Crypto isn’t a bubble. Fiat money is worthless.

According to the CIA Factbook, the total value of all the broad fiat currency in the world is close to $100 trillion, nearly the size of global GDP when you include dark markets. By contrast, the value of all cryptocurrency is about $150 billion. However, cryptocurrency today isn’t merely a digital store of value, it is the platform on which global, distributed, decentralized apps are being built, the future of the internet, or web 3.0. Even so, many naysayers and Luddites like to compare the crypto-boom with the dot-com internet bubble of 2000. They say crypto is a bubble, and it will soon crash to nothing…any day now.

They’ve said this for years, but crypto still continues to attract more and more developers, who build more and more functions and features, and the price rises higher and higher as a result, causing the naysayers to dig in with their predictions of doom and gloom, largely because they are jealous they missed out on early entry to one of the greatest investment opportunities in history and desperately want reality to match their original intuitions, that “No one will ever want to use crypto”, just like “No one will ever need a personal computer”.

During the height of the dot-com bubble, internet stocks were valued at over $3 trillion, and 2/3rds of that evaporated very suddenly. The survivors, however, went on to become some of the biggest most transformative companies in the world. Additionally, the market for internet stocks was entirely an American phenomenon at the time. Cryptocurrency isn’t even close to the overvaluation of the internet bubble, and it is a global phenomenon. Furthermore, we’ve gone through nearly two decades of inflation and growth since the internet bubble.

Call me when the price of 1 Bitcoin is $1 million, and then we can talk about bubbles.

But setting all this analysis aside, there’s one major difference I want to discuss to prove that crypto isn’t a bubble, and anyone who understands the concepts at play here should agree. In 2008/2009, central banks bailed out the global financial system with unprecedented action. The simplest analogy in layman’s terms would be that you were playing a game of Monopoly, a few people went bankrupt, but instead of declaring a winner or liquidating their properties, they just grabbed fat stacks of $500 bills from the bank – then they wrote “$500” on blank sheets of paper and added those to their accounts, too. These bailouts were largely what provoked the development of Bitcoin in the first place; the message on the genesis block, the first activation of the Bitcoin system, reads “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”. Bitcoin was intended to be a system for storing and trading value that the bankers couldn’t manipulate to keep themselves and their buddies filthy rich after they made terrible mistakes.

Understanding the banking system is quite difficult, as it seems to run counter to all good reason – how most people think money should work. But you have to remember that once money decoupled from physical assets like gold, when money became this abstract kind of thing where the only value of pieces of paper is the faith you have that others will value it, then it sort of developed its own rationality. And the precepts behind it are the mandates laid on the central banks: keep unemployment low, and keep prices stable.

Tangent Warning: Right away we can see that if the central bank succeeds at its mandate, then practically everyone will work until they can collect social security, while business models that depend on volatile prices will be shut out of the market. Is this really what we want though? As more and more jobs become automated, there becomes less and less meaningful work for humans to do, but nevertheless pressure from central bank actions will force people with a lot of money to gamble it away creating jobs that society might not value, rote busy-work, but the alternative is watching the value of your money inflate away anyway, thanks to central bank policies. At the same time, prices may want to be low, because people who already have high debt can’t afford to buy homes priced at $500,000; but instead of devaluing to what the market can pay, central bank intervention props up the price by giving financial institutions the liquidity and leverage they need to keep those homes on the books at high valuations, even though they sit empty, unsold, vacant, rotting while many people are forced to rent overpriced apartments or move back in with their parents; home ownership drops to all-time lows, the stock of homes rots away, but thanks to central bank magic, the price of housing is higher than ever. The actual utility of the central bank’s mandates is questionable in 2017, but if instead of looking at the actual conditions experienced by real living people you look at an economy as just a big equation, numbers, then it all balances out just fine, and the people the central bank wants in power stay in power. Usually.

Under central bank authority, the idea of the economy is greater than the reality of the economy.

Back on topic. The central bank achieves its objectives primarily by manipulating the price of money. The price of fiat money is the interest rate paid when new money is created when banks issue loans. If a bank issues you a $100 loan at 5% interest, then that interest is the price you pay for that money. But the bank only created $100 in new money, not $105, so you have to find that extra $5 from somewhere else to repay the bank. In 2008, a lot of people had a hard time finding the extra money they needed to pay back their loans. So, many people defaulted, making it even harder for even more people to service their loans. Liquidity seized up, money stopped flowing, and to keep the economy running, the central banks intervened by setting interest rates to nearly 0%, thereby creating trillions of dollars in new money.

Since the price of money was zero, and people with access to it had to spend it or watch its value inflate away, people reinvested this new money back into stock markets, bonds, housing, and other high-dollar assets, eventually reinflating the price of these assets back to their all-time highs. But the real value of these assets didn’t return to the highs that they never were in the first place (those original high valuations were why the bubble popped and the financial sector collapsed, unable to sustain those overvaluations), fiat money just became worthless due to central bank policies.

The supply of money more than doubled in less than a decade. Now, with traditional investment-class assets back to all-time highs, there are still trillions of dollars of new money looking for things to buy. And some of that money has recently turned to cryptocurrency. This is actually great for the economy as a whole, because if that money had instead continued to inflate the housing/stock bubble, then we’d just put ourselves at risk of another massive collapse. Stocks are already massively overpriced relative to companies’ earnings, and if the prices go up any higher, then long-term investors will carry an unprecedented level of risk that their investments never pay off.

The value of cryptocurrency remains quite volatile because there remains a great deal of uncertainty over its future, and because lots of fiat pours in and out of it every day, and because there remains so little of it relative to fiat currency that it is still possible for bad actors to manipulate the market. But this manipulation only occurs when big investors spread bad rumors, then sell off some of their own holdings at all-time highs to start an avalanche of panic-selling before stepping back in to buy the dip and increase their own long-term holdings. Yet this manipulation is much different than what central banks do, because it depends on smaller investors believing the panic and actually taking action of their own will.

But when central banks manipulate the price of money and the value of assets, there’s nothing the average investor can do about it. The market is effected no matter what you do, you just have to change your behavior to fit the new policies implemented by the central bank. And you can’t vote the chairman out of power if you don’t like their policies. This is why so many people are moving so much money into cryptocurrencies, where they know that the valuation isn’t totally out of their control.

The problem is that people still like to think in terms of fiat dollars. They see the price of Bitcoin reach $5,000 and they think “Oh, this must be the top, it can’t go any higher than this.” So they sell off, expecting others to do the same. These barriers are merely psychological, and even though Bitcoin itself will likely never reach that mythical $1 million valuation, the long-term growth prospects for cryptocurrency in general are very high, because smart investors are tired of dealing with money that is totally out of their control. When you try to price cryptocurrencies in fiat dollars, you have to remember that fiat is practically worthless. The real value of all cryptocurrency should be, and eventually will be, greater than the value of all fiat in existence, more than $100 trillion. And that won’t be a “bubble”, it will simply be the new economic paradigm.

Look at all the institutions required to maintain a fiat economy. You need universities to train professionals. You need testing and licensing and regulatory bodies to certify professionals. You need enforcement institutions to investigate and punish offenders. You need lawyers and courts to determine guilt and settle claims. You need banks and accountants and financiers to set polices and manage accounts and create financial instruments. You need exchanges and traders to connect buyers and sellers and facilitate transactions. You need thousands and thousands of pages of laws and tax assistants and agents to keep these institutions funded. The cost of all these functions is trillions of dollars annually, and you have to trust that all the participants will be virtuous and not game the system to enrich themselves beyond the already astronomical salaries and benefits and bonuses they receive to compensate them for their expert knowledge.

But to maintain a crypto economy all you really need is smartphones and wifi. There are many societies all around the world that just do not have the resources needed to set up all the institutions required to run a fiat economy. And even in developed nations these institutions are filled with corruption. Cryptocurrency enables growth and stability in undeveloped nations with only relatively minor upgrades to their infrastructure, while eliminating many of the conditions for corruption in developed economies. Cryptocurrency is the future, and it will facilitate prosperity the likes of which the world has never before seen. All it will take to make this happen is for central banks and regulators to just let go, and for the masses of people to understand the benefits of this technology and adopt it in their daily lives.

This would never have been possible if banks hadn’t so drastically devalued their currency. But their intervention means that crypto can’t possibly be in a bubble, crypto can’t possible be overvalued – not in terms of fiat dollars. Because when banks can simply double the supply of dollars over a few years to keep themselves in power, then that money has no value other than to keep the banks in power. The more you use their money, the more firmly you establish their power over you.

 

Why the big three are booming and why it won’t last

The “big three” are Bitcoin, Litecoin, and Ethereum. These three coins are practically the only cryptocurrencies that new investors can easily purchase with fiat through sites such as CoinBase. They’ve also experienced explosive growth this past month. Why? Some may point to the successful implementation of SegWit in Bitcoin, or the upcoming release of Metropolis in Ethereum. While these certainly are big contributors to the price increases of these coins, a major contributing factor is demand for ICO tokens and various “alt-coins”.

That new investors can purchase the big three with fiat is enough on its own to inflate their price relative to other cryptocurrencies. But if new investors want to acquire any of the hot new tokens like 0x or even OmiseGo, their only option is to buy one of the big three and then trade it on an exchange, temporarily driving up the price of both cryptos in the process. Ironically, demand for what some Bitcoin-purists derisively term “alt-coins” or even “shitcoins” inflates the price for their own favored asset.

Today we saw a slight drawback from many cryptocurrencies’ all-time highs. $5,000 per Bitcoin is a psychological barrier point that is just too tempting not to cash out at. And because of today’s dip, and ongoing uncertainty over the possibility of another fork in November, Bitcoin will have trouble breaking that $5,000 barrier for a significant time at least until the November uncertainty has passed. We will likely see a repeat of the downturn in July where investors trade their coins back into fiat to wait for everything to blow over. And then heading into 2018, the big three will boom into new all-time highs.

But even if investors stay strong and hold for the coming months, the explosive growth we’ve seen this year won’t last forever. Caught up in the hype, some Bitcoiners are exuberantly predicting Bitcoin at $100,000 or even $500,000. However, as it becomes easier to buy more “alt-coins” with fiat, demand for Bitcoin and Litecoin will decrease, and the price will reflect it. Only Ethereum will remain in high demand for reasons other than speculation as it will still be needed to fund and power ICOs.

Bitcoin and Network Effects

A network effect is the value created when a large number of people regularly use a product. For example, an online multiplayer game such as World of Warcraft still appeals to new players because they know that they will have an easy time finding other players to play with. Many competitors to WoW were praised for their innovative features, but they never managed to attract and sustain a sufficient player base to establish network effects to keep them in business as long as WoW. Successful games these days need millions of players all over the world, and these games usually offer some sort of incentive to players so they log in every day to collect their rewards; the number of accounts and daily logins are critical metrics investors analyze to determine whether a game deserves more funding. If players can’t find other players to play with, then they stop logging in, making it harder for other players to find other players, leading eventually to a failed game.

The most successful game isn’t necessarily the best game; it is often the game with the most dedicated players.

When asked why the price of Bitcoin remains so much higher than other, newer cryptocurrencies that have features, technologies, and use-cases that Bitcoin lacks, many people point to Bitcoin’s network effects as an answer. However, Bitcoin’s network effects may be overstated. The top 100 richest Bitcoin addresses all have tens of thousands of BTC, hundreds of millions of dollars worth of Bitcoin. 90% of all Bitcoins are held in less than 200,000 addresses. 60% of all Bitcoins are held in less than 20,000 addresses. And remember that one person can have multiple addresses. The millions of addresses that supposedly constitute Bitcoin’s network effects hold less than 1% of Bitcoin’s value.

So, there really aren’t that many people who have and use Bitcoin. And after 8 years there are still hardly any non-internet vendors that accept it as a form of payment. So what keeps the price of Bitcoin so high, if it really isn’t that popular and it doesn’t have many uses? Ironically, what keeps the price of Bitcoin high is demand for other cryptocurrencies and decentralized application tokens – what many Bitcoin devotees derisively call “alt-coins” or even “shit-coins”.

Due to various regulations, technological hurdles, and the international character of cryptocurrencies, it is a bit of a challenge for new investors to acquire “alt-coins”. New investors generally don’t have any coins at all; all they have is fiat currency, and most alt-coins can only be acquired by trading other cryptocurrencies on cryptocurrency exchanges, most of which don’t allow trading with fiat because doing so would expose them to regulation by agencies such as the SEC.

The common path most new investors take is to buy Bitcoin (or Ether or Litecoin) through a service such as Coinbase that accepts fiat, and then transfer that Bitcoin to an exchange such as Bitfinex to trade for alt-coins. Incidentally, Bitfinex holds over a half billion dollars worth of Bitcoins.

As such, Bitcoin’s market cap of $80 billion is about half of the total $160 billion market cap of all cryptocurrencies. I’d expect the ratio of this relationship to remain fairly constant in the near-term. As other tokens increase in price and demand, Bitcoin will increase as well. In reality, Bitcoin’s network effects extend through the entire market of almost all cryptocurrencies.

However, this state of affairs is unlikely to continue into the long-term. This year has seen an explosion in the number of people who mine different cryptocurrencies, meaning they will acquire more coins without needing to buy them with fiat/Bitcoin. Furthermore, as alt-coins become more popular and governments become more accepting, it will be easier to buy alt-coins directly with fiat. Finally, decentralized protocols for currency exchange, such as 0x, Kyber, Bancor, and others, will soon come online and gain a lot of the market share currently dominated by centralized, Bitcoin-powered exchanges. When this switch occurs, Bitcoin will lose a lot of the network effect value it gained by being something like the “reserve currency” for other cryptocurrencies, and it will have to live and die on its own.

Luckily, implementations of solutions such as larger blocks, SegWit, and Lightning Network will make Bitcoin more functional and increase its possible use-cases. However, infighting between different forks of Bitcoin will dilute and damage the perception of the Bitcoin brand with the mass market. Although competition can often increase a market’s appeal to consumers, who love to pick sides in a fight, the current situation with Bitcoin forks just increases uncertainty and discourages new adopters. Xbox One vs Playstation 4 excites consumers, but Playstation 4 vs Playstation 4 Pro confuses them.

Even if Bitcoin successfully implements updates that keep it competitive with other currencies, and the brand stays popular with the general public (hopefully avoiding the perception that Bitcoin is “only for rich people”) , Bitcoin will still have the problem of the concentration of the majority of coins in a tiny minority of addresses. New adopters who want to own Bitcoin to actually use it will have to pay a premium to the Bitcoin elite to play their game. If consumers can get the same functionality from another coin without paying such a high premium, then demand for Bitcoin will drop even further.

Consider: if Kim Jong-Un accumulated almost all the Bitcoin in existence and charged a very high price to buy it from him, then most people interested in cryptocurrency would just choose a different product instead of enabling a tyrant by enriching him further. And if Kim Jong-Un couldn’t find any buyers for hit Bitcoins because no one wants to play his game (or he was sanctioned by the UN), then the price of BTC would drop to $0.

The game only has value if there are many other people you can and want to play it with, and right now Bitcoin really only has the illusion of network effects. To get millions more actual individuals across the world using BTC daily, the price would probably need to balloon another 10-30x from purchases to redistribute the coin away from its current concentration. As this price rises, however, the majority of potential users will be increasingly priced out of acquisition. At nearly $5k per Bitcoin, the price is already so high that most people don’t even give it any thought, just as they don’t think about mansions or private jets or other luxuries that are on the market but they’ll never have any need or interest in buying.

Ethereum, however, is quite different. Coins like OmiseGo and Bancor are built on and utilize the Ethereum computing network for their transactions. Therefore, the price of Ether will always benefit from network effects of other alt-coins it is tied to, even if consumers buy these alt-coins directly, bypassing Ether purchases, Ether will still be in demand to power everything built on the Ethereum network. So long as Ethereum-based companies stay in business, Ether will have a solid price-floor even if consumers lose interest in Ether itself as a currency.

The price of Bitcoin, however, depends on brand salience that is increasingly diluted, network effects that are overstated and tenuous, and…well…plain old hype. There’s still plenty of money to be made with Bitcoin over the next year or two, particularly because it will take time for people to transfer their holdings out of legacy Bitcoin-powered exchanges they’ve become comfortable with to new decentralized solutions. But in my analysis, Bitcoin carries far more risk than Ether over the long-term.

Beginners’ Guides to Buying Crypto: Money, Markets, and Governance

Reddit user peacheswithpeaches has created a few URLs with step-by-step instructions on how to buy some of the more popular decentralized app tokens.

Eth: http://buyingeth.com/ Golem: http://buyinggolem.com/ Siacoin: http://buyingsiacoin.com

Aragon: http://buyingaragon.com Augur: http://buyingaugur.com Status: http://buyingstatus.com

Each of these tokens falls under my general pioneer principle for new-world-investing: markets, money, and governance. Startups that dominate these three categories in new industries will be the backbone that profits from the success of virtually any other company in that space. Any venture whatsoever requires a location in which to operate, a medium to facilitate exchange, and a program to normalize behavior and resolve disputes.

This is akin to buying securities in Amazon, the Federal Reserve, and the U.S. Treasury. Even if a company that sells products on Amazon loses money, Amazon still profits from their business activity, and the US Government still collects their tax payments. Investments in these categories tend to be less risky while offering slow but steady growth over the long term. Sometimes, they end up being “too big to fail”, and only collapse when the entire space collapses. Once a large number of smaller ventures adopt these systems as industry standards, it becomes very difficult for competitors to enter the field, because startup costs are enormous to compete at such a large scale, and they’d have to offer existing users a tremendous incentive and benefit to offset the costs of transitioning. Many smaller ventures even become so intertwined with these systems that it actually becomes impossible to disentangle themselves.

Success is in no way guaranteed, however, especially at such an early stage in the development of the industry. However, with the talent-pool so small and brands and partnerships already established, it seems increasingly likely that this network of services will play a fundamental role in new economy of Web 3.0.

Fear, Uncertainty, Doubt

Markets love good news. Markets can handle bad news. What markets absolutely despise is fear, uncertainty, and doubt. Buyers and sellers, investors and producers, need to have an idea of what the future will look like so they can make decisions. Think of it like this: if you can only take either a pair of sunglasses or an umbrella with you, but you don’t know whether the weather will be sunny or rainy, then you might just decide to stay at home. Since the middle of June, the market for Cryptocurrencies has been dominated by uncertainty. But on August 1, that all changed.

Bitcoiners didn’t know for certain whether the coin would undergo a hard fork or a soft fork or an upgrade or nothing at all. The uncertainty leads many people to imagine the possibility of the worst possible outcome – a failure of the coin and panic. The same principle leads to runs on banks: depositors doubt that they will be able to withdraw their money tomorrow, so they all rush to withdraw it today, and the bank runs out of funds and collapses. Rather than deal with the uncertainty, Bitcoiners simply sold their BTC and stored their wealth in fiat. The price fell nearly $1,000 in a month.

Then Segwit was approved, and, unexpectedly, a hard fork was announced as well at nearly the last minute. Now, the weekend after the August 1 event has passed, Bitcoin just reached a new all-time high. The fork didn’t collapse Bitcoin, the market supported Bitcoin Cash, and fear of missing out drove investors back into cryptocurrencies in a feeding-frenzy. Even Ethereum is climbing again after losing 50% of its all-time high of $400. The rising tide lifts all boats.

If the outcome of an event at a known date is uncertain and news relating to that event continually coincides with decreases in the price of the related asset, then you should consider buying low, unless you expect the outcome to be severely negative. People almost always overreact to uncertainty, they always fear the dark more than they should, it is basic nature and psychology. We try to avoid loss as much as we can, and we’ll forego gain and success if we have to risk a little to get a lot. “Be greedy when others are fearful.”

This was predictable and predicted. The only real downside risk was a true black swan, wherein the Bitcoin mining community splintered into a thousand factions. But there was simply too much money at stake for irrationality to triumph over the profit incentive. Bitcoin’s future looks bright today, so grab those sunglasses, but there still might be storm clouds far off in the distance.

Investing in networks, not companies

When deciding where to invest their money, many people research a few companies, determine which one has the best product and profit margins, then dump their funds in that company; but that is a narrow, unsophisticated strategy. Great companies have great products, marketing, profit margins, and leadership; but the best companies are part of a wide network of great companies. Investing in networks over companies reduces risk and increases gains.

Some companies start out isolated and later in their development join larger networks; but companies who stay isolated their entire lifespan often die early deaths, or do not grow to their full potential. When investing, don’t analyze a company as an atomistic entity, look closely at how it relates to and interacts with other companies across the whole market. Look at the other firms with which it has partnerships and contracts. Check the names on the board of directors and see what other investments and professional duties they have and how that ties in to the company under analysis. For example, if a former top executive from Apple is on the board of a new tech company, then you know that startup has mentorship, direction, and access that its competitors may lack.

In your research, you may discover that a company has everything it needs to succeed, yet other companies networked to it will see even more success. Even if that company has an incredible product, they might not be the organization in their supply/value-chain that profits the most from the product’s success. Consider a killer-app for a gaming console: you may expect the software developer to sell millions of copies at a profit of $10 per unit, but if those millions of consumers have to buy the new console to run the software, and the hardware company earns a profit of $100 per unit, then the hardware company is the better investment choice for the short-term. Companies such as Aragon, which make products and services that enable thousands of other companies to succeed, will benefit massively from the growth and success of  blockchain-based Web 3.0.

If a well-networked company stumbles, then it can receive support,  guidance, or bailouts from its partners. An isolated company will have to fend for itself in shark-infested waters. A company that has strong, dependable friends that succeed when it succeeds carries less risk than others. However, since their fates and fortunes are so closely linked, there lies the possibility that one major scandal or failure could bring the whole network down simultaneously. Therefore, when investing in a network, it is critical to also identify firms that will benefit if your favored network collapses; make small investments in these firms as a hedge to further mitigate risk to your portfolio.