Crypto’s Uphill Battle: Pt. 1
Happy Monday, everyone!
Last week, SEC chairman Gary Gensler pitched his vision for regulating crypto to the House Democrats. Gensler signalled that the SEC will aggressively work to close loopholes within crypto regulation & for some reason compared cryptocurrencies to the subprime mortgage crisis of 2007–2008.
Uhm, come again?
This is not the first nor will be the last instance of officials and politicians waffling nonsense about crypto. It’s no secret that the adaption of cryptocurrencies is facing numerous hurdles, mainly because they are scaring the shit out of people, as radical innovations tend to do. Although we obviously believe that cryptocurrencies will eventually replace fiat money, we shouldn’t turn a blind eye to the many risks and challenges that remain.
So, instead of bashing the status quo as per usual, today I’m taking a more critical stance towards crypto; in an attempt to also involve the vineyard-vine-wearing, boat-shoe-strutting finance Chads and Brads in the conversation. And maybe also your dad, who might possess more common sense but is financially not well-versed.
Where we’re headed
If we were to believe consulting giant Deloitte, crypto is on track to replace fiat money within as little as five to ten years. Hold up, what is a fiat money? Fiat refers to all money that is made legal tender by a government
(think: dollar bills). As such, cryptocurrencies — unless issued by governments — are not fiat. However, the more important question is whether cryptocurrencies are already money. This is frequently debated, and you might be surprised by my answer: No, crypto is not yet money.
Attributes of money
General Acceptability
Before money was invented, goods were directly traded for each other (a process called barter). One could trade four apples for a fish, which could be traded for two bottles of wine or four-hundred-twenty grains of rice, and so on. Money was essentially invented to simplify these transactions and ease trade by removing the need to barter. Implementing money only worked because the apple picker, the fisher, the vintner, and the rice collector all accepted the same type of money in exchange for their products.
Cryptocurrencies fulfil this criteria. Sure, you currently might not be able to buy a Tesla with Bitcoin, but you probably can’t buy a Tesla with Sierra Leonean Leon (Sierra Leon's currency) either. You can, however, exchange Leon (SLL) for US Dollars (USD) — around 11,357 SLL for 1 USD— and then purchase a Tesla. You can do the exact same with Bitcoin or any other cryptocurrency.
Cognisability
Money must be easily differentiable from other objects. This goes hand in hand with the idea of general acceptability, and is not an issue for cryptocurrencies.
Portability
Another key attribute of money is portability: it must be easily transportable and efficiently store large values in small quantities.
Cryptocurrencies are infinitely more portable than fiat money. One can easily carry however much they desire in their digital wallets. Have you ever tried carrying ten duffel bags containing millions of physical dollars? Haha yeah, me neither, but I imagine they’d be quite heavy.
The idea of “portability” is a funny one. I remember reading that native inhabitants of the Yap islands in Micronesia traded with a rather bizarre form of money, called Rai Stones.
Yes, they literally used big wheels of stones. Good luck carrying one of these in your pocket.
Indestructibility/Durability
As money is passed around and stored, it should maintain its form without significant wear and tear. Again, cryptocurrencies win this category as they are less susceptible to wear and tear than your fiat money. Cryptocurrencies can somewhat be ‘destroyed’, in a process called burning. Burning refers to the process of sending crypto to a wallet that can only receive but not send tokens — essentially removing token from supply.
Homogeneity
All money should be homogenous, meaning that all pieces of money with the same value must have ‘identical’ attributes, i.e., two different dollar bills should be indistinguishable. This is important, so that people are able to agree on how much value certain moneys store.
Again, not an issue for cryptocurrencies, as they even remove the need for physical homogeneity by adding another layer of transparency: physical money can be counterfeit, digital tokens cannot.
Divisibility
A unit of money must be easily divided into smaller parts without losing any value. Again, not a problem for crypto.
Malleability
The material of which money is made, should be capable of being melted, beaten, and shaped. This attribute doesn’t really apply any more (to both fiat and crypto) since we moved away from a monetary system in which every unit of fiat money was backed by a gold reserve.
Stability of Value
Money should not be subject to wild fluctuations in value. This is where crypto loses big time. Stability of value is the attribute that we think about most in our daily lives when dealing with money—in both digital and physical form. Although fiat money does fluctuate in price, these fluctuations are typically insignificant compared to those of cryptocurrencies. So long as cryptocurrencies exhibit above-average volatility, we shouldn’t acknowledge them as money.
Sure, stablecoins—cryptocurrencies whose price is pegged to that of an underlying fiat currency, commodity, or different cryptocurrency—already exist. However, commodities and cryptocurrencies are both volatile, so anything pegged to a volatile underlying asset should probably not be viewed as a ‘stable’coin. And since we’re trying to figure out whether crypto will replace fiat money, stablecoins pegged to fiat money are out of the question as well. It’s difficult (if not impossible) to determine what range of volatility makes a cryptocurrencies stable enough to be considered money. But please, don’t argue that the volatility we have been seeing should be acceptable.
Ultimately, whether cryptocurrencies can replace fiat money in five to ten years entirely depends on whether crypto prices stabilise (very possible)—or whether we start thinking completely differently about what money is (don’t really see this happening). Still, further challenges remain.
Further Challenges
Environmental Footprint
Over the last year or so, there has been a tremendous push towards sustainability. In the financial services industry, ESG (Environmental, Social, and Governance) investments have become increasingly popular. Although cryptocurrencies have also made their way into many portfolios, there has been some push back due to exorbitant amounts of electricity required for crypto mining. Arguably the two most popular cryptocurrencies (Bitcoin and Ethereum) rely on a proof-of-work model to verify transactions on the blockchain. Although blockchains with more energy efficient validation methods such as proof-of-stake and proof-of-authority have been developed, Bitcoin and Ethereum remain the most dominant cryptocurrencies in the space, leaving a substantial environmental footprint. In order for crypto to become sustainable, we will need to shift away from proof of work validation methods. Luckily, Ethereum 2, the upgrade to Ethereum’s current network, already plans on shifting from proof-of-work to proof-of-stake.
Elon Musk
OK, to be fair, not Elon Musk specifically. Key person risk is probably more accurate. Key person risk refers to the idea that any single individual has the power to cause great fluctuations in the value of a currency. Over the last few months, Elon happened to be the single greatest risk to cryptocurrencies; the power that his Twitter account has is actually scary. In case you’ve missed it, Elon single-handedly catapulted Bitcoin up over 8% when he tweeted that Tesla would accept Bitcoin as payment. Elon then went back on his word and tweeted that Tesla would no longer accept Bitcoin over environmental concerns (see above). As a result, Bitcoin tumbled as much as 10% immediately following Elon’s comment. Surely Elon was aware of the environmental implications before allowing Bitcoin as payment. To me, it seems Elon sending people for a ride and having a laugh. I don’t blame him, he’s not the idiot in this scenario, but I do believe that no one person should have that amount of influence over the value of an asset.
Government regulation
This is probably the most significant and confusing one. Blockchain technology is based on the idea of decentralisation, which is supposed to liberate people from financial institutions, governments, and other third parties/intermediaries. It would be foolish to believe that we’ll be able to cut out big financial institutions and governments without any pushback. But, in a way, I believe that in the long-term governments will not be able to stop decentralisation while remaining democratic.
Let’s remind ourselves of the definition of democracy: Democracy is defined as a form of government, in which the supreme power is vested in the people and exercised directly by them or by their elected agents under a free electoral system.
So, if the majority of people agree that monetary systems should be decentralised, only anti-democratic governments would be able to prevent decentralisation. Cutting governments out of the equation will be a painful and gradual process, which will require tonnes of education of and push back from their populations.
Open Access and Quantum Computing (TBC)
Phew, that was already a lot. Let’s not get ahead of ourselves. I will cover the dangers of open access and quantum computing + potential solutions in next week’s edition of my opinion letters. I actually want to dive into this one in more detail and make sure to explain everything properly, as the problem more technically complex.
I hope you enjoyed this issue and were able to learn a few things. Lithium is incredibly bullish on the future of crypto, but we try to remove our own biases as much as possible, in an attempt to facilitate a debate that is both intellectual and educational.
Thank you for reading. See you next Monday!
Take care,
Team Lithium x Seb
