Signals #32 – A world of hashes (II)

We’re back with part 2 of the crypto series, “A world of hashes.” Crypto’s been a large part of news and media attention in the past few years. As someone who never looked too deeply into it, it seemed like a world of high valuations fueled by buzzwords. Most of the coverage only touches on surface points like new Bitcoin prices or Ecuador’s president. Yet, crypto is a much more intricate subject with distinct incentives and narratives. We’re here to talk about them.

In part one, we talked about the basics of crypto and answered questions such as

  • How can online money be worth, checks notes, $1.5 trillion?
  • What actually is crypto?
  • Why does crypto exist?

A quick TL;DR of part one is –

The value in crypto comes from speculation. Crypto promises to replace central financial institutions, which is a bounty worth hundreds of trillions. So another way to look at crypto is as a bet on the fulfillment of that promise. Yet, fundamentally, crypto currently functions more as an asset than a medium of exchange. Despite the cryptography features, the fluctuations in price of Bitcoin or Ethereum hurt crypto from fulfilling their promise of a new financial system.

In this issue, we turn to the bull case for crypto. We’re dive into the motivations behind investing in crypto and why so many talented individuals have invested their capital and time.


Before we tackle the hard questions around crypto, it’s time for another story! This time, we’re talking about Dogecoin: the coin that is simply a meme with no fundamental backing. Or rather, the only two attributes behind Dogecoin are that it is a cryptocurrency and that its Shiba Inu mascot is quite cute.

As a novelty, the price of each Dogecoin was meant to only be fractions of a penny; more specifically, Dogecoin was worth only $0.003 in December of 2020. At its all-time high five months later, each Dogecoin was now worth $0.686. A 225x gain. In other words, if you had invested $1,000 into Dogecoin in December, it would be worth over $225,000 at the peak.

Along the way, I bought $200 worth at $0.05 per coin. The next week, prices climbed to $0.15 per coin, and I was quite happy to sell and take my $400 gain. The investment had grown 3x, from $200 to $600. But the prices kept climbing, going from $0.15 and doubling to over $0.30. It seemed like it would never stop.

At this point, I gave in again and bought myself $400 worth of Dogecoin at $0.45 per coin. And for a brief moment, I was happy as Dogecoin quickly topped $.65. But the price of Dogecoin collapsed just as fast, and I sold at roughly $0.30, marking a small $133 loss. And so, the net effect of Dogecoin remained positive for me, if only at a $66 gain.

So, why did people like me buy into Dogecoin?

Price action. To start, let me first sum up my state of mind when I first purchased Dogecoin. I had followed the coin for years, where it languished in near obscurity. Now, all of a sudden, it had grown 10x in a matter of days. To this, there are only two reactions. The more negative of which would be to dismiss Dogecoin as overpriced. After all, no asset goes up 1,000% with the same fundamentals still intact.

The more positive of the reactions, however, is to look at Dogecoin as a gamble. Let’s run some probabilities. At any given time, the price of Dogecoin could go up, down, or sideways. For assumption’s sake, let’s assume that there was a 10% chance of the price of Dogecoin 10x-ing again. With these odds, the expected value of betting on Dogecoin would always be positive. As we can see with my brief adventure in Dogecoin, even with the price of Dogecoin nearly halving, I still made out with a profit.

Price action is somewhat like a self-fulfilling prophecy. When a stock or cryptocurrency has shot sharply up, the sentiment generally turns positive. That positive sentiment then encourages purchases and pushes the price even higher. And the higher price then reinforces the positive sentiment. It’s a perpetual cycle.

And to an extent, that’s exactly what happened with Dogecoin. The prospect of prosperity is sometimes more powerful than prosperity itself.

Further, with each bull run of Bitcoin or Dogecoin, we see new participants that remain within the ecosystem. In particular, Dogecoin interest peaked in May this year, but even today, we see roughly 15x higher interest than interest 6 months ago. On the other hand, traditional assets like gold remain consistent in search interest.

gold_doge_bitcoin.PNG

In assets with such high volatility, we see human psychology as the governing factor. It’s no longer about fundamentals, intrinsic value or even rational thought (as evidenced by diamond hands and hodl). The prices of crypto are governed by a far more base factor: greed.

Is that a suggestion to buy into crypto?

The answer here is a little more complex than a clear-cut yes or no. Despite the foundation laid in part one, it’s still tough to say that you should stay away from crypto. Allow me to present a bull case for crypto, talking about the tailwinds behind crypto and why the future of crypto is quite rosy despite a flawed foundation.

Volatility

To start, let’s talk about volatility. If there’s one thing that crypto is known for, it would be volatility. It’s human nature to gamble, and the chance to make a fortune in the crypto arena will always appeal to people; similar to how I was sucked into investing in Dogecoin. For less sophisticated investors, this attribute of volatility is a sweet poison. The potential returns are lucrative but dangerous. Imagine a world where retirement accounts held cryptocurrencies, similar to holding mutual funds before the ’08 crash or dotcom stocks before ‘00. A crash would be devastating. For better or worse, it seems all but inevitable that crypto will continue to gain widespread adoption. After all, when the rewards and risks are so juxtaposed, it becomes tough for fund managers not to hedge on the off chance of another crypto boom.

Limited Quantity

Back in part one, we mentioned that one of the features crypto proponents pointed to was the fact that there was a limited quantity of certain crypto coins. For example, Bitcoin has a limit of 21 million coins possible for circulation. So once we’ve mined out all 21 million, further mining will no longer yield more Bitcoin. As a result, we’ve seen crypto be a vital replacement for countries like Venezuela, wracked by inflation. There, the fluctuations of price in crypto are actually less volatile than the fiat currency (the Venezuelan bolívar). More vitally, this limited supply means that there only needs to be a consistent level of trust in the future of Bitcoin for prices to stabilize above a certain floor.

So with each bull run and subsequent price correction that Bitcoin survives, more adopters come on board. These adopters then increase the demand and thus the price. And over the long term, with more adopters, the level of trust in Bitcoin increases which in turn improves the long term survivability of Bitcoin. As long as a consistent level of trust is held, Bitcoin valuations should increase due to inflation pressures on fiat currencies like the dollar.

Social Media

Now, let’s talk about the impact of social media on cryptocurrencies. It’s only fitting the digital world of social media and influencers its would greatly amplify a digital currency. No one really talks about the Philippine Peso or the United Arab Emirates Dirham and the fluctuations there. Part of it is because the largest move these currencies make is from being worth 0.21 dollars to 0.23 dollars. The other part is that professional traders dominate the FX (foreign exchange) market.

On the other hand, the crypto market has a disproportionately high number of amateur investors. Combined with influencers like Elon Musk and Mark Cuban, this means that money is continuously flowing into crypto and thus producing skyrocketing crypto prices.

Generational Support

Above all else, the greatest point of support for crypto is that it has taken off like wildfire among the younger generation. As these young investors start to enter the workforce and increase their discretionary spending potential, crypto will likely take a larger share in their investments than traditional asset classes like stocks or bonds. Thus, over a long timeline, crypto prices will likely to rise.

Decentralization – Why everyone is so excited about crypto.

The culmination of the previous four tailwinds is in decentralization, one of the most powerful forces behind crypto.

When the internet was first founded, decentralization was key. Its principle was to give power to its users, each of whom was a node in the overall internet structure. However, over the past few decades, the internet has steadily strayed from that ideal. Today, upwards of 20% of all internet traffic goes through Google or Facebook. The internet is genuinely centralized, with apps like Instagram, Tiktok, and Netflix that command incredible audiences.

Inherently, centralization is neither good nor evil. Centralization has made the average life of an internet user better. Facebook can afford to spend millions on getting a feature just right. Google has brought the world’s knowledge within one search bar. In the process of going from decentralization to centralization, fortunes were made. It’s no wonder that internet companies have become some of the wealthiest companies in the world in just the span of two decades.

But now that we’re in this centralized state, the internet is more akin to a stiff aristocracy than a large free for all. New ventures at social media and other internet staples are often out-competed by incumbents optimized for the local maxima. That leaves the question, where do the smart people that want to focus on internet innovation go?

The answer is the decentralized world of crypto.

In his own words, Vitalik Buterin became involved in the world of crypto to adjust the balance of power between “the big guy” and “the little guy.”

“I think a large part of the consequence is necessarily going to be disempowering some of these centralized players to some extent…. Because ultimately power is a zero sum game. And if you talk about empowering the little guy, as much as you want to couch it in flowery terminology that makes it sound fluffy and good, you are necessarily disempowering the big guy. And personally, I say screw the big guy. They have enough money already.”

Vitalik then went on to co-found Ethereum which, today has a $350 billion market cap. Not bad for changing the power dynamic between the big guy and the little guy.

There are countless more Vitaliks in the world and to them, the decentralized world of crypto is simply more interesting with more chances for wealth than elsewhere.

Ending

And that concludes this issue of A world of hashes. Right now, the global crypto market cap is $2.15 trillion. When I first started writing about crypto around two weeks ago, that market cap was only $1.5 trillion (I probably should have bought some). With so much wealth moving around in the crypto market, we’ll be taking a look at some of the more ambitious projects and trends in crypto for our next issue.