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Understanding The Cryptocurrency Boom

A ground-level assessment
Friday, June 23, 2017, 9:26 PM

I recently came across a December 1996 San Jose Mercury News article on tech pioneers’ attempts to carry the pre-browser Internet’s bulletin board community vibe over to the new-fangled World Wide Web.

In effect, the article is talking about social media a decade before MySpace and Facebook and 15 years before the maturation of social media.

(Apple was $25 per share in December 1996. Adjusted for splits, that’s about the cost of a cup of coffee.)

So what’s the point of digging up this ancient tech history?

  1. Technology changes in ways that are difficult to predict, even to visionaries who understand present-day technologies.
  2. The sources of great future fortunes are only visible in a rearview mirror.

Many of the tech and biotech companies listed in the financial pages of December 1996 no longer exist. Their industries changed, and they vanished or were bought up, often for pennies on the dollar of their heyday valuations.

Which brings us to cryptocurrencies, which entered the world with bitcoin in early 2009.

Now there are hundreds of cryptocurrencies, and a speculative boom has pushed bitcoin from around $600 a year ago to $2600 and Ethereum, another leading cryptocurrency, from around $10 last year to $370.

Where are cryptocurrencies in the evolution from new technology to speculative boom to maturation? Judging by valuation leaps from $10 to $370, the technology is clearly in the speculative boom phase.

If recent tech history is any guide, speculative boom phases are often poor guides to future valuations and the maturation trajectory of a new sector. 

Anyone remember “push” technologies circa 1997? This was the hottest thing going, and valuations of early companies went ballistic.  Then the fad passed and some new innovation became The Next Big Thing.

All of which is to say: nobody can predict the future course of cryptocurrencies, other than to say that speculative booms eventually end and technologies mature into forms that solve real business problems in uniquely cheap and robust ways no other technology can match.

So while we can’t predict the future forms of cryptocurrencies that will dominate the mature marketplace, we can predict that markets will sort the wheat from the chaff by a winnowing the entries down to those that solve real business problems (i.e. address scarcities) in ways that are cheap and robust and that cannot be solved by other technologies.

The 'Anything Goes' Speculative Boom

Technologies with potentially mass applications often spark speculative booms. The advent of radio generated a speculative boom just as heady as any recent tech frenzy.

Many people decry the current speculative frenzy in cryptocurrencies, and others warn the whole thing is a Ponzi scheme, a fad, and a bubble in which the gullible sheep are being led to slaughter.

Meanwhile, tribalism is running hot in the cryptocurrencies space, with promoters and detractors of the various cryptocurrencies doing battle in online forums: bitcoin is doomed by FUD (fear, uncertainty and doubt) about its warring camps, or it’s the gold standard; Ethereum is either fundamentally flawed or the platform destined to dominate, and so on.

The technological issues are thorny and obtuse to non-programmers, and the eventual utility of the many cryptocurrencies is still an open question/in development.

It’s difficult for non-experts to sort out all these claims. What’s steak and what’s sizzle?  We can’t be sure a new entrant is actually a blockchain or if its promoters are using blockchain as the selling buzzword.

Even more confusing are the debates over decentralization. One of the key advances of the bitcoin blockchain technology is its decentralized mode of operation: the blockchain is distributed on servers all over the planet, and those paying for the electricity to run those servers are paid for this service with bitcoin that is “mined” by the process of maintaining the blockchain.  No central committee organizes this process.

Critics have noted that the mining of bitcoin is now dominated by large companies in China, who act as an informal “central committee” in that they can block any changes to the protocols governing the blockchain.

Others claim that competing cryptocurrencies such as Ethereum are centrally managed, despite defenders’ claims to the contrary.

Meanwhile, fortunes are being made as speculators jump from one cryptocurrency to the next as ICOs (initial coin offerings) proliferate. Since the new coins must typically be purchased with existing cryptocurrencies, this demand has been one driver of soaring prices for Ethereum.

As if all this wasn’t confusing enough, the many differences between various cryptocurrencies are difficult to understand and assess.

While bitcoin was designed to be a currency, and nothing but a currency, other cryptocurrencies such as Ethereum are not just currencies, they are platforms for other uses of blockchain technologies, for example, the much-touted smart contracts.  This potential for applications beyond currencies is the reason why the big corporations have formed the Enterprise Ethereum Alliance (https://entethalliance.org/).

Despite the impressive credentials of the Alliance, real-world applications that are available to ordinary consumers and small enterprises using these blockchain technologies are still in development: there’s lots of sizzle but no steak yet.

Who Will The Winner(s) Be?

How can non-experts sort out what sizzle will fizzle and what sizzle will become dominant?  The short answer is: we can’t. An experienced programmer who has actually worked on the bitcoin blockchain, Ethereum and Dash (to name three leading cryptocurrencies) would be well-placed to explain the trade-offs in each (and yes, there are always trade-offs), but precious few such qualified folks are available for unbiased commentary as tribalism has snared many developers into biases that are not always advertised upfront.

So what’s a non-expert to make of this swirl of speculation, skepticism, tribalism, confusing technological claims and counterclaims and the unavoidable uncertainties of the exhilarating but dangerously speculative boom phase?

There is no way to predict the course of specific cryptocurrencies, or the potential emergence of a new cryptocurrency that leaves all the existing versions in the dust, or governments’ future actions to endorse or criminalize cryptocurrencies.  But what we can do -- now, in the present -- is analyze present-day cryptocurrencies through the filters of scarcity and utility.

In Part 2: The Value Drivers Of Cryptocurrency, we analyze the necessary success requirements a cryptocurrency will need to excel on in order to become adopted at a mass, mainstream level. Once this happens (which increasingly looks like a matter of "when" not "if"), the resultant price increase of the winning coin(s) will highly likely be geometric and meteoric.

Sadly, the most probable catalyst for this will be a collapse of the current global fiat currency regime -- something that increasingly looks more and more inevitable. This will destroy a staggering amount of the (paper) wealth currently held by today's households. Which makes developing a fully-informed understanding of the cryptocurrency landscape now -- today -- an extremely important requirement for any prudent investor.

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59 Comments

Mohammed Mast's picture
Mohammed Mast
Status: Silver Member (Offline)
Joined: May 17 2017
Posts: 178
Patience

mrees I greatly admire your patience. After 6 years of explanations and arguments about cryptocurrencies I am completely drained of that commodity. I only recently started posting here , after almost 10 years of lurking here (not joined because of the fear and trepidation) because I saw some of your well researched posts on cryptos. Unfortunately there are greener fields elsewhere for positive discussions. 

One would have thought this site would be an excellent place to take cryptos to the next level, but to be bogged down in endless circular arguments is draining and counter productive. Thank you for the light you shine

 

Mohammed Mast's picture
Mohammed Mast
Status: Silver Member (Offline)
Joined: May 17 2017
Posts: 178
BTW

For those who might be interested in an opportunity to obtain a new token I recommend TEZOS. You can get 6000 of them for 1 BTC.  For today and at least part of tomorrow you get 5000 "tezzies" plus a 1000 bonus . The bonus is prorated and will drop off till the end in approx. 2 weeks. All the best

jerryr's picture
jerryr
Status: Silver Member (Offline)
Joined: Oct 31 2008
Posts: 157
Transactional utility vs. speculative vehicle?

Does anybody have any information about the velocity of bitcoin? How many of the coins are primarily held in accounts being used mainly for transactions, as opposed to accounts by people who just buy the coins from exchanges and hold them, eventually to be sold back in hopes of making a profit?

If the demand is mainly being driven by speculation, then there could be a tulip-style collapse of value at any time. Or, just as likely, this bubble will burst at the next financial crisis, along with all the other bubbles.

But if a significant and increasing volume of coins are being actively used for convenience purposes, or because of the security and low transaction costs, then maybe CHS is right that this boom could have legs.

Mohammed Mast's picture
Mohammed Mast
Status: Silver Member (Offline)
Joined: May 17 2017
Posts: 178
BTC

That is a great question. in the early days of BTC they were not worth much in relation to fiat currency. They were a geek novelty. The first known purchase was 2 pizzas for 10,000 btc. I have sold items for BTC and there are places where goods and services are provided for BTC.

I believe there are many people who were early adopters who have large amounts of coins and are holding them as the price rises, however I believe they are also using those coins for exchange of goods and services. I don'tthinkit can be quantified at this time since there is a certain level of anonymity. In the old days there was a site called Silk Road  which operated on the "dark web" which catered to anyone and everything. It accounted for a large amount of commerce.

There are large and small online retailers that now accept BTC. I do not know where to find those stats but you could probably Google it. I think it is important to remember that BTC and all cryptocurrencies are in their infancy, and as such they will pass through many phases of development. There is certainly little doubt that there is a significant level of speculation right now but it is a store of value, it does have utility, and once the scaling issue is resolved it will be one of if not the best money transmitters available. To wit Western Union is exploring using it.

One of the largest spikes in its value occurred when the banks of Cyprus confiscated peoples savings. Also when the Greek crisis happened(still happening) there was another spike. The Chinese are using it to move money out of China due to currency controls. So I would say comparing it to tulips is somewhat inappropriate. the following link might prove useful.

https://www.forbes.com/sites/johnrampton/2014/07/02/how-bitcoin-is-chang...

 

 

rhare's picture
rhare
Status: Diamond Member (Offline)
Joined: Mar 30 2009
Posts: 1326
All method of payments have similar costs
davefairtex wrote:

Lastly, a digital currency has the promise of utterly eliminating the banks skim from payment systems.  Because VISA is a quasi-monopoly, merchants end up paying 2-3% fees just to get their money from the VISA payment system.  With a bitcoin-funded electronic-cash card (at least in the future, anyway) that could be a nickel per transaction, flat rate.

A minor quibble, people complain about that 3% or so that merchants pay, but it's only because they don't really think about costs associated with all payment methods.  Cash, Check, Card, and I suspect crypto-currencies all have similar costs.  If your a merchant and you do a thorough analysis you'll find all payment methods are pretty comparable.

You have the fraud costs, which will run you a percent or so depending on your business.  You have the infrastructure costs to process a transaction, etc.  Cash has costs as well, security, time to make deposits.  How much is the cost of one armed robbery where a person gets killed because your a mostly cash based business?  That 2-3% may start to look pretty reasonable.

Another way to look at it,  you pay 3% to get your money from someone who can not afford to buy what your selling, but can put it on credit,  you as a merchant are not assuming any of that credit default risk which I'm guessing is going to be far higher than 3% when SHTF.

 

davefairtex's picture
davefairtex
Status: Diamond Member (Offline)
Joined: Sep 3 2008
Posts: 5459
fraud costs in payments

The fraud costs are far from identical.  Pin-based debit had by far the least fraud, but the card companies worked very hard to keep their revenue streams up - being a 2-company monopoly helped considerably.  They wanted that percentage rather than a fixed fee.  Gas stations were grandfathered in at ... I think it was 20 cents, but everyone else had to give them that 1%.  A check was cheapest for a merchant, if they could persuade the consumer to enroll in a check guarantee program.  Checks cost about a dime.  Yay checks!  Grocery stores loved checks - from repeat customers who had gone through the credit check process.

Wal-mart and Costco found the interchange fees to be so onerous (and they were such large players) that they negotiated a special deal with the card processors - they made their own card, and handled the backend themselves.  I think they got their costs down to 1%.

Merchants are also still liable for chargebacks.  They don't just get to keep the cash.  The 2-3% interchange doesn't make them immune to losses.

My strong sense, from my relatively short time in the business, is that there is plenty of "excess profit" in the transactions processing duopoly.  I've noticed that the "free marketeers" (who assume prices always reflect market realities) sometimes don't factor in the ability of a monopoly player to impose cartel pricing structures on everyone else.  Monopoly keeps its power by granting goodies to the people that go along, either in government, or in industry.

At one point I recall asking a merchant if he found cash to be a costly way of being paid.  He just laughed at me.  "Hit me up with some more of that 'costly cash'" he said.

Here's a decent up-to-date report on how card fraud has changed over the years.   CNP fraud (i.e. Internet fraud) is by far the largest segment.

One stat: in the UK, Credit card fraud losses were 13 bp, debit 4bp, and ATM (debit+pin) 2bp.

http://www.paymentscardsandmobile.com/wp-content/uploads/2015/03/PCM_Alaric_Fraud-Report_2015.pdf

rhare's picture
rhare
Status: Diamond Member (Offline)
Joined: Mar 30 2009
Posts: 1326
I guess it all depends on your definition of "excessive"
davefairtext wrote:

 The fraud costs are far from identical.  Pin-based debit had by far the least fraud,

While most are pin based, there are also other debit card issues (source)

Fraud against bank deposit accounts cost the industry $1.910 billion in losses in 2014. Debit card fraud accounted for 66 percent of 2014 losses.

davefairtex wrote:

A check was cheapest for a merchant, if they could persuade the consumer to enroll in a check guarantee program.  Checks cost about a dime.  Yay checks!  Grocery stores loved checks - from repeat customers who had gone through the credit check process.

Yes, checks were the cheapest, but not by a huge margin.  The only costs a dime is wrong.  Handling of paper checks and check fraud gives you around 1% loss if you used a good check verification service and actually followed the procedures and followed up with a good collection agency. (at least back in circa 2005).

Consumers did not sign up for check guarantee,  that was offered to merchants, however, generally only the smaller merchants purchased guarantee services because larger merchants like the grocery stores understood the percentages.  Guarantee for a percent for the sale (more than the loss rate since guarantee companies assumed the risk and did the work) gave smaller merchants a guaranteed loss rate.  It why if your big enough and have good actuarial data, you will self insure since you eliminate the middle man.

davefairtex wrote:

My strong sense, from my relatively short time in the business, is that there is plenty of "excess profit" in the transactions processing duopoly. 

While the 2 large card associations (VISA, MC) do have some monopolistic power, they were always in competition against other cards Discover, AMEX, Citi, etc and other payment methods cash, check, debit and large players like Walmart, Applepay, Android.  No one method can stray too far from the average cost or you get pretty substantial push back, particularly from larger merchants who just won't accept those higher payment costs.  Your example of Walmart is a good example, but for Walmart a small savings over their volume can make a very large difference.  But why do you think it took until recently for the to even look at it?  It's because  they have already optimized many of their other costs, for a small merchant, the transaction cost savings it pretty small compared to other optimizations they could make in their businesses.

Also, you paint it as if the card associations are all that are involved.  There are lots of players - issuers (those to issue the cards to consumers), acquirers (merchant side banks), third party processors that do much of the actual processing on both the acquirer and issuer side), and then the card associations (what you think of when you say VISA or Mastercard).

davefairtex wrote:

At one point I recall asking a merchant if he found cash to be a costly way of being paid.  He just laughed at me.  "Hit me up with some more of that 'costly cash'" he said.

There are other reasons to take cash, but with theft, counterfeit bills, time to mak deposits, security, etc your cost to take a payment is still fairly similar.  Most people just don't think about the indirect costs.  It's kind of like total cost of ownership on a car, almost no you ask will realize any moderate priced car is over $0.50/mile, and was worse before the central bank games when you actually need to consider opportunity costs.

The point was that costs are all similar between payment methods - and generally run between 1-3%. 

You also missed what I think is the most important point, right now a merchant can sell to a customer who can not afford their goods - hence the record CC debt.  That debt will all be eaten by the issuing banks (or taxpayers/shareholders/depositors) when it becomes obvious that debt is not going to be paid.

davefairtex wrote:

My strong sense, from my relatively short time in the business,

This is my take from a NOT short time in the business. wink

davefairtex's picture
davefairtex
Status: Diamond Member (Offline)
Joined: Sep 3 2008
Posts: 5459
working for VISA?

This is my take from a NOT short time in the business. wink

Aha!  Working for VISA perhaps?  No wonder it sounded as though you are a big kool-aid drinker.  :)

For us, VISA was the gatekeeper on interchange fees, and we got the sense that they didn't care about fraud.  Not really.  How long did it take to roll out chip cards?  Two decades?  All that skimming & nobody cared.  Fraud.  Y-A-W-N.  :)

Also - the lawsuit that Walmart has filed against VISA for their monopolistic practices is a monopoly-case in point.  Ditto the lawsuit (& settlement) in the mid-2000s.  Retailers certainly would take my side, I suspect.  Banks have a lot of weight in this country - so do the card associations.  Individual retailers are much less powerful.  That's just my sense.

Another point: as a merchant, are you allowed to give a discount for cash?  You are not.  Is that a free market?  No, it isn't.  Monopoly at work!

A bank I know in a certain foreign country decided not to offer VISA cards any longer.  Why?  VISA charges too much.  Their new cards work on the Union Pay network.  Not sure how well that works in the US.  Probably, it doesn't.  Could be the future, though.

I do know about the one good thing cards bring for the retailer: people spend more money if they pay with a card.  That's a pretty consistent survey result.  Something about forking over cash makes people exercise restraint.  That, and buying stuff with money they don't have - to your point.  Perhaps the CC makes the float through to the next paycheck easier.  I'm not sure that the additional net debt from cards moves the needle.  Net CC increase per month: $2B.  Total retail sales per month: about $480B.  Maybe it moves the needle very, very gently.

Bottom line though: I thoroughly distrust processing cost analysis that come out of the card/processing industry that talk about how expensive cash or checks are to process.  Kind of like I don't trust Monsanto to review the health effects of their pesticides properly.  There's a million ways to skew results if your paycheck depends on coming up with a certain answer.  Ultimately, "cash" has no friends - not in banking, not in transaction processing, and not in government.  Unless they want to confiscate it, of course.

Reminds me of gold, a little.

rhare's picture
rhare
Status: Diamond Member (Offline)
Joined: Mar 30 2009
Posts: 1326
So dismissive....
davefairtex wrote:

  Aha!  Working for VISA perhaps?  No wonder it sounded as though you are a big kool-aid drinker.  :)

You would be wrong. I have experience in multiple payment methods, but mostly check and ACH, so we were the competition.

davefairtex wrote:

For us, VISA was the gatekeeper on interchange fees, and we got the sense that they didn't care about fraud.  Not really.  How long did it take to roll out chip cards?  Two decades?  All that skimming & nobody cared.  Fraud.  Y-A-W-N.  :)

You would be wrong here as well.  The card associations very much tried to get issuers and merchants to change, but there was a very large infrastructure built up around magnetic stripe cards in the US.  It's the whole you get their first, your then the last to upgrade to the next great thing (in this case chip cards).  

The push that finally made it happen was the rule change that went into effect on Oct. 1, 2015, when the responsibility for fraud was changed to the entity who had the least protective infrastructure.  This finally created enough of an incentive to upgrade aging (but paid for) magnetic stripe based infrastructure. 

davefairtex wrote:

Bottom line though: I thoroughly distrust processing cost analysis that come out of the card/processing industry that talk about how expensive cash or checks are to process. 

Good thing I was primarily with the check/ACH side or you might really be dismissive....

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