invented. The most popular one may be Tether. Tether is supposed to be backed by the US Dollar and as such its price is generally around $1. According to the company, when it was first created around 90% of the Tether coins in circulation were backed by real currency but over the years that number has reduced. As of 2021, Tether themselves released data that showed that less than 3% of their coins are backed by actual cash. Recently. They flooded the market with $1.5 billion worth of liquidity i.e, increasing the amount of Tether in circulation. The problem is that none of this is real money but it is also being used to purchase cryptocurrency which then affects the price. So when Tether decides to increase the supply of its tokens, people use those tokens to go and buy things like Bitcoin, therefore, driving up the price. The problem is that this increase in price is entirely artificial because it will be impossible for people to cash out. There would be no actual cash to withdraw when they sell their cryptocurrency. If even just 10% of the total Bitcoin market attempted to sell their holdings tomorrow, it would cause a bank run.
A lot of the value associated with cryptocurrencies are imaginary. Some critics have described the whole market as a ‘bigger fool scam’. This is when an individual purchases an asset at a price that far exceeds its intrinsic value with the hope of selling it to someone else who believes that the asset is worth even more. The way to create those beliefs is through hype and a lot of what happens in the crypto space revolves around hype. People talk about a new coin being the ‘next big thing’ and how it’s going to ‘revolutionise the ______ industry’. Usually, there are just a small group of people who own a majority of the coins in circulation and they artificially jack up the price leading to 1000%+ increases over a very short period of time. Of course, the coins aren’t actually worth that much but the causal investor who hasn’t spent enough time researching will get caught up in the frenzy when they see those figures. It is this casual investor who sustains the market. The early investors rely on these people to cash out and they create the hype to make sure that the casual investors come knocking. This is why it is known as the ‘bigger fool scam’ because you need a bigger fool to buy into the original fraudulent concept.
The latest invention intended to create hype arrived on the mainstream last year in the form of a ‘non-fungible token’ or NFT. The same marketing tactics were used, touted as a revolutionary new development that would disrupt the art world, the prices of some NFTs reached astronomical heights. Beeple, the creator of the second most expensive NFT, sold his artwork for $69 million in March of 2021. Later that year, he commented that NFTs are merely an ‘irrational exuberance bubble’. The hype around NFTs have died down a bit since then and it has thus far not changed anything about the way the art world works. The fundamental reason why NFTs exist is to drive up the prices of cryptocurrencies. You need to have a crypto wallet in order to purchase or sell an NFT so the whole point is to try and bring in more users in order to jack up the price. This is just another example of the bigger fool scam being played out.
The crash in the price of Bitcoin and other cryptocurrencies over the last month is not something that is unusual. These assets are known to be extremely volatile and they will likely bounce back up. It may even reach new heights. It is important to understand, however, what cryptocurrencies really are and that is the reason for writing this article. Understood within the context of the financial crisis of 2008, it should be clear to see that cryptos are not going to change the world. Rather, it is just a continuation of what is already happening. When the internet was first invented, it was a democratic platform where users could easily create websites and interact with each other. That changed over time as the potential of the internet became apparent and people wanted to build services that required specialised skills. You needed to become a software engineer to build those services and this is how companies like Google, Facebook, etc. came to be. The early visionaries such as Jeff Bezos, Bill Gates, and so on capitalised on this.
Today it is a closed-off industry where new startups can only hope to be bought by a bigger company. It is impossible to compete with Apple, Microsoft or Google because they simply have too much money and power. Cryptocurrencies were supposed to level the playing field. They were supposed to give everyone an equal chance but in reality, all that is happening is that it is creating another situation identical to that of the tech space in 90s. Those who are early to the party will be rewarded handsomely and they will use their rewards to consolidate and grow their wealth and power. The goal is not to create a fair and democratic platform, it is to become the new Jeff Bezos or Bill Gates. The only difference this time is that people like Bezos built services that are actually useful. With cryptocurrencies, that is yet to be the case.