In the first of our series on the Cryptoverse for Newbies, we noted the challenges to nailing down more nuanced terminology and the dangers of utilizing equivalence where one does not exist. We noted the example, “cryptocurrency” and “digital currency” which are decidedly not the same thing.
Multiply this many times over, then add in rapidly and evolving crypto and other interacting ecosystems, and it becomes clear that there are no short-cuts to understanding; either to grasping the mechanics, nature, potential, or danger of cryptocurrencies. Elsewhere we have noted the soundness of the fundamental idea, but without an equally sound and exhaustive understanding of the ecosystem, investors are going to be lost at sea. Continuing that metaphor, our need is for a thorough understanding of weather systems; the fundamentals that separate good sailing prospects from the bad.
To facilitate this journey of understanding we previously set out six questions and answered two of them; defining then listing the characteristics of a cryptocurrency. We now move on to tackling the remaining four:
- Where does “value” come from and what is it?
- What opportunities do cryptocurrencies hold?
- What are the risks?
- What are some potential long-term outcome trajectories?
Inherent Value in Fiat Currencies
In an era where printing presses are running overtime, it might surprise the reader that fiat currencies not only possess inherent value but that this value is nothing less than astronomical (which explains why the global banking sector is so large). This value is not in the paper per se, but the payments system infrastructure that surrounds it. Most of the time it is unnoticed and innocuous, but, for example, use some kind of payment-friend app to send money out of the country and find the recipient only receives around 80% of the total; losing a considerable slice to exchange rate and transactions fees.
Alternatively, you can send fiat abroad via your bank, but there are still fees and even bigger costs in time. If you are a domestic business you pay a fee every time you receive a payment through a card, smartphone pay, or cash. In Economic terms, we cite these as examples of seigniorage (though not in the traditional sense) and arbitrage.
At this juncture, two things become very clear. Firstly, there is a lot of money to be made in money. Secondly, if a way can be found to replicate what money does but without fiat and the fiat infrastructure, the result would be a win-win situation. Less drag would be placed on commercial efficiencies benefiting the global economy as a whole. Best of all, the most disadvantaged under the current system would benefit the most.
Global GDP could grow at several percentage points higher, almost in perpetuity. Over a generation, this would make a considerable difference both by opening up opportunities to new forms of commerce in mature economies and in enabling the developing world to participate more fully in global commerce, benefiting everyone.
Cryptocurrency as the Next Step in Finance
This, of course, is the potential of cryptocurrencies as a best-case scenario. It is not, however, the only one. Previous articles have made references to digital fiat and other tokens and to the centralized blockchain, all of which will facilitate commercial and Central Bank fight-back. While there is a lot we could explore at this juncture, only four critical points need to be made:
- Cryptocurrencies are emerging at the center of this highly volatile and very high-stakes game.
- They offer vast potential.
- The pitfalls are both many and growing in number.
- Despite this, fundamental rules are governing both their evolution and that of alternatives.
What these points do is obviate risk by defining parameters. One additional point now needs to be made; the market is immature and unproven. As with any infant, the dangers are those of emotional volatility, failure of discipline, irrationality, and lack of moral compass.
Those who can exhaustively describe the mechanics and characteristics involved in this infancy are best equipped to engage in the more lucrative, but risky, cryptocurrency investment opportunities. For others, these are pathways to explore and learn, and so build foundations from which take advantage of future opportunities. Such ambitions may sound overwhelming, but in the end, everything distills into supply and demand, and the factors that shape them.
This all having been said, there is one defining characteristic totally outside market forces that can change everything; government legislation.
The Three Trajectories of Crypto Adoption
In conclusion, we map out some potential longer-term cryptocurrency trajectories:
- Adaptation of centralized blockchain technologies by existing commercial institutions to make existing transactional/payments infrastructures more secure, more quickly adaptive to changing legal requirements, cheaper to operate, and capable of ubiquitous, but highly regulated, instant transactions. Though to some extent preserving the status quo oligopoly, would improve competition, speed transactions, cut costs, contribute to economic growth, and enfranchise some of those excluded from the current system. These changes would positively impact opportunities for cryptocurrencies, if only on account that the system as a whole is embracing change. This may allow crypto turnovers to reach hundreds of billions of dollars, but would still appear small change against the trillions handled by the traditional vehicles of transactional commerce.
- A second scenario would witness a more subtle and long-term challenge to the existing global banking systems by mega-corporations such as Amazon, Apple, Facebook, Google, as equally their Chinese equivalents. With resources beyond what the majority of national governments enjoy, and markets on a scale of almost self-sustaining ecosystems, the logistics of implementation would be straightforward and a degree of success guaranteed. The most likely evolution would be the creation of a parallel payments system or commercial infrastructure, whose advantages would be realized and developed over time, creating a shift away from fiat and in their favor. As with (1) above, this would both increase competition, make for better services all around, and by the very fact of change open the door to more radical innovations and alternatives, including DeFi and cryptocurrencies.
- A third scenario would be a structural leap away from traditional commerce brought about by a number of factors coalescing, including growing disillusionment with traditional banks (as the real cost of services and borrowing becomes increasingly outrageous), awareness of vested interest entrenchment, exasperation at the deliberately engineered reduction in the purchasing power of domestic fiat, disillusionment at the government use of macroeconomic policy to shift the debt burden to savers, continued rise in wealth inequality, and perhaps the trigger to it all, radical shifts in global values reflected in the now dominance of Millennials, joined by the rapid ascendancy of Gen. Z.
All three scenarios are actually being played out. The fundamental factors driving them have been increasingly in play since 2008, but a combination of COVID-19, supply chain weaknesses, the move away from globalization to new geopolitical realities, together with the rise of bilateralism, have all provided a coalescence and an impetus hard to exaggerate.
The good news for unseasoned investors is that this is a learning time for everyone, which, in part, levels the playing field. The successful investment will largely depend on how much FOMO can be set aside in favor of developing critical strategies and tactics. It is this that separates the investor from the fly-by-night speculator. In parallel, it also separates the sound opportunity from the modern-day Ponzi scheme.
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