Crypto's Coming Of Age: Thoughts On The Sec's Recent Decision And Other Things

Research
• Jan 12, 2024
Crypto's Coming Of Age: Thoughts On The Sec's Recent Decision And Other Things

by Ryan Shea

Key Take-aways

  • According to latest estimates the number of crypto users globally is over 420 million, implying crypto adoption continues to track the pace of internet adoption two decades prior.
  • Internet usage is now ubiquitous and this is the inspiration behind the popular “It’s still early” crypto meme.
  • Going mainstream, which is required for crypto adoption to continue to keep pace with internet adoption, means jumping what PR/marketing people call The Chasm.
  • Spot Bitcoin ETFs have the potential to facilitate this transition. This is why the SEC’s recent decision to green light them is such a big deal.
  • The arrival of spot Bitcoin ETFs on the crypto scene is not the only reason for judging that crypto is coming of age. Last year’s price action was also extremely important.
  • Faced with yet another failed prediction of crypto’s demise after last year’s bear market, some doomsters are starting to pivot.
  • One such example is The Economist magazine which recently introduced the “cockroach theory” of crypto, which albeit begrudgingly and disparagingly, acknowledges crypto’s apparent indestructibility.

According to the latest Triple-A estimates1, global crypto ownership stands at 420 million, or around 5% of the world population. As many readers will recognize, this figure implies that crypto adoption continues to track the pace of internet adoption with a two decade lag.

While the internet has been around since the 1960s, its early life was as a closed system only accessible to select academic/research institutions with connections to the US Defense Department. The first commercial ISP (internet service provider), Telenet, was launched in 1974, but the internet did not really come into being until the TSP/IP protocol suite was introduced in 19832. Over the subsequent 15 years, the same time interval that has passed since Satoshi Nakamoto released the Bitcoin white paper, the number of people using the internet globally rose to 190 million, or 3.1% of the total population3 - so definitely in the same ballpark.

Fast forward to today and more than two-thirds of the world’s population has internet access, either via landlines or, more commonly, smart phones. Global internet connectivity is ubiquitous. It is the anticipation that this analogy will continue to hold that is the basis of the popular “It’s still early” crypto meme - a rallying call, it has to be said, one tends to hear more during bear markets than bull markets due to the psychological comfort it provides crypto hodlers nursing less than stellar financial returns.

Going Mainstream

Regular readers of the Trakx blog may recall that in an earlier research note “Roadmap To Utopia” and presentation "Crypto Outlook: Boom, bust, next?" I included a graphic showing the famous technology adoption curve, which segregates populations into five distinct cohorts based on their attitudes towards technology – reprinted below.

Stylized Technology Adoption Curve

Crypto's Coming Of Age: Thoughts On The Sec's Recent Decision And Other Things

Source: Author

The segment most positively-inclined towards technological innovation are known as the tech enthusiasts (the folks that used to queue up all night for the latest iPhone, behaviour that now seems rather quaint). They are followed in decreasing order of technological receptivity by visionaries, the early majority, the late majority and, finally, those least positively inclined to technological innovation, the skeptics.

There are no hard and fast rules, but the general opinion of sociologists is that tech enthusiasts comprise between 2-3% of the total population, with visionaries accounting for around 10-13% of the population. In keeping with their labels, the early/late majorities comprise the largest cohorts accounting for roughly two-thirds of the total population, while the laggards account for the residual 15% or so of the total population.

The estimated 5% of people using crypto today puts it firmly in the tech enthusiast / visionary cohort brackets. Going mainstream, which is required for crypto adoption to continue to keep pace with internet adoption, means onboarding the early and, eventually, late majorities. PR/marketing people label this transition phase the Chasm and it represents the critical phase in the adoption of any new technology. This is why I consider the introduction of a spot Bitcoin ETF at this juncture of crypto’s evolution to be such a big deal.

The Right Step, At The Right Time

Commentary related to the SEC green lighting of a spot crypto ETF (applications have been filed for both Bitcoin and Ethereum) contains a great deal of speculation as to how much capital is “sitting on the sidelines” waiting to be deployed when these products go live4 and how much of a price boost they will bring to Bitcoin. For short-term speculators this is obviously of considerable interest, but for me it is the longer-run impact it will have on driving crypto adoption that is more important.

Tech enthusiasts and visionaries may be happy to embrace new mental models, not be put off by unfamiliar jargon and prepared to risk putting their hard earned resources (time and money) into new ventures. However, the majority of people are not. Typically, they are more risk-averse and conservative in nature. ETFs make crypto more amendable to these cohorts because they are packaged in a way that feels familiar. Moreover, because they are being issued by tradfi giants such as BlackRock, Franklin and Fidelity, spot ETFs are able to lean on these companies’ reputations, thereby providing crypto with greater financial legitimacy.

I readily acknowledge that such products do not sit easy with the decentralized ethos of crypto. But, if crypto is to succeed as an asset class, and especially become a competitor to fiat money – see: “A Network Theory Of Money”, it has to jump “The Chasm” and gain wider public acceptance. For the reasons just mentioned, spot Bitcoin ETFs have the potential to facilitate this mission critical transition, so as much as die-hard crypto anarchists may object to them, at this stage in crypto’s evolutionary journey they constitute the right step, at the right time.

The arrival of spot Bitcoin ETFs on the crypto scene is, however, not the only reason for judging that crypto is coming of age. Last year’s price action was also, in my view, extremely important.

Zero To Hero

A long standing criticism of crypto - Bitcoin initially, but it has come to encompass the entire sector - is that it is simply a high Tech Ponzi scheme in an “asset” whose price gains are entirely dependent on the “greater fool theory” making it highly susceptible to speculative bubbles.

One of the most egregious examples of such thinking occurred a few years back when The Economist magazine published a chart – reproduced below - showing the 2017 Bitcoin “bubble” to be the greatest speculative bubble in financial history, greater even than several earlier asset price bubbles which have become synonymous with speculative excess and the madness of crowds5.

The Economists’ View

Crypto's Coming Of Age: Thoughts On The Sec's Recent Decision And Other Things

At the time, the authors of The Economist article probably thought they were on to a winner, that is to say, nailing the bursting of the $3tr crypto Ponzi bubble, something one doesn’t often get to do in one’s financial career. Imagine, then, their chagrin when, fuelled by excess liquidity injected into the global financial system to ward off the negative effect of the Covid lockdowns, crypto prices surged to new all-time highs in 2021, more than 3X the 2017 peak.

Despite this, and the several prior crypto resurrections, many of the doomsters repeated the error following the bankruptcy of FTX by predicting the 2022 cryptowinter would constitute an “extinction event” for the industry. Yet, one year on and not only is crypto still around but it is thriving as evidenced by the near 150% rally in the Bitcoin!

This is not how Ponzi schemes are supposed to behave. Once popped they are supposed to wither away and die. As Max Keiser famously quipped “You can’t taper a Ponzi scheme6. So what went wrong?

The answer lies in the fact that while a rapid price increase is a necessary component of a speculative bubble it is by no means sufficient.

According to a 2014 working paper by Sornette and Cauwels a financial bubble is defined as...

“...a period of unsustainable growth, when the price of an asset increases ever more quickly, in a series of accelerating phases of corrections and rebounds. More technically, during a bubble phase, the price follows a faster-than-exponential power law growth process, often accompanied by log-periodic oscillations. “ (My emphasis)

The missing piece of the speculative bubble jigsaw is that the price increases must be unsustainable. But how can one determine whether a price move is sustainable or not? The answer is fairly straightforward. Price increases are unsustainable when the spot price of the asset in question (whatever it may be) exceeds the fundamentally warranted valuation (whatever that is, or however it is derived). If this were not the case then rising prices – even rapid - would be justified on fundamentals, and hence deemed by investors to be sustainable.

The error the doomsters make is due to their attaching a zero fundamental valuation to crypto7. Based on this flawed assumption – and let’s be clear it is both an assumption and flawed - inevitably all crypto price rallies end up being viewed as speculative bubbles.

Insanity Plea

Of course, history is replete with examples of people continuing to repeat the same errors time and time again. It is the inspiration behind the famous definition of insanity usually attributed to Albert Einstein.

Insanity is doing the same thing over and over and expecting different results”.

Continuing to label every surge in crypto prices a speculative Ponzi scheme, only to see them rebound and break to new all-time highs, is a classic example of such behaviour.

That said, having witnessed yet another crypto resurrection, it would appear that some of the doomsters are finally beginning to see the light. In a recent article in the The Economist, the authors outlined a new “cockroach theory” for crypto – see below.

Volte Face From The Economist

Crypto's Coming Of Age: Thoughts On The Sec's Recent Decision And Other Things

Source: The Economist magazine

To wit,

“… with each boom-and-bust cycle, it becomes clearer crypto is not a bubble like tulip mania in the 1630s or the craze for Beanie babies in the 1990s.

Crypto has its uses, too, such as portfolio diversification and keeping money safe under despotic regime. And, as has been shown, it is just about impossible to kill.”

That is worth reading again. Even the leading voice of the tradfi world now, albeit begrudging and disparagingly, acknowledges crypto’s apparent indestructibility.

Give me a hallelujah crypto bros!

Virtuous Cycles

The beauty of crypto is that once it gains a foothold, it has the potential to establish a virtuous circle because like many other technologies such as social media platforms, ride sharing or food delivery apps, it benefits from network effects: the more people who own and use them, the more valued and valuable they become. For crypto though, there is an added benefit, one that will serve to further silence its detractors.

In the early stages of its evolution, demand for crypto was largely driven by speculative motives (for the avoidance of doubt, this is not the same thing as a speculative bubble), as typified by Satoshi himself when he wrote8

It might make sense just to get some in case it catches on. If enough people think the same way, that becomes a self fulfilling prophecy.

People buy finite supply cryptocurrencies, like Bitcoin, anticipating that their price will appreciate in a world where governments, via their agents central banks, are seemingly unable to curtail the creation of fiat money for political reasons,which eventually undermines its purchasing power (see “Crypto Wager”).

Because in the early stages purchases of crypto were motivated by the same factor – higher expected future prices – demand is strongly positively correlated. In combination with an inflexible supply curve (Bitcoin’s supply curve is not upward sloping as per the standard illustration in economics textbook of demand and supply, but is vertical and shifts to the right every time a block is created and miners earn the block reward), shifts in the demand curve have a significant price impact – see image below. This combination is the reason why crypto typically has higher price volatility than other financial assets.

Supply Curve Slope Impact On Price

Crypto's Coming Of Age: Thoughts On The Sec's Recent Decision And Other Things

Source: Author

Critics argue that this elevated price volatility constitutes an impediment to its use as a medium-of-exchange – one of the three prerequisite functions of money. Such criticism is valid, but volatility is not a deal-breaker when it comes to something serving as a store-of-value as I have previously demonstrated – see “Fed Fears: Exploring the Case for Cryptocurrencies as a Store of Value Amidst Fiat Money Uncertainty“ .

Over time as greater numbers of people, either via the application of logic or based on experience, recognize crypto’s ability to serve as a store-of-value, demand will naturally increase, generating both upward pressure on prices but also – importantly – on its fundamental value (network effects get monetized). But there is another interesting twist that occurs.

Demand Rebalancing

Higher spot crypto prices implies that the expected profit from speculation falls (i.e., the expected return from hodling declines), which will naturally result in diminished speculative demand for crypto. For a Ponzi scheme such a shift in demand dynamics would be toxic. However, for crypto this loss of speculative demand is replaced by increased transactional demand due to Thier’s Law.

In contrast to the more famous Gresham’s law (“bad money drives out good money”), Thier’s Law states that given the choice people will prefer to transact in money they believe will be the strongest in terms of maintaining its purchasing power. It is the reason why at times of severe economic crisis people switch to transacting in US dollars or Euros in the black market rather than continue to use devalued domestic currencies – Lebanon is very timely reminder of such behaviour (Bonus question – what would happen if there is a loss of faith in the US dollar or the Euro to maintain its worth?). Because people’s transactional demand for money is influenced by a multitude of different factors9, combined with a reduction in speculative demand, overall demand for crypto should become less correlated. This, in turn, should translate into lower price volatility, thereby enhancing crypto’s ability to serve as a medium-of-exchange and bringing it closer to satisfying a second of the three prerequisite functions of money10.

Speculation is not, as the doomsters argue, crypto’s Achilles heel. Rather it is the bootstrapping mechanism by which crypto goes mainstream as we are about to find out.

Until next time.


1See: https://triple-a.io/crypto-ownership-data/

2The world wide web, which many people think of as the internet, arrived eight tears later in 1991 - see: https://www.usg.edu/galileo/skills/unit07/internet07_02.phtml

3Bear in mind that the global population has increased by approximately two billion since 1998 - see: https://ourworldindata.org/internet

4The introduction of gold ETFs in the early 2000s is a popular analogy – see: https://twitter.com/QuintenFrancois/status/1744283862123884986

5Updating the chart using the 2021 Bitcoin peak as the reference point, it is interesting to note that the Bitcoin bubble is no longer the greatest in financial history. In fact, the Mississippi and Tulip bubble are both two to three times greater. Data and chart available on request – see: https://en.wikipedia.org/wiki/Extraordinary_Popular_Delusions_and_the_Madness_of_Crowds

6A comment made in reference to the Fed’s decision to taper its QE programme.

7Some have even gone as far as to suggest a negative valuation for Bitcoin given its impact on the climate arising from its energy consumption ((https://markets.businessinsider.com/currencies/news/bitcoin-value-negative-environmental-impact-nouriel-roubini-cryptocurrencies-2021-2-1030067687)) , a perspective that is about as misguided as one can get for reasons I have outlined elsewhere ((https://trakx.io/resources/insights/2023-crypto-outlook/ and https://trakx.io/resources/research/crypto-power-plays/)

8See: https://satoshi.nakamotoinstitute.org/emails/cryptography/17/

9Not everyone’s car breaks down at the same time, nor does everyone want to buy a house at the same time.

10For a detailed expose of this transition from speculative to transactional demand for crypto works I recommend this blogpost by Parker Lewis, author of the recently published book Gradually, Then Suddenly – see: https://graduallythensuddenly.xyz/pay-me-in-bitcoin-theory/

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