All money is fiat currency. Its value depends upon your faith in the state that backs it. Bitcoin’s value is skyrocketing because it does not depend on faith in a government. Is this a warning flag on the future?
Talk about the impact of digital transformation. The market value of all cryptocurrencies has exceeded $100 Billion. Bitcoin, the original, smashed through a price of $6,300. That’s a 500% gain this year alone. It’s hard to believe that when launched in 2010 it was worth only $0.008 (eight-tenths of a cent). Yet, Jamie Dimon, CEO of J.P. Morgan Chase, calls it a fraud and China has banned it. Meanwhile, celebrities like Paris Hilton, Jamie Foxx and Floyd Mayweather are backing some thing called Initial Coin Offerings or ICOs.
What is going on here? Is this another tulip bulb bubble? There is definitely some speculative energy here driven by FOMO (Fear Of Missing Out). But something deeper is at work: another example of how going digital creates changes in our lives that no one could have envisioned.
Let’s back up a bit. What exactly is a crypto currency? There is a lot of confusion and misinformation around this. One of the clearest explanations I’ve seen was just published by Adam Ludwin. I am going to borrow from him as needed but I encourage you to read his full article.
First key insight: “cryptocurrencies are a new asset class that enable decentralized applications.” The word currency throws most of us off because the term is loaded with all sorts of references that mislead us. Instead think of Bitcoin as a new kind of financial asset. Equities, government bonds, and home mortgages are all asset classes that serve the needs of their constituencies. In this example: corporations; federal, state and local governments and you and me – Joe homeowner, respectively.
The next key term is decentralized. In the other asset classes we described there is a centralized authority as a guarantor of record. We know them as governments or banks, etc. The digital transformation enables something heretofore not possible. This new asset class serves the need of someone who wants to avoid a centralized authority. That is what creates its value.
Who would they be in this constituency? They are someone who wants censorship resistance. They can send Bitcoin to anyone, anywhere they want. The government can’t control the flow of this capital as it can with its own currency. It cannot tax the transaction because there is no central clearinghouse for it to monitor. And, yes, on the dark side it cannot see transactions that it might deem illegal.
Why is this attractive? Our relationship to our institutions is changing. Just like in the realm of privacy where we were assured the government would never spy on its citizens; we are told it would never restrict what we could do with our money. As to privacy, that blew up with Snowden and other revelations. (Who says Big Brother is not watching?) The result: Signal and Telegram are popular to encrypt our communications.
Now the money side, let’s look at China. After 30 years of skyrocketing growth the screws are being applied. Imagine yourself as a successful Chinese entrepreneur. You now must “sell” one percent of your company to the Chinese government and submit to “guidance”. You are encouraged to staff your enterprise with Chinese Communist Party members. Those business leaders who appear too big and independent are arrested. The writing on the wall is there for you to see.
(Of course none of this could happen in a Western Democracy. No, no, of course not but consider Directive 10-289 in fiction. Don’t believe it could happen? How about Executive Order 11615 in reality.)
Time to get your money out of Dodge before it’s not yours anymore. And people do. $3.8 Trillion left China in the last decade. That’s about a third of China’s annual GDP. The authorities respond and China drops the hammer with a set of tough capital outflow controls. Money made in China, stays in China. Now what, you still have a lot of wealth in China. How do you get it out? Before the digital revolution you didn’t have much choice – smuggle out suitcases full of yuan? That’s not going to work for long.
But you have an alternative – Bitcoin and other cryptocurrencies. Now you see why the Chinese have banned it and there is such a rise in value. Take your other assets and convert them to a cryptocurrency and they become invisible to government censorship. This offers a way to circumvent the government and for you to take control. It is demand for this feature that drives up the value.
In these situations, it’s not surprising that a speculative bubble in cryptocurrencies emerged. Sadly, there is certainly some fraud. A number of the ICO’s are almost certainly “pump and dump” or Ponzi schemes, so beware. The key is to not to get swept up in the in the euphoria (or panic, your choice) and stay with the legitimate offerings.
Remember all money is fiat. If a government stumbles – take a look at Venezuela’s Bolivar – the currency drops in value. Confidence in government is at an all time low. Digital technology can give you an alternative. What’s in your wallet?