1. Governmental crackdowns
Governments regularly use surveillance to track illicit behaviour and curb or curtail activities. Our own government in the US regularly looks for cases of racketeering, attempts to crack down on the drug trade, tries to prevent illegal sex trafficking, looks out for insider trading on stocks, tries to stop child pornography and so forth.
Of course, all of these illicit activities take place precisely because there are so many economic interests at stake in providing “social bads” to people who want to consume them. It’s no wonder that the creation of a currency that has total anonymity would gain favour first with people for whom so much money could be gained by improving the ability to transact without governmental oversight.
No event has gotten the U.S. and other governments so involved in the crackdown of monetary flows than the movement of money for terrorist activities post 9/11. Terrorism at scale can only occur when these organizations can move money around to finance people who make bombs, buy guns, train recruits and so forth.
And if you think the U.S. government is going to allow wide-scale movement of money within the United States in which the government can’t identify the sources and uses of capital you’re kidding yourself.
Also recognize the important the monetary policy plays in government leaders try to preside over stable societies, to offer benefits and services to its population and even to finance wars in foreign lands or to protect one’s interests at home. Whatever you think of these governmental activities I can assure you that governments won’t cede monetary control easily.
China has already made moves to massively curtain Bitcoin activities so that should be a clue to what is to come. You think Turkey is going to be eager to allow the movement of capital it can’t track? Russia? Iran? No way.
I know Putin talks about cryptocurrencies but since his geopolitical strategy seems to be destabilization of democratic regimes and alliances it would seem to me that Russia would have a strategy to use cryptocurrencies in a destabilizing way to its advantage. Think for example if the people with whom you’re trading currency can use huge piles of cash to drive up the value of your currency in a short period of time and then use coordinated groups to then drive down prices through trading and misinformation to destabilize people.
Destabilizing untraceable currency markets unpinning our technology ecosystem must be at least as attractive as manipulating our social media advertising and media markets before an election. It certainly should be food for thought. Of course, this won’t trouble your friend who just made eight times on his or her Ethereum coins over the past year. But if you’re thinking critically about the long-term future this should at least be part of your consideration set.
2. Regulation
Many cryptocurrency mega-cheerleaders are radical libertarians that want no governmental control of currency or trade or other forms of regulation. I understand why people are turned off by regulation and of course undue regulation can stifle business.
But for the same reason, we have SEC oversight on trading public stocks, we need oversight or nefarious actors will manipulate the system. There is a fascinating story in The Ascent of Money by Niall Ferguson in which Ferguson describes how the modern corporation emerged. About 400 years ago merchants from the Netherlands were sending ships to Asia in search of spices widely desired in Europe. More than 50 per cent of all ships that sailed wouldn’t return so groups of people banded together and formed the Dutch East India Company to share the risks and the rewards of their conquests.
This is amongst the first examples of the modern corporation. The company brought back spices and reaped profits that went back into building more ships and sailing back to Asia. The company didn’t distribute the profits to individual shareholders who instead were issued the modern form of a share certificate for their ownership. Because they couldn’t monetize this ownership they started selling shares of their ownership to others, thus perhaps the first stock market and transaction dating back to the early 1600s.
No sooner did people start selling shares in these companies than market speculators started spreading false stories about merchant ships being sunk or about large spice conquests to drive up or down the price of these stocks through false information and manipulation. So oversight became necessary to establish trust in the value of these assets.
This is where I see cryptocurrencies today. I speak to colleagues who participate in trading crypto who tell me that there are coordinate rings on encrypted instant messaging platforms like Telegram to have coordinated buying and selling of new currencies. This sounds to me like fraud, pure and simple.
And I know that ICOs (initial coin offerings) are all the rage amongst startup and some are raising for entirely good and valuable reasons. On the other hand, with no oversight of the ICO process and with the possibility of Dutch East India Company style manipulation by either companies or individual buyers of these currencies, I worry about the integrity of the market unless there is oversight.
What I can tell you from my vantage point: I see companies that have been trying to raise professional money for years and have struggled suddenly gearing up for ICOs because they know there is so much demand from them — precisely because so many people speculatively made money on Bitcoin and Ethereum.
Ask yourself this — how did it go when a bunch of Internet companies went public in 1998–1999 with limited revenues or oversight? Why would pouring hundreds of millions into even earlier stage startups with even less or no oversight be a good idea?
Regulation will come. It needs to come fast.
3. Trust
Between 1998–2000 the world became enamoured with the “new economy” and Internet companies that were going public on NASDAQ in the United States. Not to be outdone, the UK promoted the AIM market, Germany the Neuer Markt and France the Nouveau Marché all with the aim of taking Internet companies public.
Many of these countries hadn’t been big stock speculators but the gains of the U.S. Internet companies were too tempting. So ordinary citizens poured hard-earned money into owning any company that could claim to be an Internet company and their valuations skyrocketed with no underlying rationale.
Unsurprisingly a whole generation of first-time stock traders became jaded about not just Internet stocks but the entire public stock market system as many people lost a large portion of their net worth. Trust doesn’t come back easily, which is why the role of regulation is so important.
In order for people to trust cryptocurrencies, in the long run, they will need to believe they are transparent, fair, stable, safe and that somebody is watching over them to provide an imprimatur of trust.
Without trust no currency has value.
C. The arguments that should make you suspicious
1. Cryptocurrencies offer a better mechanism for companies (or funds) to raise money
ICOs are not a better way to raise capital than traditional routes, they are a different way and can work together with other forms of fundraising including traditional crowd-funding and/or product pre-release funding like Kickstarter and Indiegogo.
I welcome the role that ICOs may play in some technology companies where a legitimate purpose exists for a “coin” or some form of token to exchange value between market participants. But I also believe that the backlash that will happen against ICO fraud will likely burn some people to future participation until and unless there are some frameworks for oversight of the market.
2. Cryptocurrencies will eradicate VCs
I know that people hate having to deal with people to raise money and the idea of being able to turn to an anonymous crowd and if they value what you do they will provide you money is appealing.
But putting large sums of money in the hands of first time or even experienced entrepreneurs with absolutely no oversight is a recipe for disaster. The fundamental role a VC plays is the role of board members and their job is to provide oversight (and even auditing) of the company for the purposes of protecting shareholders. This is the same board role that emerged from the Dutch East India Company to provide more transparency to investors.
So however populist the idea of cutting out people from the process may be, I strongly doubt it will replace the role of the existing venture capital ecosystem. In many ways, it could even become a new tool for earlier shareholder liquidity including the exit of some VC money. We’ll have to see how it all plays out.
3. Cryptocurrencies will drive a reorganization of societies into more libertarian structures
The most vociferous promoters of cryptocurrency include a group of people who have a total disdain for governments and financial markets and imagine a world in which technologists cut out all power structures and create a truly flat world.
I understand the idealistic tendencies in the same way I understand the idealistic tendencies of those who long for socialism or communism. It seems like the world would be a more fair place if it weren’t for leaders who run countries and organizations and benefit from these activities.
The problem without having governmental systems, however imperfect, is that the opposite is anarchy. And through every idealistic movement to bring equality to all ends in newer forms of power structures and usually wants that are less benign as they seek to hold on to power.
I know it seems strange to veer into this topic in my post but the more time you spend listening to cryptocurrency promoters the more you realize that there really a small undercurrent who have an objective of subverting existing order. And no prizes for guessing who would benefit if this order was disrupted.
D. So where do I personally net out?
As with many things in life, I’m super optimistic that out of this current wave of innovation around distributed ledgers (blockchains) and cryptocurrencies (like Bitcoin and Ethereum) will come some great leaps forward of innovation that will benefit the world.
At the same time, I remain skeptical about the motives of many of today’s market participants and extremely skeptical about the massive run-up in the valuation of many of today’s cryptocurrencies. The arguments “for” of many market participants ring as hollow as they did in 2005 when they told me I was an idiot for believing that Florida real estate prices would drop or in the dotcom 1.0 boom where many companies had deeply inflated values.
As with every situation, I always try to think through, “What are the motives of those who are telling me A or B?” and “what is the intrinsic value of a given asset and what will determine its future value?”
Appendix
If you really want to have an informed opinion money and currency then it would help to read a historical primer on the topic and I have two great recommendations. The first is “The History of Money” by Jack Weatherford (who also wrote one of my favourite books on world order & world trade, “Ghengis Khan and the Making of the Modern World”). And another great book on the role currencies play in the creation of governments and in war and peace read Niall Ferguson’s, “The Ascent of Money.” It’s pretty tough to pretend to have an opinion on cryptocurrency without first understanding the origins and evolution of money throughout the last 2,500 years.
p.s. Because this is a single sitting, top-of-mind post it shouldn’t be thought of as a research paper, it may be incomplete and I’m not trying to be the final authority on the topic. I think of this as more of a 101 primer for those who want to develop their own framework for thinking about the topic.
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