I've been wanting to got back to talking about economics for a while now, but wasn't sure if I had anything interesting to say on the subject. And I've absolutely been wanting to return to the notion of energy-backed currency, but every time I start it doesn't go anywhere fruitful. Luckily some recent discussions I've had on a cryptocurrency forum have spurred fodder for a couple more posts, and hopefully more will spin out of that.
The cryptocurrency community is almost like a religion with competing sects. Each sect believes its particular form of currency is the one true currency, and the belief that its value will soon rise enormously is sacrosanct. Go on the Ripple subreddit and question the enormous valuation of the company, and you will be met with downvotes and responses like "market capitalization doesn't matter for cryptocurrencies." These communities contain an irrational belief system coupled with a demand for uniformity. They fit the criteria for a cult, at least as far as this blog has defined the term.
It's probably not fair to pick on the cryptocult too much in this regard. Most of what passes for investment these days is just adopting a belief system. Nearly everyone is invested through their retirement plans, which just amounts to a belief that the stock market will grow in value. Why will it grown in value? Because other people will keep buying stock! The fact that nearly all retirement programs are now private market investments means we can trust money will keep pouring in. We aren't investing in the underlying companies so much as we are investing in the belief that other people will keep investing. To invest wisely means not to judge the material worth of an asset, but to predict other peoples' belief in its worth.
The same holds for cryptocurrencies, but even more so, because they have no underlying value. When you invest in a company, you are taking part ownership of a firm with physical assets. When you invest in a normal fiat currency, your investment has value because some government will accept it for settlement of tax debts. Cryptocurrencies have no intrinsic value. Yes, they are guaranteed to be scare, but that is not enough in itself to confer value. That requires belief. When you think about it, it's not surprising that the cryptocurrency forums feels like a den of believers. The whole industry is dependent on belief, and belief alone.
A veritable cottage industry has grown up around the success of Bitcoin. The best route out there today to get filthy rich is to create a new cryptocurrency that gets popular. But how do you get popular? Bitcoin is big because they were first. There are a few others like Litecoin and Etheryum, but there is only really room for very limited number of cryptocurrencies that bear no intrinsic value. Entrepreneurs are now trying to create market forces that give their currencies value, or at least the appearance of value. The biggest one is Ripple, who made big headlines last week after their cryptocurrency soared in value. Ripple aims to disrupt the market for settling international monetary transfers. It's a lofty pursuit in itself, but where the owners are really making bank is with the cryptocurrency. They are now billionaires, on paper at least. The currency is highly valued because people are buying it, because they want to be holding on to the next big thing. (Disclaimer: I'm one of those people.) The financial success of the Ripple's creators has less to do with the value they're providing to the world, and more with their ability to enrich themselves from a belief system. It's inspiring, in a way, but also appalling because the whole thing is like a can of condensed greed.
There's another belief out there amongst the cryptocult, that cryptocurrencies will solve the problems of sovereign fiat currencies, and will (or at least should) replace them one day. They say that fiat currencies are inherently inflationary, so cryptocurrencies will be inherently more sound. But that belief is double wrong. Fiat currencies aren't inherently inflationary. Fiat currencies aren't inherently anything. The government decides how much money is spent into existence. It can inflate and deflate the currency at will. Now, governments do tend to inflate the money supply, and in fact all mainstream economists and the Fed themselves are quite open about their goal of light inflation. Why governments want inflation is a topic will save for tomorrow's post, but certainly they do. That's not a problem inherent to the currency, but government control of the currency. Okay, so maybe they say the solution is that cryptocurrencies prevent the government from being able to abuse their powers of inflation. But the problem with that is cryptocurrencies are inherently deflationary. There are only a finite number of Bitcoins. It's not much different than gold in that regard. But it doesn't seem rational to replace a currency that can be driven to inflation by governments with one that is guaranteed to be deflationary. (Unless the economy shrinks, that is.)
There's a lot of money to be made out there in cryptocurrencies right now. But realize they mostly amount to belief bubbles. You want to get in and cash out smartly, and not be left holding the bag when the belief bubble pops.
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