Justifiability of Resource Deployment in Cryptos is Questionable

Every good produced in any economy has some utility. That’s basic economics. A factory produces something that has demand in the market, and this demand relies on utility of that product. In a nutshell, this is what trade and commerce is all about. One factory undertakes some economic activity that is sold in the wider market where buyers are workers in some other factory producing some other good.

Cryptocurrencies don’t seem to fit this textbook definition of trade and commerce. What are they? Are they a store of value just like traditional bank notes, or are they an investment instrument like shares and debentures? 

Arguably, at this point in time, they are nothing but sentiments. Yes, sentiments that are driving their demand globally. Sentiments that hold a belief that any funds parked in this ‘revolutionary’ investment instrument will return profits (read exorbitant profits).

The world has embraced cryptocurrencies unlike any other instrument. From institutional investors to retail ones, cryptos have captured the imagination of all.

This capturing of imagination and this hyper-positive sentiment have led to gigantic involvement of resources, from human capital to revenue expenditure and electric consumption, going into this ‘economic activity’.

Consider these two latest developments. 

Coinbase, a company that allows buying and selling of digital currencies, listed on NASDAQ in April, and this event made it to top headlines globally. Shares of the firm traded at such high price that firm’s market value exceeded that of traditional corporate giants like British Petroleum. Brian Armstrong, cofounder of Coinbase, became one of world’s wealthiest persons in, literally, no time.

In the second development, the S&P Dow Jones Indices catapulted digital currencies to new prominence by launching new cryptocurrency indices. From Bitcoin to Ethereum, these indices will track movements in prices of digital assets to which they have been tied.

Meanwhile, both private firms and governments have deployed resources in mining of digital currencies. This means that electricity, computers, human, land and other resources will go into producing something that has yet to prove its true utility, if any. Is it not true that funds deployed towards production and promotion (Coinbase and S&P’s new indices are part of this) of digital currencies would have gone to some other economic activity, say vaccine production or infrastructure development in the absence of cryptocurrency frenzy?

All this investment comes in a backdrop where companies and governments are reeling from recessionary pressures owing to restrictions on domestic and international trade and commerce due to the COVID-19 pandemic. Governments, from the US to India, have committed to record fiscal deficits to have more public investment and to subsidize wage earners and businesses.

Has sanity gone for a toss? No, the argument is not that digital currencies are just a bubble. In fact, the argument here is not absolute, it’s relative. Had it been a growth period without any disturbance like the pandemic or heightening geopolitical tensions, deployment of such huge resources towards a yet-to-be-proved tech could have been justifiable. After all, revolutionary ideas are the genesis of human growth.

This crypto frenzy has gripped not just one investor segment. Big and popular firms, large institutional investors, prominent hedge funds, and retail investors, all have their money at stake. A few, indeed, are becoming richer. But at this point in time, any profits made on investment in digital currencies come solely from further investment bets. No utility underpins this unique growth saga, it’s ‘sentiments’ alone.

The rally in digital currencies defies traditional textbook theories. May be, it is what proponents say ‘the currency of tomorrow’. But that very claim has a ‘may be’ in the beginning. What’s certain is that from companies to governments to individuals, enormous resources have gone into producing and promoting this product. And the biggest worry is if that ‘may be’ doesn’t hold true in coming days, these resources would go into outright vain.

Institutional investors and big firms may still be able to remain largely unscathed if anything untoward happens to the whole crypto saga. One segment that will find it hard to recover will be retail investors.

Among all other theories in the crypto space, the above is too a theory, something that may never become a reality. But as advisors – sane and pragmatic ones – the onus is upon us to warn the investors of any underlying threat, be it in the digital currency space or in government bond space.