Disruptive innovations all have at least one characteristic in common. They percolate through an economy seeking a best use scenario because it’s the market, and not the inventor, that makes a determination of utility. Cryptocurrency is undergoing such a moment and it may be hampered by use of “currency.” Is it a currency or a security?
Cryptocurrencies have proliferated like rabbits. One study concludes there are 1,448 of them and the number is growing. https://coinmarketcap.com/all/views/all/ In a world of central banking, reserve currencies and sophisticated trading markets, is there a place for this asset category? There is little doubt that cryptocurrency is a disruptive innovation but its existence begs the question of what’s being disrupted.
Some advocates say that cryptocurrencies are a new form of currency that skirts the limitations of government-controlled currencies by avoiding regulations. But those principles also represent hard-won knowledge about how markets work and how best to control inflation and ward off the worst effects of recession. Also, there is little of value backing up cryptocurrencies which makes them pawns in a confidence game at worse or just another fiat currency at best. But other fiat currencies, like the dollar, are backed by “the full faith and credit” of the nation state and its ability to tax or otherwise use the assets under its control to support the value of currency.
Others look at this asset class more as investments akin to securities that can fluctuate on open markets. It’s possible cryptocurrencies are both or neither but the current rollercoaster ride seems tailor-made for figuring it out.
It’s possible we may have to get used to a duality of uses for this asset class. Sometimes cryptocurrencies act like currencies while other times they act like securities. As a metaphor, this is reminiscent of the quantum duality of light—it can be described as an energy wave (electro-magnetic radiation) as well as a particle of zero mass (the photon). We routinely use the best definition for a circumstance. Or consider silicon, a “semi-conductor” a material that can act as either a conductor or a resistor depending on the electric current flowing through it.
Currency and banking
As it stands cryptocurrencies are not very good currencies. Their value changes depending on the whims of the market and there is no central banking facility to maintain liquidity in times of financial stress or to manage inflation and the money supply. Cryptocurrency can be used in transactions the same way that Monopoly money can be—under very specific circumstances and so long as both parties agree.
As we’ve recently seen, cryptocurrencies are not great stores of value either, because their value can fluctuate significantly within a day or a week. Stability in a currency is vital for without it, people would be resistant to spending it if they felt that the price was likely to rise or they would be resistant to own it if they expected it to inflate and become valueless in the near term.
Securities and finance
Markets for cryptocurrencies act more like stock exchanges and we’ve seen wild swings in recent trading of Bitcoin, the grand daddy of the group. So cryptocurrency seems to be a better fit as a security whose value is expected to fluctuate.
Fluctuation can be a good thing. I was a guest on the streaming show, “The Gillmor Gang” last week when the discussion turned to cryptocurrency. Another guest, Keith Teare, a venture capitalist involved with cryptocurrencies, described his use of crypto to raise capital for his venture funds. His method avoids the typical funding process of raising big contributions from a small number of investors. Instead it can raise any amount from average investors by selling cryptocurrency. Tears’ description and explanation begins at the 46-minute mark and it’s well worth the time.
Unlike a crowdsourcing model in which people invest money at face value, say $100, Teare’s model generates heavily discounted cryptocurrency and sells it to investors while giving the hard currency raised to startups. For example, he might issue a crypto dollar with a value of one cent based on the value of the startups in the portfolio. As the startups progress through time the value of the currency increases (or not). At some point your investment is either worthless in which case you’ve lost one cent on the dollar or it’s worth potentially more than the face value of the cryptocurrency.
Generally, if you invest this way in a portfolio and not an individual company the chances of all portfolio companies going south is small and the odds of your investment becoming worth more than one cent on the dollar in the future is reasonable. But wary investors will note that this scheme operates outside of the rules of the Securities and Exchange Commission (SEC) in the US and similar bodies elsewhere. So, sadly, there’s room for the unscrupulous to game the system.
Nevertheless, in this process the cryptocurrency acts more like a stock or a bond or possibly some as yet unnamed derivative that combines aspects of each. The cryptocurrency is far from being a legal tender for all debts but in the right situation it’s a good fit. In this model it’s easy to see how cryptocurrencies could proliferate, each securing part of a transaction such as a venture fund, in the same way that bonds are issued for a particular debt offering. So at the end of the day, the cryptocurrency acts both as a security and as a currency, that’s the duality.
When crypto currency is used for discrete commerce or as an investment it works reasonably well. Teare’s use of crypto is a good example of using it as a form of a bond. Like a bond, it is heavily discounted initially and its value fluctuates but it still generates value in a kind of interest payment.
Cryptocurrency is more likely to be a disruptive innovation in finance but not one in banking and currency. It’s too volatile to act as store of value but might well have a place as a token of debt or more broadly as a security such as a bond with some stock attributes.
As a currency cryptocurrencies lack the necessary central banking infrastructure so it will be hard gaining traction there. The exception is that convertibility to dollars, Euros, or another established currency enables a cryptocurrency to access part of the beneficial aspects of conventional currencies such as the liquidity provided by central banks.
So as long as there are real currencies and the central banks needed to keep them functioning, it’s difficult to see how they replace conventional currencies. But it’s also hard to see how they harm functioning economies unless they all evaporate. This is an area of concern for anyone who appreciates how involved Russia and China are in cryptocurrencies. A hostile power intent on doing harm to the global economy could, in theory, flood the market is bogus cryptocurrency inflating them and rendering them useless and valueless.
Proponents of cryptocurrencies point to blockchain technology, a distributed ledger system designed to make it virtually impossible to carry off such a scheme. Two years ago one might have said the same about social media and democratic systems.
A recent article in the New York Times Magazine, “Beyond the Bitcoin Bubble,” by Steven Johnson observes,
“The Bitcoin bubble may ultimately turn out to be a distraction from the true significance of the blockchain.”
and blockchain could ultimately be the tail wagging the dog in all this.
My two cents worth
It is entirely possible that the disruptive innovation of cryptocurrency has not found its niche yet. If the market for cryptocurrency tanks, its use as a neo-currency will be over. As a way to raise money and reward investors crypto might face better odds especially if it can find its niche.
Here’s an idea.
The conventional economy seems reluctant to embrace the infrastructure needs of a world in crisis over climate change. Cryptocurrency could turn out to be the financing arm of a movement that builds more renewable power generation and distribution or that finances new ecosystem service provisioning. For example, increasing the amount of fresh water available to support populations in arid regions is such an ecosystem service. So is supporting a Green Race that promotes more photosynthesis planet-wide in an effort to reabsorb atmospheric carbon.
As we said at the start, inventors create products but the marketplace is responsible for defining best uses. In this, the experiment in cryptocurrency is not over by a long shot.
Not long ago a vendor asked a friend of mine to speak at a conference. Analysts speak at conferences all the time so the request was not unusual except in the conditions attached. There would be no compensation for the effort and the analyst would need to provide transportation and housing out of pocket. So the invitation was a money-losing proposition from the get go. I don’t know if the offer was accepted. There are times when an analyst might speak for no fee such as when plugging a book. But this was different, the vendor had the budget to pay for the service but just chose not to.
This happened around the time that Taylor Swift had her now famous disagreement with Apple over its attempt to recruit new listeners to its streaming music service. You can read the New York Times article about it here. Apple planned to offer 3 free months of service to new subscribers and intended not to pay the artists for the use of their music.
I wasn’t a Taylor Swift fan before because I am not very musical—I need a permit to carry an iPod. But I’ve become one because of Swift’s classy approach and principled stand. In her open post to both fans and Apple on Sunday, Swift explained that she was pulling her latest album, 1989, from Apple so that it couldn’t give away her work for free. There was no ranting, no cussing or questioning anyone’s parentage or species—just cold hard facts. I thought that was just right.
Artists earn a living, or at least try to, by making art for sale in the marketplace. They are quite comfortable with letting the market decide whether and how much to pay and sometimes that’s nothing. You can say much the same for any content provider. But such decisions are personal and not corporatized–appropriating a product and making money on it without paying the primary producers has become a form or legalized (so far) theft. I see Swift’s principled stand and my friend’s speaking invitation in a similar light.
The logic—if you can call it that—behind appropriating content without paying for it appears to be a variant of, Hey, we’ll make you famous and you can charge big next time. But next time never comes. It’s really the logic of an economic bubble and it sometimes goes by other names like the greater fool theory. Ten years ago speculators paid silly prices for real estate because it was assumed that there was a bigger fool out there ready to pay even more when you flipped the property. Every bubble has the greater fool at its core and, as we saw with real estate, it works really well until it doesn’t work at all.
I think a version of the greater fool theory is invading the analyst space. Well-paid PR firms chase analysts to take briefings from companies that pay for the PR consulting but not for the advice they get in the briefing. They very often don’t engage further than the briefing.
They seem to think we’ll look so prescient if we just write about this up-and-coming company that others will want to pay for our sage advice later. As we’ve seen others try to recruit speakers at their conferences stating up front that they won’t pay anything and that your travel expenses are yours. But consider all the exposure! The obvious problem with the greater fool theory is that it eventually ends—the music stops and the greatest fool is always left holding the bag.
I hope my friend turned down the speaking gig, I haven’t asked. Speaking for no fee is one thing, we all do it especially if there’s something real but intangible involved. For instance, I speak at CRM Evolution every year for no fee and I write a column for the magazine too. But my expenses are paid for and the magazine really has set itself up as one of the arbiters or real information about CRM. In this case our interests align because we’re both in the same business trying to disseminate information about CRM. The vendors I’ve described are, to put it nicely, looking for an endorsement.
The music business is such an economic wasteland today that songs are not being written and people are looking elsewhere to make a living. But the opportunity to write those songs will not come again. To my mind this is a dangerous time in the content business because fewer and fewer people are making a living and that’s true anywhere a form of content gets made and distributed whether in publishing, blogging, or music and it’s always been true in acting and visual art. There’s an old saying: if you can’t make money at your business then you don’t have a business, you have a hobby. What happens when we have an economy of hobbyists?