(This piece was first published on projectUBU’s blog in July 2017)
“The farther back you can look, the farther forward you are likely to see” – Winston Churchill
As humans, we are socially conditioned to a monetary system that rarely, if ever, gets questioned. Assuming you know a five year old child, how would you answer them if they asked you “Where does money come from?” Pause momentarily to think about how you’d answer that.
The explain-it-to-me-like-I’m-five test is my go-to when trying to simplify the complex. It is an intellectually challenging exercise in critical thinking. It forces you to confront assumptions you’ve always taken for granted — things you’ve never had to question, but unconsciously accepted because everyone else did.
Before currency we exchanged goods on a needs basis regulated by supply and demand. You had a cow and a spare pail of milk. I had chickens and a spare dozen eggs. We traded goods based on our excess of one item and shortage of the other. As trade routes expanded the logistics of exchanging physical goods became too complex, so currencies emerged in many forms from cowrie shells to silver and gold and paper money. Currencies became a simple way of standardising the complexities of exchanging milk, eggs, textiles, building materials, labour, transport — i.e. goods and services.
A currency is both a unit of account and a medium of exchange with four characteristics: portability, divisibility, durability and fungibility. Money also has these characteristics plus it is distinguishable from currency in that it’s a store of value — which is derived from scarcity. Since the abandonment of the gold standard, because governments can and do print currency, their value is continually diminishing. The so-called gold standard of currencies, the US dollar, has depreciated 95% since the creation of the Federal Reserve in 1913: i.e. it has lost 95% of its buying power. Ergo, one could argue, money has intrinsic value, currencies don’t.
Currencies are based on confidence which stems from trust in the “system” — that being the authority which gives fiat currency its official decree. That trust is rapidly diminishing as ordinary people discover they’re no more than mere worker ants in the system. Behind political instability lies economic inequality. With economies and currencies being so globally intertwined, the scale and pace of this loss of trust is accelerating exponentially.
Once trust is undermined, systems based on it are prone to collapse. The politically induced hyperinflation of post-war Germany, Argentina, Greece, Zimbabwe and Venezuela are testament to this. There’s no such thing as “too big to fail”. What the world witnessed in 2007/8 was the systemic collapse of the banking system. Future taxed generations will pay dearly for the trillions of dollars in bail outs because governments simply printed more currency, thereby kicking the crisis further down the road. There is no value underpinning this QE deception other than the potential value of the toil of future generations. We’re borrowing from our children to sustain our status quo.
George Washington said, “No generation has a right to contract debts greater than can be paid off during the course of its own existence.”
Since the abolishment of the gold standard that principle has been gleefully abandoned. When governments debase a currency investors flock back to proven stores of value like gold. But gold alone cannot underpin all the world’s currencies.
So, if money is how we measure value, by what measure is value applied? It’s an intangible concept because it’s relative. You can’t describe something’s value without referencing something else — such as money. People express the value they place in something by the amount of another thing they’re willing to sacrifice, such as the milk and eggs exchange. The market price of an item is found at the intersection of buyers and sellers expressing their value for it in terms of something else . Money should be the most frictionless asset, but because most exchanges of value are routed through a regulatory intermediary, it’s not. Because of diminishing trust, sustainability fears, friction, devaluation and control, financial systems are undergoing an unprecedented challenge from centralised authority to decentralised networks. This has been made possible by the advent of blockchain technology.
What we perceive to be of value is far more emotional than rational. Perceptions are forged firstly psychologically, then sociologically and finally economically. This is the story of gold and diamonds. Why is gold considered to have such intrinsic value when its practical applications are so limited? Just 12% of gold is used for industrial purposes, compared to silver’s 56%. Scarcity? The annual silver supply is 8 times that of gold. Total silver reserves in the earth’s crust are estimated at 17 times that of gold. Neither of those scarcity measures explains why, one fifth as useful, gold is 76 times more valuable (as measured by price). The difference between these metals is that gold is produced, not consumed. Silver is an industrial commodity, so it is needed, but gold is desired.
Gold and silver both have the characteristics of money, but that doesn’t determine their value. Logic, based on supply metrics, suggests that gold’s value should be between 8 and 17 times that of silver’s. That gold is worth 76 times more is because enough people believe it to be. It’s a truism of our species that if enough people believe in something it exists. Supernatural deities are a reality to billions despite zero scientific evidence thereof. Intelligent civilisations believed the earth was flat despite scientific evidence to the contrary. People accept the assumption of others around them so that perceptions become tightly held societal beliefs that in turn get bound into economics. A great commercial example is De Beers’ famous 70-year-old proposition “A diamond is forever”, where a single company convinced hundreds of millions that it’s appropriate for a man to put one on the finger of the woman whose hand he asks in marriage.
Blockchain technology is a mega-trend that allows other macro-trends to scale securely, converge and combine. It’s ushering in the next phase of the web, 3.0 or the network economy. It enables a more decentralised and autonomous infrastructure that unlocks previously impossible economic models. Blockchain technology represents a fundamental shift from centralised and human mediated systems to algorithmic trusted, decentralised and autonomous networks. Bitcoin’s price rocketed from $1,000 to $19,000 in less than a year. Many believe it’s tulip mania, but that ignores the unit’s underlying adoption. What’s driving the surge in cryptocurrencies is adoption at scale. The governments of Japan, Singapore, Canada, South Korea and Australia have moved or are moving toward not just crypto adoption, but also crypto development. As these heavily regulated markets relax, investors are charging like bulls headlong into a new era of freedom of financial expression — one devoid of institutional political influence in the form of government, devoid of regulators and skimmers and where trust is ceded to the community comprised of players with skin in the game.
When I was selling my first house to accommodate the rapid arrival of offspring the estate agent gave me an invaluable lesson in the concept of market value: “Your house is worth what somebody’s prepared to pay for it” she chimed. There are billions of people who may be willing to pay the asking price for cryptocurrencies precisely because, unlike fiat, the perception of value is inextricably linked to their ability to influence the community. No cryptocurrencies adequately meet the characteristics of either currency or money, but that’s changing. Arguably, for some, such as Bitcoin, their only unproven characteristic is a store of value, because a decade isn’t long enough to present sufficient empirical evidence. If you’d invested early in Bitcoin or Ether you’d certainly argue that it’s not only delivered as an inflation hedge, but has been a comet for wealth creation. Investing today could well turn out to be the best investment class of your lifetime, provided you have the appetite for volatility and go long.
The other beauty of cryptos is if investors don’t like one community they can pick others. As an investment strategy most players will have a diversified portfolio in any event. Cryptocurrencies hold the promise of becoming the democratic tool that political democracies are failing to deliver. And with that level of influence, the prospects of a more equal, prosperous world are infinitely brighter.
