Investing in Crypto

Equity vs Crypto

When you buy a stock, you become a shareholder of a company.  The most common stock equity ownership is common shares.  Your shares entitle you to be compensated ratably for the value of the company according to your percentage.  Your equity is tied to the profitability and future cash flow of the company.  When your invested company grows in value, your shares rise in value alongside it.  There is no discontinuity between the increase in the value of the enterprise and the value of your shares.  The company equity and your share value have a direct relationship.

When you buy a crypto company, you are purchasing its currency. Investors think they are purchasing a crypto company whose business plan, execution, adoption, and marketplace success determine its value, but that is not true.  It’s an anomaly of digital currency’s requirement to validate a blockchain and Satoshi’s fixed supply flaw.  Satoshi’s flaw gave birth to thousands of fixed supply crypto copycat assets.  It doesn’t matter whether the cryptocurrency is based on Bitcoin’s decentralized proof of work protocol, Ethereum’s contracts form of payment, proof of stake, a hashgraph DLT low fee consensus node validation, a native GAS for on-chain content creation, a distributed token, a useless shitcoin fraud, or any other type of crypto asset.  The currency associated with the crypto company defines its value.  In the history of currency, no fixed supply currency has ever backed and sustained a major economy.  The promise of the digital blockchain economy is no different.  It requires a stable value currency.

Since a crypto’s currency defines the asset value, one cannot equate crypto investing with equity investing.  If an equity company builds a better mousetrap and the marketplace flocks to it, its value will increase correspondingly with rising profits associated with demand for the product.  With a crypto company, it is different.  Suppose a crypto company builds a blockchain with better security, validation, throughput, transaction speed, and lower fees that enterprises demand.  It is not its marketplace adoption and potential profitability that determines its value but rather its currency.  How the crypto company manages its currency’s supply relative to demand determines its value.  Currency demand determining value is entirely separate from marketplace demand and profitability determining value. 

A currency’s value is a function of its supply relative to its demand. There are many ways that crypto assets manage their currency supply. Bitcoin’s decentralized, fixed supply halving mining algorithm creates its currency in known quantities. Centralized blockchain solutions have Federal Reserve-like governing councils that distribute currency under rules they define—but ultimately, the governing council has carte blanche to do with its currency whatever it deems necessary. There are cult Ponzi scam currencies that eventually implode. Finally, there are any number of ways someone can create and market a cryptocurrency based on any premise such that someone will buy it.  A pre-launch white paper that defines the company’s business plan pre-announces the control and supply of its currency.  The current rolling crypto bankruptcy contagion exposes the fragility of companies valued by their digital currency.  A cryptocurrency conjured out of ether nothingness based on a suspect blockchain solution or crypto application can quickly return overnight to ether nothingness.  

Because all cryptos use some form of fixed supply, the greater the future demand, as the supply limit approaches, the higher its price.  The uniqueness of cryptocurrency needs to be put in context.  Unlike non-fixed supply currencies like gold with thousands of years of monetary creation or fiat with decades or centuries, crypto starts from zero and has to immediately attain a supply that sustains functional use.  Again, either a decentralized mining algorithm or a centralized authority distribution accomplishes the initial large issuance followed by decreasing supply to an ultimate fixed supply.  Market value then becomes a function of creating demand for the cryptocurrency. 

Satoshi never meant for Bitcoin to end up with thousands of crypto alternatives; he meant for Bitcoin to be a stand-alone, borderless global currency that would disrupt the fiat system.  The dollar does not have thousands of currency competitors, and neither should bitcoin.  Currency exists to facilitate trade.  Businesses desire to transact with a single currency of stable value.  A currency without stable value makes trade less efficient and more costly. It’s true that federal government legislation eliminates dollar competition within U.S. borders.  However, bitcoin’s borderless digital decentralization empowers it to compete with dollar dominance.  It merely requires a better unit of account than the fiat dollar.  Bitcoin, and all crypto, can never achieve this with fixed supply.    

Ultimately, a stable value functional cryptocurrency that negates the thousands of clones is where crypto is headed.  For now, crypto remains locked into Satoshi’s fixed supply flaw that unleashed the speculative crypto frenzy rife with fraud. 

The Crypto Catch-22

There are many cryptos facilitating blockchain financial disruption and efficiency with revolutionary technology.  Still, their currency defines their market value, not their potential marketplace adoption.  Let’s take a fictional crypto company Xchain and their associated currency Xer, as an example.

Xchain has built a better blockchain application.  Their consensus Xgraph algorithm validates transactions securely, quickly, cheaply, and competitively on their blockchain.  Xchain appears to have the potential to disrupt the current global payment system.  The reason that Xchain won’t disrupt the fiat system, despite its superior efficiency, is because the Xer in no way defines a functional currency.  Xchain’s white paper admits that its currency only exists because blockchain validation requires it.  The Xer is an afterthought to its primary blockchain application.  Like all other cryptos, Xchain limited the Xer to a fixed supply with some matter of defined, controlled distribution.  Xchain retained the caveat that ultimately, its governing council can do whatever it deems necessary with Xer distribution. 

The Xer has no method to achieve long-term stable value.  In its beginning stages, the Xer is cheap because the initial supply distribution far exceeds demand.  Xers are also distributed for node validation that enables its blockchain.  With cheap Xers, it is inexpensive to use Xchain’s service, and adoption increases rapidly. Over time, Xers will reach their supply limit.  Any increase in Xer demand will increase their price.  It then becomes more expensive to use Xchain’s product which is denominated in Xers. With limited supply, price volatility increases with demand.  Volatile price changes limit Xchain’s marketplace utility and its potential for future growth. It’s a crypto Catch-22. The greater the marketplace demand, the greater the Xer volatility, which limits marketplace demand.

Xchain’s inability to achieve currency stability relegates Xchain to a niche utility.  Xchain may enable the fiat system, but it can never disrupt it.  That requires a blockchain validated by a currency stable in value.

If Xchain was an equity company, one could discern its revolutionary, efficient blockchain, expect widespread adoption, and invest in it based on high growth and future cash flows.  The market would determine its valuation accordingly.  Instead, Xchain is a crypto company, and the Xer determines its value.  Xchain’s governing council is its own Fed.  At least the Fed understands that fixed dollar supply can’t work. It instead errs on the side of excess dollar supply and devaluation for perceived economic goals.  Fixed crypto supply and fiat devaluation are two sides of the same coin.  They both result in a currency of unstable value and financial chaos.   

Currently, all crypto prices rise and fall as paired trades with Bitcoin or Ethereum.  This is a result of underlying fraud in the crypto ecosystem that relies on unbacked, created out of thin air stablecoins. Stablecoins exist to dampen the volatility caused by fixed supply, yet they require actual reserves.  Tether remains the largest stablecoin and has never had its reserves audited.  The crypto community is well aware that Tether does not maintain 1:1 dollar asset reserve backing.  A crypto company’s market value rises less on demand for its product’s practical application and more on its ability to market demand for its currency by any means.  Yield farming, marketing scams, social influencing, and outright fraud result in soaring crypto values far more than demand for actual product services.  At least in the short term. 

The crypto world hasn’t come to terms with this anomaly.  It’s too interested in quick riches and the ridiculous narrative that bitcoin will go to $1,000,000.  Crypto regulation is coming, and the pervasive scams will get eliminated.  When it all shakes out, the same problem will remain.  For crypto and the blockchain to reach their potential requires a currency of stable value upon which to innovate the disruptive efficiencies of the blockchain.  

If Agustin Carstens’ stated BIS totalitarian CBDC takes over and facilitates Agenda 2030; it won’t matter.  The security state’s suppression of individual liberty is not conducive to entrepreneurial innovation. When you’re happy owning nothing, why innovate?   

2 Comments

  1. alberto aceña

    1) Xchain could set fees in USD instead on Xers, so adoption of the network would not imply an increment in cost to users and it´s not a deterrent for future grow (this require a network with no vulnerability to DDos attacks, leaderless consensus)
    2) No need for Xers to be stable in price or not fixed in supply. Being the layer 0 which support new apps&servvices (not only payments: data integrity, tokenization, etc), Xers price would reflect in some way the value of the legder as an enabler and security layer for this apps&services. From this layers 0, stablecoins will emerge and be used for payments and micropayments.
    3) You mention stablecoin USDT which all agree has shotcomings but do not mention USDC which is very transparent and compliant.
    4) Again, a very negative view of the industry which, recognizing its actual issues, will change the world in the end. In the long term could be a disservice to your readers.

    Reply
    1. Michael Kendall (Post author)

      Even though Xchain sets the fees in USD, clients pay them in Xers. The fee in Xers, therefore, may vary from hour to hour and will definitely vary for Xer price changes over longer holding periods. The only way around Xer price volatility is to purchase them at the time of a transaction in the fee amount. As fixed supply approaches, volatility will increase. For now, Xchain can manage the Xer price by supply manipulation.

      USDT remains the backbone of the entire crypto space despite USDC’s emergence. Maybe a smooth transition from the scam USDT to legitimate USDC will occur, or maybe Tether will fail and take down contagion cryptos with it. It remains to be seen how this plays out.

      I don’t see my views as negative; I see them as realistic. A functional cryptocurrency and the blockchain have revolutionary disruptive positive potential. What’s missing is a crypto with a functional currency.

      Reply

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