Crypto assets - or liabilities?
The OB view on Crypto
Dear reader
As well as my other article today speaking to Gold busting through $2,100 we see Bitcoin busting through $66,000.
Should you invest into Bitcoin? Do what you like, this is not advice. But what’s my view? Well, I have a great respect for Cathie Wood and for the Big Ideas 2024. But I’ve not ever seen a need for Bitcoin, or at least how it’s being executed. Nor have I ever been given any kind of clear answers to its rationale, and how the “investment” can actually add up. I see no more of a need for Bitcoin, than I can for the accumulation of Tulips or for Bubbles of a South Sea variety.
Bitcoin or Blockchain?
At this point a reader might pull me up and tell me about the value of distributed ledgers and the efficiency of those versus reliance on a central database owned by a counter party. I did consider this argument for a while and even feel it might have legs. Shun the crypto asset but buy into the “picks and shovels” play of Blockchain. But the picks and the crypts are inextricably linked, and there is no actual commercial implementation (to my knowledge) of a distributed ledger, worldwide. Just Crypto and those who provide services into Crypto. Moreover our current system of “market makers” (like London Stock Exchange or London Metal Exchange) works reasonably well especially as businesses (and consumers) increasingly embrace digital transformation and we are increasingly seeing a world without book keepers. I digitally communicate with the LSE every working day. Manual data has already been replaced by flows of data in a Digital EcoSystem. But one, where each participant maintains one’s own ledger and shares data selectively. No great copying of data across networks of distributed ledgers which would require vast amount of storage and power (and already do - Bitcoin alone accounts for 147TWh of electricity).
Big Ideas
Any back to Big Ideas 2024 which speaks to a 2040 future where:
Cryptocurrencies have displaced most permission-based, centrally controlled monetary systems, enabling financial ecosystems to reformulate around a digital asset that can eliminate counterparty risk while continuing to facilitate transaction flows.
Big Ideas asks what if more and more people and institutions allocate money to Bitcoin. If 1% of the $250Tn of investable assets were allocated to Bitcoin then Bitcoin would be $120k each. Yes, that’s probably true. And if $2.5Tn were allocated to Tulips then I dare say Tulips would be possibly around that price too.
Governments control currency and have done so for millennia. Since the dawn of civilisation. How exactly will that change per the Big Ideas thought piece in the next 16 years? How will worldwide governments relinquish control? Could some QE, sovereign debt and unsustainable repayments lead to a new uber-crisis making the 2009 Great Financial Crisis pale? Bitcoin is the saviour? Unlikely. Far more likely out of the ashes of any such crisis (if/when it happens again) governments and government intervention provide a solution - even if that solution were a government produced/backed crypto currency “The new Dollar”, the “DigiDollar” would rule and supplant current Crypto. Governments still can (and already have) banned Crypto whenever they choose to. Even if Crypto achieves everything its supporters claim, how does it follow that Bitcoin or any become the de facto? Why would government not just supplant it? It reminds me of Tyrion explaining the rules of lending to Bronn. I lend and then you pay me back - and he replies “but what if I don’t?”.
Moreover Bitcoin (and other current) cryptos do not currently play any meaningful role as a currency so it is inaccurate to call them a “currency” - at least for now. Bitcoin transactions aren’t particularly cheap either. Statista tells us $5-$25 per transaction. For that sort of cost would that be a practical form of exchange? Compared to a metal coin or a precious metal I can hold in my pocket or barter with or even the many inter-bank transactions and well established Visa/Mastercard/Amex payment on rails which usually costs me zero and the retailer 2%-3% (for the latter). Who exactly is paying $5-$25 per crypto transaction and for what? Since I think it unlikely this is for milk, eggs and a newspaper so the only conclusion I can come to is that those fees are loaded into each Crypto purchase and sale. So these fees are a burden for anyone hoping to live their life earning Bitcoin and buying their goods and services via Bitcoin. Do any such people exist? Even Tesla stopped letting you buy their products in Bitcoin or was it Doggy Coin? I forget.
Thinking about Bitcoin leads you to inevitably ask: Who pays for Bitcoin mining? Why does the answer feel like it is a ponzi scheme? Follow the money. Miners, we are told, get rewarded for processing transactions. Rewarded by whom? So new entrants to the scheme pay the holders of Bitcoin i.e. the miners. Miners mine coin and sell them but also get rewarded for processing Bitcoin transactions.
But what happens when there are no new entrants? No coins to sell. After all there is a limit of 21m Bitcoin we are told. This limit will be reached by 2040. Who pays after that date? Who pays to process all the transactions?
Also between now and then there will be a series of halvings where miners must do double the work, including a halving event in 2024, when miners have to do twice as much work as before and therefore the price of Bitcoin will “have to go up”. Isn’t that another way to say the rewards for the next tier of Ponzi entrants are going to get less?
What are the Miners Costs?
Apart from equipment (servers, data centres), electricity is a large expense. Bitcoin consumed 147TWh of electricity last year. At $0.15 a KWh that’s over $22bn in electricity - and growing. Let’s imagine the other costs were $2bn-$3bn.
But we then learn from this link $5-$25 per transaction fees only covered a total of $10bn of fees in 2023.
So the remaining ~$15bn+ of cost must be (logically) deducted from the value miners get from selling the Bitcoins themselves. But these earnings halve this year and halve again in 2028 and again in 2032. Another way of saying this is that the reward decreases, costs increase relative to the value of the output (i.e. a bitcoin). Higher prices solves this but prices are determined by the demand for Bitcoin, not by its supply, and meanwhile existing Bitcoin still need to be traded. Who processes those trades if the Miners stop mining? As costs go up the supply goes down.
So by 2040 and probably in the next few years, by my reckoning, fees would have to substantially increase to cover the $25bn and growing annual cost to process transactions. That could mean up to $75 a transaction to actually cover costs and give miners a profit. And that assumes trading volumes continues. What if it doesn’t? Prices must rise further still.
Comparing Crypto with Gold once the Gold Miner has mined the gold it’s sold and then owned. No further payments necessary to the Miner. With Bitcoin that’s not the case - the miner is also manning the vault. I suppose it’s like every Gold Miner also charging custody charges and all Gold Mined is managed in an ETF with custody charges. Of course with gold that’s optional - with crypto it’s not. If gold relied upon ongoing custody charges would it lose its allure? If the amount of mining was determined by the number of gold holders going in and out of their vault - is that not a ludicrous conclusion to the business model?
Since Bitcoin is now being described by some advocates as an asset and store of value rather than a currency, doesn’t the current levels of Bitcoin trading have to continue to keep (literally) the lights on? Taking $40 a transaction as a mid point trading cost, there’d have to be 625m transactions to pay the miners today and more tomorrow. Since miners would be competing for transactions and their service is generic and duplicated (multiple ledgers held across the network) what utility would it provide? It feels like duplication and waste not reformulated financial ecosystems that facilitate transaction flows.
Of course if digital wallets by the likes of Apple, Paypal and Alipay could be supplanted along with the payment rails of Visa, Mastercard and Amex, along with the entire banking system then yes, Crypto could elevate to the status of a currency. There are then 500 Billion (and growing) annual transactions just within payments. If 100% were processed on Bitcoin that would equate to less than 0.5c/transaction assuming existing mining could cope with that volume at no extra cost (which I doubt). This report by FIS sees the short/medium term where Crypto remains fringe to 2026.
If Crypto were to replace current transaction currencies who would pay for all the infrastructure to replace all that we use now? Given this is decentralised finance it’s not as though there’s an actual Bitcoin company who would roll out infrastructure for payments and strategically plan the dominance. Does this stuff “just happen”? Pfff!
What does the Smart Money do? And know?
There are many smart people who’ve dismissed Crypto. Warren Buffett, Jamie Dimon, Nouriel Roubini….. In fact this Redbull list of famous critics is worth a read.
Then yes, there are smart people who advocate Bitcoin but who also have a vested interest to do so. Do you know a smart person who says its amazing but doesn’t own any? Aren’t they just talking their own book?
Crypto feels like it’s becoming a “hot” speculative area where you “can’t lose”. Especially young people appear to have this idea. Dare I say the naiave? I was out on a long walk in the countryside yesterday listening to the Paul Stockopedia Podcast on my Lucyd smart glasses and I think it was his masseur who asked after crypto. Even if the Smart Money’s involved with Crypto at all, aren’t they riding this up and then planning to exit ahead of another crash?
Or am I cynical and well wide of the mark? Vote:
This is not advice
Oak
I began nodding my head in agreement right from the mention of "Tulips". Too many holes in the scheme and you've pointed out most of them.