Soliloquy on Crypto

A Stonk investor’s greenhorn take on cryptocurrencies

• Decentralization of monetary policy, a key idea behind the birth of crypto. The technology pieces to build cryptoeconomy were around for years — cryptography, digital time-stamping, probability theory.
• Cryptcurrency trades like a commodity because marginal demand and supply dictates the price, however, it aspires to trade like digital gold which requires a few hurdles to cross. Easy to price but difficult to value crypto.
• Underlying blockchain technology has evolved at supersonic speed and the applications are disrupting the world of supply chain, finance, payments and creating new marketplace platforms with NFTs, Defi etc.
• As many Blockchain/ Crypto evangelists say, it is probably in early Internet like days and the next decade of growth could be similar as well. Hard to predict the evolution of cryptocurrencies and risks related to regulation, technology, security etc.
• Most of the cryptoeconomy companies are private with Coinbase, listing as first public crypto exchange — Not much choice of public companies in the cryptoeconomy.

The birth of original cryptocurrency in 2008 in the midst of Great Financial Crisis was a bona fide attempt to fill the void left by bond vigilantes as the central banks tossed aside formulaic constraints that tied monetary expansion to GDP, inflation, and on. Hindsight 20/20 for me, Bitcoin has propelled the evolution of blockchain technology, the mothership for decentralized, distributed shared ledgers that could possibly have been born only in the Internet. So, why did Stonk investors miss it? I mean the Internet, born in the 90s, was joined at hip with Wall Street and we had our dot com bubble but aren’t cryptos living and breathing in a universe separate from Stonks.

The private market has become robust over the past couple of decades and companies in general have been staying private a lot longer before their IPO since the dot com bubble — 10+ years in post dot com world vs. <4 years pre dot com. Venture capital investments have grown ~5x in the last decade in the US to $150b annual run rate . While crypto companies have attracted greater VC interest in the recent years, crypto companies in their initial years had found an alternate source of financing, ICOs (initial coin offerings), with Ethereum leading the charge in 2014 and the surge in subsequent ICO offerings mostly avoided regulatory scrutiny until 2017.

The investment menu in cryptoeconomy has expanded well beyond cryptocurrencies to crypto applications and enablers — New stablecoin offerings tied to fiat currencies and mushrooming exotic cryptocurrencies are now catching up with wild dodgecoins and other crazy coins inscribed on millions of tweets a day. The art, collectibles and sport NFTs have become an alternative trading sport among crypto fans with over $2b NFTs traded in 2021 — there are clear pockets of irrational exuberance in NFTs and cryptocurrencies in a world inundated with liquidity and low interest rates. Beyond the frenzied trading mania, the underlying technology has demonstrable disruptive application for the enterprise world as much as consumer and retail for the coming decades. A host of new blockchain protocols and applications based on smart contracts driven lending, trading etc. (popularly known as DeFi) have emerged to become a $150b market with real B2B, B2C applications — an area that seems set to continue disrupting finance sector.

I am fascinated by these applications that resemble early Internet days with decades of disruptive growth ahead of them, however, the $2 trillion cryptocurrency market is less appealing to me. As Stonk investor, You would want to know how to value cryptos, if you are not confused between the definition of price and value, based on the hypothesis that value is what you get for the price that you pay. The general logic of discount free cash flows from the Stonk world is not an easily transportable feature to cryptos and neither is the economics concepts of purchasing power parity — crypto pricing at best resembles commodity pricing, with marginal demand or supply dictating its price. It makes sense for the tug of war between the marginal mining cost on the supply side and the loudest voice on twitter on the demand side to dictate price discovery of cryptocurrencies.

There are a few clear uncertainties for cryptocurrencies over the next decade. Regulations in the US and globally are bound to tighten over times because as it is likely a matter of when not if for regulators to enforce AML/ KYC and of course, the tax authorities are constantly updating guidelines on capital gains treatment of crypto assets and mining. The other unknown is the threat to one way mathematical functions — the primary line of defense for blockchain security — from Quantum Computing or other powerful computing power innovations. It is very much possible that blockchain protocols can upgrade themselves to replace digital signatures with quantum cryptography and similar innovations to stay relevant and secure but it is a risk at this point. I am going to skip the debates around energy consumption, majority attack, and double-spending among many other contemporary debates.

Overall, the path to adoption as a store of value for cryptocurrencies has mostly been proven with the exception of wild swings in daily prices but most enthusiasts and evangelists believe and profess that the digital gold status is not far away. However, the currency status could not possibly be achieved without adoption for payments and transactions where the limitation of Bitcoin, for example, is the limited supply that would definitely limit the velocity of transactions and could continue be a hurdle to broader adoption. Conversely, the unlimited supply of other currencies such as Ether, even with annual supply constraints and decreasing supply growth, bear no different risk than posed by unlimited central bank monetary supply. Long term trust is the most key factor behind the adoption of any currency that could only transpire with passage of time.

There are not much choices in the Stonk market for cryptoeconomy companies. Coinbase, the first crypto exchange to be listed, cleared $150b+ in trading volume last year — a tiny fraction of the overall $10+ trillion trading volume in 2020. MicroStrategy market cap is driven by its bitcoin holdings but it is not really a crypto company. In terms of indirect exposures, payment companies such as Square and Paypal have supported cryptocurrencies but it is a very small part of their overall business. Chip makers such as Nvidia and AMD have enabled crypto miners and made some windfall profits in the past but crypto is no more than 10–15% of their business even in the best year. Retail acceptance of crypto is growing and Tesla began accepting Bitcoin but has flip-flopped on its stance a bit while largely remaining supportive — however, there is not many choices there. So far, crypto companies didn’t need much help from the Stonk markets to tap capital but there could be other possible listings to follow after Coinbase direct listing but Stonk investors have limited choices in crypto for now.