A few months ago, I was mailing a package at the UPS store, and the guy behind the counter saw my Bitpay debit card.
“Oh I love Bitcoin but I like other cryptos more,” he said. He can’t have been much older than 21 years old. Like many young people he is drawn to the idea of a permissionless investment. He enjoys the game. He likes making money. He finally has a way to save. And he enjoys living with extreme frugality while socking away as much as possible in these fun new markets.
We had some of the usual banter about what exchanges he uses. Then the topic turned to his favorite cryptoassets. He rattled off a string of currencies I had never heard of. I pointed out that probably most of these are going to zero. He completely agreed. But then he added: “Among them might be the next Ether,” referring to the token of the Ethereum platform that still serves as the ideal of what every speculator in this realm hopes will happen to their picks.
Sign of the Times
It would be easy to observe that when such conversations happened with kid clerks in mail rooms we have the surest possible sign of a bubble. I’m not here to refute this. Some of these, even most of these might be wildly overvalued. The trouble is that no one can really know what the real value is supposed to be, if there even is such a thing as a real value.
What’s underlying all of this is a new technology for permissionless exchange of scarce ownership rights. This has never been possible before in the history of humanity, and it is only made possible by a beautiful combination of factors: the internet, cryptography, distributed networks, marvelous entrepreneurship, all operating alongside an official system of money, banking, and finance that is no longer trusted by vast swaths of the public.
It’s hardly a surprise that regulators are becoming extremely worried. We should not forget – though it is easy to do so – that these people imagine that they are there to protect investors against scams, bubbles, financial rackets, and unsafe investments. They worry about that day when some popular scheme goes belly up and the person in charge is dragged before Congress to report on what he or she did to warn the public.
The SEC Warning
And so the warnings are becoming ever more frequent. Just yesterday, the SEC said: “Cryptocurrencies, while touted as replacements for traditional currencies, lack many important characteristics of traditional currencies, including sovereign backing and responsibility, and now are being promoted more as investment opportunities than efficient mediums for exchange.”
Furthermore, when investors “are offered and sold securities they are entitled to the benefits of state and federal securities laws, and that sellers and other market participants must follow these laws. Unfortunately, it is clear that many promoters of ICOs and others participating in the cryptocurrency-related investment markets are not following these laws. The SEC and state securities regulators are pursuing violations, but we again caution you that, if you lose money, there is a substantial risk that our efforts will not result in a recovery of your investment.”
I’m try to hear this warning with the ears of our friend at the UPS store. Let’s just say that he is more than willing to take the risk upon himself. If his picks crash and burn, he will chalk it up to what it means to live and learn. In fact, I don’t know anyone in this financial space who expects the SEC or anyone else to protect him. In fact, that’s part of the point.
It’s worth noting that Bitcoin soared up 11% following the announcement. Ether grew to over $1,000 for the first time. The market capitalization – despite the fall of Ripple from its highs – reached a new record: $768 billion. It’s not a stretch to believe that the SEC’s warnings actually had the opposite effect than was intended. And here is the great paradox of this sector: the more crypto comes under attack, the stronger it gets.
But let us address the initial observation of the SEC that cryptocurrencies lack features of “traditional currencies” such as sovereign backing. It’s true that Bitcoin is not backed by the state as legal tender. Nor are the institutions that buy and hold it guaranteed against failure. It was not invented by the Fed, the Treasury, or any large bank. It emerged on the internet and was given away through an email list, and was adopted by enthusiasts, many of whom were anonymous.
Is this a problem or is it more in accord with the deeper history of money? If you look back in history before the 20th century, private currencies were part of the money stock. Foreign coins circulated freely in the early 19th century in the US, and were valued based not on government backing but on precious metal content. In the Industrial Revolution, factories in England frequently paid workers in private coinage because government had no minted coins in small denominations, as shown by George Selgin in his book Good Money.
What’s more, Carl Menger (1840-1921) long ago argued against the state theory of money. As James Canton says, Menger theorized that, “A commodity that becomes commonly valued by all actors comes to efficiently intermediate exchange. Once the recognition becomes widespread, the commodity attains the status of a commonly accepted medium of exchange.”
There is nothing particularly speculative about that observation. We see this in prisons all the time, where the money function is served by a valuable commodity like mackerel cans or ramen noodles. No edict from the prison warden is necessary to achieve this. The realization of money grows out of exchange. Once anything is acquired for the purposes of trading for other goods rather than consumption, it has begun to operate as money.
In the case of cryptocurrency, the story is complicated because the underlying value is not a commodity but rather a service: a peer-to-peer network for sending immutable information packets in a way that is not subject to forgery or censorship. Once the network was proven to be workable (over 10 months) the value came to be imputed to the numeraire that had the authority to make changes in ownership rights on the network.
That’s a complicated story, however, and neither the Fed nor the SEC is inclined to accept it.
Let us now address this distinction posited by the SEC between a money and an investment vehicle. There needs to be a wedge driven between the two. It’s like saying that the railroads in 1880 were not really about carrying passengers; they were about the perpetuation of investment schemes. In reality, they were both. New technologies do not descend into the world on a cloud in perfect form; they are introduced through the messy process of real markets and improved along the way.
It’s true that these days, there is very little return on dollars held. This is an unnatural state of affairs. Even in the Bible’s Parable of the Talents, we see the master lecturing the bad servant that he should have put his money in the bank to earn interest. That’s barely even possible anymore. As for making money in the stock market, the regulatory labyrinth makes that forbidding for vast numbers of people.
Had the state-backed systems of money and payment been working properly, and had been upgraded to work in the digital age, there would have been no need for crypto in the first place. This is the point that official organs will never admit.