Cryptomania continues this week, with prices roaring and news of broke buyers using credit cards and loans against their homes to get in– classic financially-suicidal behaviors.
Bizarre as all of this may seem, manufacturing digital credits is reminiscent of what governments have been doing with a vengeance the past decade in issuing and selling treasury bonds to financial intermediaries, collecting the cash, and then funneling it to central banks to buy bonds and other securities off those same financial intermediaries (QE). Corporations too have been issuing bonds to raise cash to buy back their own shares and drive up their market price. These are the speculative cheerleaders of our time.
Different from government and corporate securities though, cryptocurrencies have no physical assets or claim on future cash flow backing their notional value at all. Cryptos only have value to the extent they can be exchanged for goods and services or for another currency at a higher rate than one paid to acquire it.
In a survey last month, just 8% of bitcoin holders said they planned to use bitcoin to buy goods and services. Most said it was a ‘store of value’ or an investment, but 56% said they intended to hold on to their bitcoin for less than 3 years and would convert it back to their home currency after the credits had risen further in value. And although more businesses are acquiescing to requests from crypto advocates to accept alt-coins as payment, most are only doing so on the premise that they are liquid and can be easily converted to the local currency in which they pay their operating expenses.
In practical terms, we need the bulk of our assets and income in the same currency unit in which we pay our bills. If some people come to earn their income in a cryptocurrency and pay their bills in the same unit without facing the cost and need for costly conversions and intermediaries, then perhaps it may make sense for them to do so. But the time-old concerns of safety, security and liquidity are likely to remain.
Many crypto proponents argue that as the economy enters another crisis, virtual currencies will hold or increase in value even as other asset prices fall. We doubt it.
The world is awash in debt and record leverage and those obligations are denominated in currencies like dollars, pounds, Euros and Yen, not cryptocurrencies. Just one example shown below, the mountain of NYSE margin debt outstanding today (in red) is all owed in US dollars and will need to be repaid in kind as asset prices fall in the next bear market.
When a credit crunch hits, people need cash to pay loans, margin calls and afford living expenses. To raise it, they sell everything, starting with the most liquid assets first. History suggests that the next global liquidity crunch is likely to trigger the selling of cryptos just as it did precious metals, and the bonds and shares of even the most beloved, global corporations during previous downturns.
Case in point: while being one of most innovative and dominant tech companies of the last 20 years, Apple shares were still liquidated with other risk assets, falling 80%+ in 2000-02 and 60% in 2008-09. The internet has been a world-changing innovation, and still many of the early leaders went bankrupt (Nortel anyone?), and the basket of surviving tech companies making up the NASDAQ Index fell 78% into 2002 and spent 15 years thereafter just growing back losses.
As usual, the loudest proponents of a financial product or theme are those in the business of selling it to others (in exchange for our cash). Note the booming crypto-service sector and rush of financial firms clamoring to bring crypto-funds and futures to market, all for our buying enjoyment!
With no income flow or asset backing of any kind, cryptocurrencies can’t be valued as an investment and are the very definition of speculation.
If one is interested in speculation, then like when heading to a casino, there are two critical rules of self-preservation: never borrow to speculate, and always limit the wager to an amount you feel comfortable losing, without any negative effect on lifestyle, future goals or peace of mind.