Cryptocurrencies Make Sense As Uncensorable Mediums Of Exchange
Cryptocurrencies are useful because millions of people want to make transactions that their governments want to prevent
Welcome to the latest installment of my quest to try to put my finger on a web3 value prop. Today we’ll be exploring whether cryptocurrencies like Bitcoin might plausibly have any good value props. If you’re just joining, you may want to catch up on my previous posts:
- Chris Dixon’s Crypto Claims Are Logically Flimsy
- Naval Ravikant and Chris Dixon Didn’t Explain Any Web3 Use Cases
- Why Web3’s Shared Data Across Applications Doesn’t Matter
Cryptocurrency is the original kernel of the blockchain and web3 ecosystem, and still my best candidate for a blockchain-powered value prop that’s genuinely differentiated from non-blockchain alternatives. Cryptocurrency’s value props fall under two categories: medium of exchange and store of value. In the rest of this post, I’ll tell you why I think the first one is strong and the second one is plausible:
- As a medium of exchange, cryptocurrency has a big advantage over digitized fiat because it’s much harder for a government or other middleman to stop you from conveniently and securely buying and selling whatever you want. This is admittedly awesome!
- As a store of value, cryptocurrency’s price will not go to zero as long as it has steady demand from people using it as a medium of exchange, but who knows if its market cap will tend toward $10B or $10T.
Medium Of Exchange
Cryptocurrency has a few dimensions on which it might differentiate itself as a better medium of exchange than fiat. I’ve listed them in order of most to least promising:
- Uncensorability — If your government can stop you from transacting in domestic and foreign fiat, or if third parties can interfere to block certain types of fiat purchases like porn and drugs, but you can still transact in cryptocurrency
- Irreversibility — If once a payment is received, the risk of having that payment reversed is low
- Privacy — If other people can’t see what transactions you made
- Stability — If cryptocurrency is less volatile than a country’s fiat currency
- Transfer Speeds— If you can transfer cryptocurrency faster than fiat
- Fees — If you can transfer cryptocurrency cheaper than fiat
There’s also the security and fraud dimension, where having a crypto wallet can be more secure than having a bank account or credit card, but I won’t focus on that dimension because I think traditional finance has a significant lead over cryptocurrency at keeping your money safe from loss and theft.
Uncensorability seems to be the #1 thing cryptocurrency has going for it. Cryptocurrency gives you all the privacy, flexibility and durability of transacting in physical cash, plus you get the magic of the internet to transact it quickly with people and machines all over the world.
This whole tweet thread by Alex Gladstein is definitely worth a read. It tells compelling stories of people in struggling countries coming to rely on Bitcoin for very real value props. Here are a couple excerpts:
BYSOL, a grassroots Belarusian human rights org, has moved more than $500k of value peer-to-peer to striking workers inside Belarus, in a way the regime can’t stop. Activists or protestors normally get their bank accounts frozen.
There are countless cases of individuals fleeing Venezuela to other countries with their wealth stored in Bitcoin, something previously very difficult for other refugees, who had to flee with whatever they could carry and then whatever wouldn’t be stolen on the way out
I’m very moved by hearing stories of specific people reporting specific moments where cryptocurrency gave them value, where I can’t think of how a non-cryptocurrency solution could have given those same specific people that same specific value. These are real-life value prop stories, which prove that cryptocurrency has passed beyond the great filter that most startup projects never pass.
How uncensorable is it? A good case study is China, which just outlawed Bitcoin. My understanding is that most Bitcoin activity in China has stopped, but the 1% of people who most care about using it are still finding ways to use it, and the government is happy enough to stop the 99%. That’s kind of a bad sign, but it doesn’t mean much because we don’t know how desperate the situation is for most Chinese Bitcoin users. If China’s own currency options became unusable to Chinese citizens, they’d get more desperate about switching to Bitcoin, and I’m pretty optimistic that they’d succeed to a significant degree, similar to the stories in Alex Gladstein’s tweet thread above. I’m optimistic that uncensorability is actually a durable property of cryptocurrency.
Irreversibility is a close cousin of uncensorability, because the ability for third parties like credit card companies to reverse a transaction effectively means they can censor it.
As a credit card user, I’m sometimes on the opposite side of the table, wanting to reverse my charges. I love the consumer protection feature that allows me to hold merchants accountable when they overcharge me, or fail to adequately deliver what I paid for. So irreversibility might not benefit me personally in most of my transactions.
But if I want to go shop for a sex toy, or porn, or weed, then I understand if the merchant has decided to require irreversible transactions due to the problems that middlemen cause for these types of businesses.
Companies that sell adult content and services have historically had a hard time with their payment processors. Payment processors don’t like these businesses because their customers are more likely to claim that their charges were unauthorized, so their chargeback rates are high. Stripe classifies them as restricted businesses.
That’s why PornHub has entirely cut out traditional fiat payments. As of last year, PornHub only accepts cryptocurrency payments. I consider this to be hugely important validation for cryptocurrency’s value prop.
(Unfortunately, the rest of web3’s alleged use cases have not been similarly blessed with the validating power of porn, to the best of my knowledge.)
Cryptocurrency doesn’t just let you avoid government restrictions, it also lets you block the government from ever knowing which transactions you made. That’s the privacy factor.
A great example of cryptocurrency being used for private uncensorable transactions is darknet markets, which a guy I know has tested for himself. For instance, let’s say I hypothetically were to purchase a fun but illegal substance like LSD on a darknet market using Tor and Monero. It’s very difficult for the government to detect and prosecute such purchases. Both the Tor web traffic and the Monero payment traffic does a great job of hiding what’s going on from any observer.
This is a strong validating success story for Monero’s use case as a medium of exchange with differentiated privacy characteristics (and for Tor as an anonymized web browsing service).
Let’s say your country’s fiat currency is currently hyperinflating. Businesses have a hard time operating because they can’t figure out if their prices should go up or down 50% because the currency is too volatile to know what makes sense. If they switch to transacting in less-volatile BTC, then they’d be able to price their goods accurately and keep running a profitable business.
This medium-of-exchange value prop story pre-assumes that BTC is relatively stable (non-volatile), which I can grant as a plausible assumption in some unfortunate countries whose fiat currency is so volatile that it makes BTC look stable.
Transfer Speeds and Fees
Moving fiat around is sometimes slow and expensive. If cryptocurrency could make transfers significantly faster and/or cheaper, then that’s a differentiated value prop.
In this tweet thread, Jack Mallers reports that the Lightning Network let him instantly transfer Bitcoin from the US to El Salvador:
But in recent years, the size of the problem to be solved has been shrinking, thanks to good old web2 and finance innovations. For instance, Wise is a popular service for transferring money internationally and converting between almost any pair of currencies. It usually takes 1–12 hours, and it rarely takes more than 1–2 days. The total fee for a Wise transfer is usually in 0.5–1.9% range.
Sure, it would be better if Wise would take only 1 second and charge only a 0.01% fee. There are still a few order of magnitude of potentially noticeable improvements to be made. Which is why the Wise team is still hard at work. I feel good about Wise’s chances to continue putting up stiff competition on speed and fees vs cryptocurrency-based transfers.
Stripe’s Patrick McKenzie makes a similar point that non-crypto financial innovation is actually happening to lower international money transfer fees:
Anecdotally, as someone who has for almost 20 years had to move money between the U.S. and Japan, all-in costs have declined by 90% for small transfers and double digit percent for large ones. Japan to the U.S. is a relatively high-cost corridor (mostly due to user willingness to pay), but Wise (nee Transferwise) has gotten the pricing on a $1,000 transfer down to about $10. The best provider in the market used to charge $40 plus a (conveniently underdisclosed) ~2% spread on the currency conversion.
And ACH transfers have been getting faster:
“Moving money between bank accounts takes 3–5 business days” has been the rule in the United States for most of my life. This quietly changed and many people have not really noticed. It happened via a combination of sustaining innovation, greenfield transfer networks, and heuristic credit decisions made at superhuman rates by computers.
There may continue to be places in the world where Wise is unavailable, and other transfer services are either unavailable or slower and more expensive than some cryptocurrency’s transfer fees. I’m open to this possibility. But it seems that the likely endgame of traditional web2 technologies and the traditional finance system will be to stabilize on low transfer fees and fast times, and not leave much room for crypto to differentiate itself on speed and fees.
Those are six medium-of-exchange differentiators that all favor cryptocurrency over fiat in some applications: uncensorability, irreversibility, privacy, stability, transfer speeds and fees. The first three — uncensorability, irreversibility, and privacy — already have proven traction, without any clear way for fiat to catch up. The last three — stability, transfer speeds and fees — are more of a fair fight with fiat, but could plausibly also end up as decisive crypto success stories.
Store Of Value
Now let’s consider the popular claim that cryptocurrency is a store of value, using Bitcoin as an example.
Let’s say you’re seeking to preserve the value of your hard-earned savings across years or decades, but you live in a country whose currency is at risk of losing its value rapidly — like, a 10%/yr inflation rate or higher. Even though Bitcoin itself admittedly has a significant risk of being very volatile, and may occasionally have rapid drops in value by 10% or more, that could still be less risky than holding your country’s fiat, or at least be uncorrelated with it, and therefore be worth diversifying part of your savings into.
I’m a US citizen, so let’s think about whether I should be using cryptocurrency as a store of value. In the US, 1973–1982 was a decade of 10%/yr inflation, far beyond the 2–3% inflation rate that our government normally targets. Many people fear that the US is now at risk of experiencing these peak inflation levels again, or worse. So what should I do — should I buy cryptocurrency in order to “store value” better?
First of all, I haven’t ever attempted to use USD as a store of value over a multi-year period, so it’s not like I have a pool of USD sitting in my portfolio and we can discuss whether that pool of USD should be converted to Bitcoin. The main way I store value is with a diversified portfolio of index funds which give me an equity ownership stake in over a thousand profitable companies based in dozens of countries around the world. Less than 1% of my net worth is stored as USD, because everyone knows USD isn’t designed to be a strong store of value on a multi-year timescale (nor am I trying to pull off a market-timing strategy that requires holding back a reserve of USD).
How well does my portfolio store value if the US enters a high-inflation period? I would expect my US equities to drop in value, for a few reasons:
- P/E ratios justifiably go down in periods of high inflation
- High interest rates raise the cost of capital for stock investment (a liquidity crunch)
- Bonds offer higher yields, which causes lower demand for stocks
But while the price of many US equities is falling, other countries’ equities will behave differently. Foreign equities are likely to rise in value, since their currencies will be strengthening relative to the USD. Only 45% of my equity portfolio is currently allocated to the US market. By owning index funds that span across many international markets, I’m comfortably hedged against a high-USD-inflation scenario. Furthermore, this scenario presents an opportunity to rebalance my portfolio, i.e. liquidating some of my gains from foreign stocks and rotating them into US stocks when I can get them cheaper from a P/E standpoint.
For educational purposes, let’s also consider what would happen if my portfolio was 100% US equities, so my portfolio is a “closed system” where inflation is happening across the board. Eventually, whether it’s after a year or a decade, the inflation rate would get under control. At that point, more money would flow into stocks and P/E multiples would expand again. If I’d simply left my portfolio alone during that period, and the companies I’d invested in were still generating profits, then the P/E multiple should spring back to what it was before inflation started, and my value should have been successfully stored — more than just stored, but also enjoying the gains from investment in the form of dividends and buyback-driven appreciation.
As you can see, I seem to already possess a great store of value in the form of a diversified equity index fund. But to be fair, not everyone in every country has such easy access to purchase globally diversified index funds and own them securely. Furthermore, even if everyone can purchase index funds and use them as store of values, it’s still plausible that cryptocurrency are another kind of store of value… just like gold is.
Millions of people have been using gold as a store of value for millennia. Can people similarly use cryptocurrencies as a store of value? Yes, I’m receptive to the argument that crypto can function like digital gold in many ways. I’m not a meatspace chauvinist who thinks gold is super different from cryptocurrency because it takes up space in the physical world, although I do think gold’s much longer history makes it much more Lindy than Bitcoin.
The main question is, how much should we expect cryptocurrency to be worth, and how should we expect its value to change over time?
With gold, we know it has a nonzero minimum price because it has ongoing inflows of demand from buyers who want it for consumption and manufacturing purposes. But the actual market price of gold seems to be much higher than what a commodity model would estimate, because a large fraction of gold’s demand comes from people who purchase it to hold in their saving and investment portfolio, which makes the price analysis get recursive and complicated.
With Monero, how do we know it has a nonzero minimum price? Stephen Diehl thinks “arguments for the non-zero valuation of crypto assets are all predicated on belief in infinities, circular logic, or faith in invisible hand of future forces yet unknown”. I disagree. I think the argument for the nonzero valuation of Monero is rooted in the belief that people will demand it for its differentiated medium-of-exchange use cases.
For example, if I want to buy some LSD (a chemical abbreviation, not a currency abbreviation), I’m going to want to buy some Monero. And I’m willing to pay a significant fraction of how much the LSD is worth in order to obtain Monero so I can go forward with my purchase. As long as LSD is transacted this way, whoever owns Monero can assume that there will be an inflow of demand from people like me at nonzero prices.
There’s no widely-accepted model of how to model a cryptocurrency’s price by starting from medium-of-exchange demand, and then recursively factoring in that a bunch of people will demand it for their savings and investment portfolios. It’s not clear if the market price should even converge to one value, or if it will fluctuate chaotically forever, like a drunkard’s walk on a log scale.
My conclusion is that cryptocurrencies may have a long-lasting store-of-value use case, or they may not. I think it’s very plausible (more than 10% chance) that all cryptocurrencies’ prices might fall by 90% one day, and never recover, but just keep fluctuating around that new level for decades to come. I think it’s not necessarily wrong to mix some cryptocurrency into one’s investment portfolio. But because the risk of a very large downside is very significant, I strongly discourage people from holding more than 5–10% of their savings/investment portfolio in cryptocurrencies.
Why I hold Bitcoin, Ethereum and Monero
I’m currently holding 4% of my personal savings and investment portfolio in Bitcoin, Ethereum and Monero. [Update: I sold the last of my cryptocurrency holdings in March 2022 and don’t plan to ever buy more.]
I first became interested in Bitcoin in 2011 because I estimated that it would be a large return from a probabilistic expected-value standpoint:
At the time, the thesis I bet on was simply that this cool new internet-based currency could maybe (10% chance) evolve into some form where it would be widely used and create tons of value. From my current standpoint, ten years later and 100x richer, it still seems like a good thesis. But the price is now high enough where I think a 100x return is less than 10% likely, since that would imply a future market cap over $100T, or over 20% of the entire world’s wealth. So I no longer have a strong opinion that investing in Bitcoin is high expected value.
On the contrary, I think what’s currently being somewhat under-appreciated is the high risk (20%+) that Bitcoin and other cryptocurrencies may suffer a very large and possibly permanent price crash in the next few years, because there’s no reliable model saying that their current order-of-magnitude price is the long-term order-of-magnitude price. The best model that would explain the price behavior we’re seeing is probably just a model of a hype-driven speculation bubble, and that model predicts a large crash happening in the future.
Therefore, in addition to betting 4% of my portfolio on cryptocurrencies, I’m also allocating 1–2% of my portfolio to place a bet that cryptocurrencies will suffer a very large price crash. I don’t necessarily think this is a more-than-50% likely scenario, I just think it’s a very plausible scenario that’s being unappreciated, and the odds of betting on it are pretty attractive. If tomorrow we wake up and there’s been some kind of triggering event that crashes the price of cryptocurrency by 90%, I will stand to profit about 2,000% on my bet.
What does this mean for the rest of Web3?
Cryptocurrency having a genuinely differentiated medium-of-exchange use case is exciting, and it helps explain why people are so hyped for a blockchain and web3 revolution. But I still think most of that extrapolated excitement is misguided.
The most likely endgame of blockchain technology, in my view, is that we’ll use it for cryptocurrency, and maybe a few other kinds of ledgers like NFTs and domain names. But 99% of the technology we build web apps with will continue to be web2 technology.
Web2 services will accept cryptocurrencies when it’s useful to do so, and they’ll make themselves uncensorable when it’s necessary to do so. Just like PornHub and darknet drug markets are already doing today.
Here are some posts by people I respect who I think have made good points questioning cryptocurrency’s value props:
- The Non-Innovation of Cryptocurrency by Stephen Diehl
- The Economics of Bitcoin by Matt Ranger
- Crypto vs. Fiat by Lyall Taylor
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