16.1: Cryptocurrencies and NFTs

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Cryptocurrencies

Bitcoin and other cryptocurrencies are not investments. They are pure speculations. You must “buy low, sell high.” In this manner, they are similar to gold and the other precious metals. In truth, cryptocurrencies are even worse than gold and other precious metals. At least gold and other precious metals have some practical applications in engineering and manufacturing. There is no practical application or use other than for pure speculation on the part of the general public and for creating systems for criminals to bypass the established financial systems. Let’s recall our definition of an investment from our very first chapter:

An investment is any vehicle into which resources can be placed with the expectation that it will generate positive income, or that its value will be preserved or increased, or both.

Cryptocurrencies do not generate positive income. Of course, currently, there is the expectation that their value will increase. However, that is only because of the Greater Fool theory. Somewhere there is a Greater Fool than I am who will buy my cryptocurrency for more than I paid for it. This is nothing new. This is the reasoning behind all bubbles and manias of the past. While the bubble is inflating, you will hear, “It’s different this time,” and “The old ways of valuing assets are gone,” and, “It’s a new era.” Many individuals become fabulously wealthy; most others will lose. Some will lose everything.

On the bright side, the technology behind cryptocurrencies, blockchain, is valuable and will survive. Eventually, legitimate currencies backed up the economies of governments will utilize this technology to create digital currencies that are regulated and stable and resistant to the criminal elements who utilize cryptocurrencies to bypass the established anti-money laundering mechanisms.

Yes, yes. I can already hear some of you yelling. “Aw, c’mon, Paiano. Whatcha’ got against Bitcoin and the other cryptocurrencies? You’re just old, that’s all! This is the future! We’re all gonna’ get rich, rich, rich!”

Let’s reiterate. You can’t invest in a cryptocurrency; you can only speculate. The value is worth only what others believe it is worth. Cryptocurrencies do not pay interest, dividends, rent, etc. In other words, there is no cash flow. And most importantly, there is nothing backing the currency.

Now it’s your turn to scream, “But what about the ‘fiat’ currencies, huh? Aren’t they the same? Dollars and Euros and yen or other fiat currencies are only worth something because we believe they are!” Not so fast.

You will hear people say that our dollars and other fiat currencies are not backed by gold and are therefore worthless. Poppycock! (By the way, what is gold worth? As we have seen, gold, as an investment, is also a speculation except for jewelry and the few industrial uses that it has.) Our dollars are backed by our economy, the Great American Economic Machine. Our dollars are backed by what the United States can produce and consume, our Gross Domestic Product. Walk into any grocery store and look around and then tell me that our dollars are worthless. Ha! And if you still believe that our dollars are worthless, I will give you your own special bag. You can run to your bank, take out all your worthless dollars, put them in the special bag, and give the special bag to me. Problem solved! You won’t have any worthless dollars holding you back anymore.

The job of the Federal Reserve Board is to make sure that there are enough dollars in circulation to match the production of our economy with the consumption of our economy. Too many dollars and you get inflation, not a desirable outcome. Too few dollars and our economic output is stifled and opportunities for growth of our wealth are lost, also not a desirable outcome. It is not an easy job. Being humans, the Fed has made mistakes in the past, sometimes monumental ones, and we can expect them to make mistakes in the future. However, most of the time, they have actually been able to achieve this delicate balancing act of full employment of economic resources and keeping inflation under control fairly well. I love it when you hear people scream, “End the Fed!” Oh, yeah, as if you could do a better job?!

So now how does this relate to cryptocurrency and how do you explain the success of Bitcoin? Well, there is absolutely nothing to stop other individuals or groups from starting their own cryptocurrencies. Indeed, isn’t this what has happened? All you need is a computer algorithm and a celebrity to hawk your new coin. There are approximately 23,000 cryptocurrencies at the time of this writing. Just a few years ago, there were over 2,000. (My favorite is Jesus Coin. Don’t believe me? Look it up!) It’s tulip bulb mania all over again! Eventually, the bottom will fall out and some people will get very rich and many others will lose a whole lot o’ money.

However, as Stephen Colbert so astutely observed, “It’s good for nerds.” Most likely, a few of the larger currencies will survive and eventually start to behave like gold, which we have seen, has barely kept us with inflation. Until then, if you do indulge in speculation of cryptocurrencies, prepare yourselves for some serious “volatility!”

The Scarcity Argument, Revisited

Many cryptocurrencies enthusiasts will point to the provision of Bitcoin and other cryptocurrencies that limits their production. There is a finite number of Bitcoins and once they are all produced, no more can be created. In contrast, the central bankers can create an infinite number of the dreaded “fiat” currencies, thereby making them worthless. Although there are times when central banks have issued too many dollars or Euros or yen, etc., it makes absolutely no sense to tie the ability of your economy to produce and consume goods and services to a set number of digital assets governed by a computer algorithm, just as it makes no sense to tie your economy to a certain amount of a precious metal such as gold.

The scarcity argument is an echo of the scarcity argument of gold used by the gold bugs. Again, it falls flat on its face. Just because something is scarce doesn’t mean that it is valuable, except for the die-hard fans whose belief in the scarce asset class will never be shaken. “It’s gold for nerds.”

Cryptocurrencies, Criminals, and Scams

Do we even have to mention the criminal activity and scams that have been accompanying cryptocurrencies? Many cryptocurrency advocates declare, “We don’t want the government involved in our business! That’s why we want cryptocurrencies.” Unfortunately for them, for a modern, technologically based civilization to survive, the proper duly appointed authorities will always have the need to be able to track criminal elements much in the same manner that can be done with established anti-money laundering techniques. If anyone really wants to escape the authorities, we suggest they purchase an island somewhere far from civilization and establish their own laws and institutions. We wish them luck.

Currently, there is no regulation in the cryptocurrency markets. Hence, we would expect there to be plenty of scams and, of course, we have been proven correct. They have been plentiful. The owners of a Turkish cryptocurrency exchange raided their exchange to the tune of US$2 billion dollars. A cryptocurrency tied to the popular Netflix series Squid Game turned out to be a scam. Again, eventually, authorized central banks supported by the production and consumption of national and regional economies will create well-regulated cryptocurrencies. Until then, you are at the mercy of criminals.

Non-Fungible Tokens (NFTs)

This is how we can be sure that we are in a bubble/mania with regard to digital assets. Individuals are now paying small, medium-sized, and enormous sums of money for Non-Fungible Tokens (NFTs). Someone paid $69 million dollars for a collage of digital artwork that is freely available to anyone on the Internet. However, that special someone can claim that the NFT is theirs, even though anyone can download the graphic from the Internet. That special someone is also quoted as saying that they thought the price was a bargain. Mark Twain is quoted as saying that, “History never repeats itself but it rhymes.” During the height of the dot-com bubble in late 1999, Excite@Home bought the online greeting card company Blue Mountain Arts for over $700 million dollars. Two years later, Excite@Home sold Blue Mountain Arts to the American Greetings card company for $35 million. Excite@Home then promptly declared bankruptcy the next year. Also during the dot-com mania of the late 1990’s, someone paid $10 million dollars for the website year2000.com. What do you think it is worth today? How much do you think that $69 million dollar NFT will be worth twenty years from now?

Of course, for those of you who are artistically inclined, by all means, bundle together some of your artwork and start hawking it as NFTs. While the music is playing, why not dance? We wish you much success. But don’t spend the money yet, okay?