Recently, there has been a great deal of discussion regarding the value proposition of cryptocurrencies (“crypto”) serving as a “Store of Value”. These discussions have been very thought-provoking yet somewhat complex. In what will be a series of blog posts, I intend to break this concept down for new investors, as well as offer my own insights. Keep in mind that this is a relatively new methodology with constantly evolving theories.
The Original Purpose
Before we dive into the notion of “Store of Value,” and other investment theses, it would be helpful to go over the raison d’être of cryptos. The crypto space has become so convoluted and hostile, new participants are likely unaware of the foundational values crypto was born from. In a nutshell, crypto enthusiasts are in search of sound money. Sound money is usually defined as being fungible, scarce, secure, uncensorable, and a few other attributes. But sound money is much more than a set of attributes. It represents an ideal so impactful and world-changing that millions have become completely enthralled with the idea. Unfortunately, none of the major leading world currencies today satisfy all of our requirements for a hypothetical “perfect” money. As a very simple example, fiat currencies lack scarcity due to the central banks’ ability to print money.
The pursuit of improved monetary systems is a several thousand year old endeavor, and cryptocurrencies represent our generation’s bid for success. To understand how we have reached this point, it helps to become familiar with the obstacles that have historically stood in the way. The focal problem waiting to be solved revolved around keeping the system immune from any third party interference. For example, in the 1990s several early attempts at digital money were easily shut down by the U.S. government. Their disapproval is not surprising due to the threat posed by alternative monetary systems. If the world’s money is to truly be secure, however, it must resist every attempt at being obstructed.
Engineers started chipping away at this problem in the 1980s, when they surmised that recently discovered cryptographic techniques (hence the term cryptocurrency) could help them create such a protocol. This turned out to be a very difficult problem to solve, but many computer scientists strived hard to make incremental progress over the years. Finally, in 2008 Satoshi Nakamoto tied it all together and, with a breakthrough of his own, achieved what engineers had been longing for: a censorship-resistant (C-R) protocol upon which sound money could operate.
(Side note: there is a lot of contention in the community regarding if Satoshi’s contribution was the foundational censorship-resistant protocol, or the sound money itself. For now we will assume ‘both,’ but this is a topic for another post)
Censorship-Resistance as a Foundation
But how does a censorship-resistant protocol lead to sound money? What is censorship-resistance, anyways, and why is it so important? Let’s clarify a bit. I’d like to distinguish between the subtleties of 1) the definition of a C-R asset, 2) the technical properties of a C-R asset, 3) decentralization, and 4) the benefits that arise from a C-R asset.
1) Definition: a C-R asset is one that cannot be stopped or confiscated by any authority, including governments. Users are uninhibited from owning or transferring value at their discretion. No entity (including developers or miners) has any undue influence on a user’s assets.
2) The technical properties which make up a C-R asset are typically encoded directly into the protocol. This is where the cryptography, engineering, and game theory all come into play. This is where you typically hear about mining, blockchains, consensus protocols, and so on. All of these technical aspects play some part in the overall goal of creating a C-R asset. How, exactly? The key takeaway here is that whatever technical features we choose, they are unchangeable after the fact. A C-R protocol’s technical features are so well guarded, that not even the developers themselves can alter them after deployment. An example of a parameter could be the block size. Once this number has been chosen, it is effectively permanent, and thus immune to any interference. Choosing the optimal parameters/features for every aspect of the protocol is easier said than done, however. There is a lot of contention on what the optimal parameters/features should be, and these conflicts are ultimately what lead to the myriad of competing cryptos. Even though every team has their own idea of what’s “best,” it goes without saying that most crypto teams are all striving for the same goal. This is the area where the majority of crypto research takes place today.
3) But what actually makes these technical properties unchangeable? Why can’t the code simply be rewritten or edited? The answer is because these technical properties all contribute towards keeping the protocol ‘decentralized.’ Decentralization is in itself an extremely nuanced topic, and one that we will explore more in depth a bit later. For now, however, decentralization protects the set of technical properties (which induced the decentralization in the first place) from being altered without consensus, creating a feedback loop.
With an unchangeable set of technical properties in place, we can then enable a cryptocurrency to operate upon our C-R protocol, where we would typically incorporate our desirable feature set. For example, one usually prefers their assets to be fungible, private, secure, inflation-proof, and a whole host of other features. It’s important to note here that decentralization still isn’t the goal, but rather the means towards achieving our ultimate goal of censorship resistance. One day, someone might invent a protocol that confers censorship-resistance without the ‘decentralization’ requirement. As of today, however, this is the only known method.
4) Finally, what benefits can we realize once we’ve established our C-R asset? The advantages of this technology are outside the scope of this piece, but I will touch upon the main one (which arguably inspired Satoshi to invent Bitcoin). The primary value proposition of a C-R asset is that it cannot be arbitrarily inflated. Because a supply schedule for a coin can be hard coded directly into the protocol (as part of the desirable feature set), it becomes impossible for any entity (such as a government) to print money and inflate the monetary base (which would be a failed attempt at changing unchangeable rules). Given that a seemingly endless amount of world economic problems are caused by governments printing money, we can infer the impact of stripping that power away from them.
To be clear, though, the ethos of crypto isn’t about “taking down the government,” but rather empowering the individual, and helping them protect their wealth from any malicious actor who attempts to interfere. Because it so happens that the number one malefactor tends to be (poorly managed) governments, the immediate use case is protection against these entities (whom, ironically, were designed to protect the people in the first place).
Censorship-resistance is the key property needed to establish a cryptocurrency that can act as sound money. In fact, without this property, most would argue that cryptos would theoretically be worth nothing. By now, it’s not too farfetched to accept that, if it all works as advertised, then this technology is valuable. But valuable in what sense? How much should it be worth? Should it be compared to a company like Google? Is Bitcoin a stock? What’s the difference between all of the different coins? Can they all co-exist, or will it be a winner take all? Where does ‘Store of Value’ come into play? This is where things begin to get a little murky…stay tuned for the next post.
Cyrus Younessi is Director of Research and Trading at Scalar Capital Management, LLC, an investment manager focused on cryptographic and blockchain related assets. Scalar Capital holds or may invest in the assets or asset classes described in this article.