Cyber Assets, Digital Currencies, and Money

It does seem that we are in an era where language has been debased.  Friends on Facebook are not friends in the
way the word traditionally meant.  Grande at Starbucks does not mean
large any more.  It is their second-smallest
serving. 

In 2013 and 2014, the desire for alternatives to fiat, central bank
controlled currencies were called Alt-Coins
.  Now, as interest has
grown, they are often referred to as cryptocurrencies.  However, crypto
and currencies are names that do not have their traditional meaning.  Crypto
refers to secret allegiance to a political creed.  This is an unnecessary obfuscation and gives an aura of a
cult.  Currencies refer to money, and yet rarely are the cryptocurrencies
used to purchase goods or services or retire financial obligations.
  

Economists mean something specific about money.  It is a means
of exchange.  It is a store of value.  It is a unit of
account.   Cryptocurrencies do not provide any of these
functions.  This could, of course,
change in the future, but there is a contradiction at the core.  If
cryptocurrencies are to be a preferred alternative to central bank money, then it makes sense that they are hoarded.  However, the more they are hoarded, the less they are used as a means
of exchange and do not reach that
critical networking mass.  

Some places do accept Bitcoin,
the most popular and largest among the cryptocurrencies. 
But this
seems to be more a novelty and marketing ploy.  A company that accepts the
cryptocurrencies faces exchange rate risk as it was
just paid
in a “foreign currency.” 
This may seem acceptable provided the
crypto-currency is appreciating, but corporate treasury offices, for the most part, do not seek to be profit-centers of the
business.

Given what appears to be the historical link between money and taxes, we
thought that a test for the viability of this cryptocurrencies is if a
sovereign accepts them for payment.
  A small town in Switzerland
(Chiasso), near the Italian border, says
it will accept Bitcoin for taxes but caps it at CHF250, which also makes it a
bit of a novelty. It also begs the question what will the town do with the
Bitcoins, as there is not much that town can buy with them. 

In the US, before the Federal Reserve, the banks in different states
would issue bills that would trade at discounts in other locales.
  It
was as if there were as many different monies as states.  This seemed to be hinder interstate commerce and the development of a national economy. 

Imagine that each state has its own
currency.
  It would be terribly
inefficient.  This was the case in
Europe before the advent of the euro.   A shopkeeper now willing to
accept cryptocurrencies for payment might need a  huge price matrix as
there are over 100 presently  Given the high fixed costs and practical
considerations, perhaps there is a tendency for a natural monopoly of currency
issuers.  

In the polemic zeal and in the face
of surging prices, the inefficiencies and limits on the ability to scale have
been brushed over. 
Consider, for example, that now there may be 300k
Bitcoin transactions a day.  VisaNet, just to pick one of the main credit
card companies, can process  56k transactions messages a second.   The Bitcoins does not need to simply double or triple its
speed to compete with an alternative.  Visa.net  can handle more than
150 mln transactions in a single day, and at a fraction of the cost.

The price to pay for a decentralized payment system is high. 
Consider that the mining (solving extremely difficult mathematical problems and
the confirmation of each transaction requires a great deal of electricity,
which is why the miners (who are also verification services) are increasingly located in areas that have
cheap electricity.  Estimates suggest that
each
Bitcoin transaction uses roughly the same amount of electricity as
a US household may use in a week.   The Bitcoin runs counter to
conservation and concerns about the environment. 

The cost of producing a Bitcoin is a function of the price of computing
power needed for the mining and the validation process. 
  More
computing power is needed to solve the mathematical challenges and this, in turn, requires more
electricity.   One estimate suggests
that the Bitcoin ecosystem was using around
the same amount of electricity as 2.26 mln homes.    Bitcoin
currently accounts for around half of the daily turnover of cryptocurrencies.
  

Many argue that cryptocurrencies are anonymous, but this is not as true
as it is supposed.
  Reports suggest that there are currently people in
jail who used Bitcoins to procure contraband.   The US tax authorities are
also working with a company called Chainanalysis,
which monitors the cryptocurrencies for high frequency and large trading.
  The state has at least two legitimate interests.  Illegal activity, including money laundering
and financing for terrorism and the avoidance of taxes.  Despite the talk
among many participants about how much money they have made, only 802 people
reportedly paid taxes on their Bitcoin profits in 2015, according to press
reports.  

Some proponents assert that the cryptocurrencies are unseizable,
immutable, inflation-resistant, non-correlated to other assets and are a store of value. 
Yet these claims have not been
proven.   They simply have not been around long enough to know if
they are indeed immutable, inflation resistant and non-correlated to other
assets.  The price of many cryptocurrencies appears too volatile to be a
store of value yet.  They are experiencing amazing price appreciation for
sure, but that is not evidence of a store of value.  

Are cryptocurrencies not correlated with other asset prices? 
The ample liquidity and the high levels of capital sitting on corporate balance
sheets and intermediated by the financial system are driving all asset prices higher.  All risk assets are
having a banner year, like the corporate bonds, emerging markets, and high yield bonds.  Consider
that MSCI Frontier Markets (equities) Index is up more than a third this year and its Emerging Markets  benchmark is up nearly 24%.   Isn’t it possible that the
cryptocurrencies are correlated to risk
assets, and when the broad risk appetite changes
and the lower quality assets are marked
down, then the cryptocurrencies also will fall?  

While cryptocurrencies may be disruptive, they have not negated the
economic principle of trade-offs.
  There is no free lunch.  Building a functioning, trustworthy,
decentralized payment system is extremely expensive.  It leaves a large environmental footprint and has
low transaction capacity.   Do most transactions really need to bypass a central third party,
like a bank or credit card company?  

Owing to the anonymous and decentralized
nature of cryptocurrencies
, it is difficult to speak to the market
structure
.  However, two things appear likely.  First, Bitcoin
ownership appears highly concentrated.   Also, many miners also have had to pool their computing power as the math
problems become more difficult.
  Second, the value of the daily
turnover appears to be around 5-10% of the market cap (outstanding dollar value
of all Bitcoins).  It seems that most Bitcoins are not traded or used as
a means of exchange to buy goods or services.  

Still, the stellar appreciation of many of the cryptocurrencies has fostered a sense of FOMO (fear of missing
out). 
The CME is in the process of launching a futures contract on
Bitcoins, which will be among the first ways one can short the Bitcoin in real time if one was so inclined.  Others are
looking for ways to participate.  Some banks are looking at whether they
can accept a client’s cryptocurrencies
like they would other assets.  To be sure the ecosystem is still
evolving.  The underlying problems
with them as a form of currency or a store of value, the non-correlated
characteristic claims, the environment
footprint, and the difficulty in scaling is not addressed by the availability of futures
contract, an ETF, or the like.  

Stocks and bonds are assets.  There are agreed upon models of valuation.  There is an income
stream or earnings stream associated with them.  There is a debate in the
literature whether currencies are an asset class.   Central banks may
issue their own digital currencies. 
These would likely be digital forms of their current currencies and not new
instruments.  

The future of cryptocurrencies may not lie as an alternative to fiat
money issued by sovereigns.
  It may not be in crypto anything. 
It may be a new asset class, a cyber asset that enables
decentralized applications.     These applications are related
to cyber assets as emails are related to
the internet.  It’s still early days
for the development of such assets, and just like when the internet was commercially launched, investors (as
opposed to speculators) need to be careful of being sold vapor-ware by well-meaning zealots as well as some that may
be less well-meaning. 

Disclaimer
    

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