Cryptocurrencies soar in value, plunge, hit new highs, are written off, rebound, and hit new highs again, and the cycle repeats. We should be terrified. Over the last five years, cryptocurrencies such as Bitcoin and Ether have outperformed the overall market. However, can the general trend of outperformance last, or will these digital assets drop over 90% like some of its other crypto brethren? Is there a sustainable performance that creates the foundation for either a new currency or a valuable asset class? Probably not. Forces that drive these eye-watering returns seem to be the same as those that drove the social media-driven insanity behind meme stocks such as GameStop. We are seeing social media mobs controlling demand to a limited supply, creating price spikes that look attractive to any speculative investor. Unfortunately, demand can dry up quickly and the price subsequently falls through the floor. Financial markets ruthlessly sort nonsense from substance. Volatility and existential threats have been brutal and extreme for digital assets and the reckoning for crypto has been predicted for some time. However, digital assets are not on their way to history’s dustbin. Reality is more nuanced, and I try to provide a more detailed analysis since a broad brush hardly seems appropriate. The weakest and craziest portions of the crypto world have been exposed as nothing more than silliness. But some valuable components remain resilient and offer tremendous opportunity. I will explore these in detail. There is more cause for optimism than pessimism among the best and the brightest. We will explore these opportunities while harshly dismissing the hype and silliness – avoid the terror of a worthless market.
It has taken over 30 years for the overnight sensation of the Metaverse, but now hype, money, and large technology companies are charging in. Most obvious and conspicuous is Facebook’s maneuver to change its name to Meta Platforms and commit $10 billion. Microsoft is making a $70 billion acquisition of Activision to mostly focus on Metaverse platform development. Following on top of these two elephants is tens of billions of dollars of venture capital. The opportunity is considered comparable to the original iPhone. None of the iPhone’s component services – mobile phone, computer, camera, and operating system, were new or distinct. The iPhone revolution is the convergence into a single device (or platform) and, most importantly, the entrepreneurial spark that lit millions of application developers to create value from the iPhone platform. The Metaverse can best be thought of as the intersection of technologies and users. It combines virtual and augmented worlds, virtual assets, digital assets, and gaming into a single platform. However, there doesn’t seem to be anything too disruptive about the Metaverse or Web 3.0. It’s reasonable to be skeptical, and while there is an economic opportunity within the specific creation of Metaverse assets, the real opportunity remains with the infrastructure, intermediaries, picks, shovels, and “the arms dealers” of global digital war.
Cryptocurrency staying power has certainly been challenged these last few weeks. There is been a general market drop (even correction), but crypto has been collapsing in value and, to many, is in a death spiral. Of course, reality is more nuanced, and with more detailed analysis, a broad brush hardly seems appropriate. Certainly, the weakest and, honestly, craziest portions of the crypto world have been exposed to be nothing more than silliness. But some components remain resilient. The market is quite effective at sorting the specifics of an otherwise overgeneralized sector. There is no such thing as “crypto.” There are stable and valuable digital assets, globally exchangeable and disruptive. Others have nothing but fluff. Of course, government should insist on more reliable information, and institutions should guard more effectively against fraud. But, there is wheat among the chaff, and it continues to have the potential to be disruptive, create substantial value, and enhance global prosperity.
Recently, I gave a lecture at a graduate program focused on innovation, technological disruption, and the impact on global industries and investment opportunities. My lecture focused on digital assets and attempted to draw distinctions between disruptive and substantial opportunities and hype, nonsense, and unsustainable business models. This is a quiz given to the students that reflects the main points raised in this lecture. For fun, I am including it here because it makes a series of fundamental points that I think are especially important, and the true-false construct conveys those points with clarity.
Super lofty ideas get attention and publicity, but they are not real. Narrow, specific applications are where true foundational value is created. The financial revolution will certainly not be based on a process where someone buys coins or tokens and simply waits for them to increase in value. On top of that, despite the belief that there will be frictionless peer-to-peer transactions, purchasing any cryptocurrency requires a crypto exchange like Coinbase or FTX that charge high trading fees and have questionable security. Blockchain is an evolution for businesses, it is not a disruption or a new infrastructure. It will improve user experiences, regulatory clarity, and interoperability. Crypto proved that digital transfers and settlements were possible, it is the blockchain platform that enables this efficiently and securely. It may be boring and we’re not going to have any stadiums or arenas named after a technology platform, but real change will be driven by a blockchain. The rest is a noisy sideshow.
Digital assets are disrupting finance – the world’s largest industry. All assets, intellectual property, and even currency can now be digitized, and anyone can access anything from anywhere. The finance industry is being this intermediated and globalized, economic development and policy will be forever changed.
Decentralized finance (DeFi) can disrupt global finance – but only if Defi systems and central governments cooperate. Yes, sworn enemies cooperating for the greater good.
While each seems to be the sworn enemy of the other, ultimately, a cooperative relationship between decentralized and efficient (versus anachronistic and cumbersome) financial infrastructure and government central banks with stable currencies is absolutely necessary.
Defi transactions, to scale globally, require stable and predictable value. Government-issued currencies are the only reliable and foreseeable foundation. Cryptocurrencies, such as Bitcoin were never currencies. They are a sideshow that will remain a speculative asset, and increasingly unimportant.
Cryptocurrencies represent an architectural shift in how financial infrastructure and technology interact, and therefore, it is disrupting how the financial industry works globally. It is neither a new kind of money system nor a danger to economic stability. It is more important than that.
Economic predictions have always been highly variable and uncertain, and, for some reason, relied upon as if the future were a magical algorithm. Essentially, economists would make one fundamental mistake. They thought they were practicing a science. Data could be collected, inputted, and a predictive algorithm could be generated. Even Nobel Prize winners like Paul Samuelson believed that with enough data we could come to understand the economy and how it functioned.
This is nonsense. As Daniel Kahneman and Amos Tversky have shown us, human behavior and irrationality, combined with unpredictability and randomness (thank you Naseem Taleb) make this even a questionable social science. Using existing analysis and algorithms to reliably forecast is a fool’s errand, essential for someone’s tenure, and maybe even a Nobel Prize, but doesn’t add much that is useful. Some of the more laughable Nobel Prizes have been given to people who determined that markets were efficient. They are not. Economies can be predicted with useful data input. They cannot. A couple of inputs about inflation and the unemployment rate, and we know how to manage an economy. We can’t. That last one is the Philip’s Curve – true for a limited time and then it goes spectacularly wrong – a lot like most risk and market prediction models.
Digital currencies, crypto assets, digitized securities, and distributed ledgers require an enormous amount of power. While the combination of these assets is subject to tremendous hype, the environmental impact has been mostly ignored. However, this is changing because there has been increasing alarm about crypto’s carbon footprint and environmental impact. While there are attempts to use alternative energy, such as solar farms, thermal heat, and wind farms, sustainability for processing digital assets is still evolving. One thing is clear, as advancements are made in clean and renewable energy, digital asset mining will reduce its requirement for carbon-based energy. This is an essential trend if digital asset processing is to be sustained as an important component of global finance. The trend toward digital assets disrupting global finance is irreversible, thus green energy solutions are essential, and a condition precedent in order to participate and profit from this economic opportunity. It is crucial for crypto mining to address the environmental concerns attached to digital asset processing and creation. There is an irreversible shift to decarbonization and lower carbon footprints. The digital asset market is not going to go away, but since energy is such a critical component, energy efficiency and green energy are the essential components to any long-term perspective of a digital asset strategy. The low-cost provider wins. With digital assets, that means the combining lowest carbon footprint with scale and the ability to connect to the electrical grid.
Digital Assets, Distributed Ledgers, and the Future of Capital Markets “Distributed ledger technology and digital assets have the potential to dramatically disrupt global equity and debt markets.” (World Economic Forum, May 2021) Distributed ledger technology (DLT), otherwise known as Blockchain technology, will radically simplify financial markets and, more importantly, fundamentally change the market’s infrastructure. Specifically,…