Can Bitcoin Serve as a World Currency?

More often than not, Twitter ends up being a malapropos use of time given the noise to signal ratio. But every once in a while, a gem surfaces to the top. This post is the direct result of a pseudonymous personality on Twitter that put me onto an essay written by Benjamin Franklin in 1729. The essay was penned as The Nature and Necessity of a Paper-Currencythe ideas it expounded had me thinking all weekend, and so in typical fashion, I needed to get them out in a piece of my own. Before we begin, however, I want to call attention to a nota bene: I am a novice in the topic of monetary systems and currencies, so advance apologies if the topics we are about to discuss are elementary in nature. My goal is to understand. To do so, I rely on the classical art of putting abstract thoughts into written text. I leave it to you then, my attendant reader, to correct me where I am wrong so that hopefully in the future, I am no longer. 

Title page of “A Modest Enquiry into the Nature and Necessity of a Paper Currency,” April 3, 1729. The Library Company of Philadelphia

Title page of “A Modest Enquiry into the Nature and Necessity of a Paper Currency,” April 3, 1729. The Library Company of Philadelphia

Bitcoin, the digital asset that gave birth to blockchains, cryptocurrencies, and ICOs, has a fixed supply. In total, there will only be 21 million bitcoins. At the time of this writing, roughly 16.5 million bitcoins have been mined, leaving us with 4.5 million bitcoins to be mined in the future. Without getting into the specifics of mining inflation, let us take these facts and proceed to thinking about whether bitcoin can serve as world currency (for the remainder of this piece, we refer to bitcoin the asset rather than Bitcoin the protocol). To do this, we will rely on first principles thinking, resorting to little to no source material. We will use source material for hard facts, but not for ideas, as we will want to develop the latter from the former. 

Many supporters of bitcoin believe that it can serve as a worldwide currency. They believe it can transcend artificially constructed geographic borders and create an un-seizable, censorship resistant (the key word is resistant, not immune), and peer to peer digital currency that no centralized institution can control. 21 million bitcoins will ever exist; no fewer and no more. In this world, irrational and corruptible humans cannot manipulate the fixed supply. If you own one bitcoin, you have full confidence that the supply of bitcoins, and thus denominator, will never change. This is an extremely noble goal, and one that the population of the world certainly deserves. Upon reading the aforementioned essay, however, I no longer think bitcoins can serve as the currency for the world. To understand why, let us turn to the arguments laid forth by Benjamin Franklin. 

Excerpt from  The Nature and Necessity of a Paper-Currency.

Excerpt from The Nature and Necessity of a Paper-Currency.

In the essay, Franklin argues that scarcity, or a fixed supply, is not a desirable attribute of a currency. His logic is refreshingly simple, unlike many arguments used by cryptocurrency enthusiasts. And in my experience, logically simple arguments usually make the most sense. 

While Franklin artfully constructs his reasoning, let us attempt to understand, using clear, modern English, why a scarce currency is not an ideal currency for society. To begin, let us construct a world that uses a scarce currency. In this world, you can buy items and pay for services using a scarce resource with a fixed supply — bitcoin. In our mythical world, wealth is measured by how many bitcoins you own. It follows, then, that in order to increase your wealth you need to increase your holdings of bitcoins. Using simple math, the amount of bitcoins you own is the numerator, and the fixed supply of bitcoins is the denominator. If today you hold 1,000 bitcoins (1,000/21,000,000 of total bitcoins), your wealth would increase if you held fifty additional bitcoins (1,050/21,000,000 of total bitcoins). Wealth is dictated by your ability to amass currency. 

In this world of fixed supply, in order to increase wealth you are incentivized not to part with your bitcoins. Selling or exchanging bitcoins for another asset would only decrease your numerator, and thus your wealth. In the early days, let's assume that 21,000,000 bitcoins are evenly distributed to a world with a population of 21,000,000. In other words, each person gets one bitcoin. Distributing a fixed supply is simple enough, but making sure each person has the same productive capacity is not. 

As time goes on, certain people may want to exchange small amounts of bitcoin for food and water. Over time, those with the ability to supply assets in demand (such as food and water), will have more than the one bitcoin since they have not parted with their original distribution. That is because these productive citizens now own the original bitcoin they received and the bitcoins they received for the assets they exchanged. They have used their productive capacity to create value — food and water — in exchange for bitcoins. We can dictate how many bitcoins will be created and how they are initially distributed, but we cannot force everyone in the world to have the same productive capacity. In short, wealth will aggregate with those that create more than they consume. 

The logical conclusion of this experimental world, then, is those with productive capacity will convert the value they created into bitcoins. And since there is a fixed supply of bitcoins, a productive individual will not want to part with her bitcoins. There will be some folks, however, who need bitcoins in order to become productive, such as when they want to build a factory to product food. To build that factory, these folks will need to borrow bitcoins from those who have bitcoins to lend. Lending, however, is a business like any other. As such, there is a transaction cost to lending; this is commonly known as an interest rate. Those who lend, then, will eventually receive the initial amount of bitcoins they lent in addition to the bitcoins they earned from charging interest. Their numerator has now gotten even larger.

Wealth has now aggregated with a select few hard working and forward thinking individuals. These individuals are now able to command the rest of the population who were not as hard working and forward thinking, or whose elders were not as hard working and forward thinking, and thus did not leave an inheritance.  

In this piece, the initial process of bitcoin distribution to wealth aggregation went by relatively quickly. But in a real-world scenario, this process would most likely take hundreds of years. The first hundred or so years may seem rosy, as bitcoins are relatively well-distributed. But down the line, the effects of productive capacity multiply, leading to extreme wealth aggregation. Those who want to store their wealth in bitcoins will be able to do so with ease. But those who want to attain wealth will have a much more difficult time since they can only reach productive capacity by borrowing bitcoins for a fee denominated in bitcoins. Thus, the only way to increase your wealth, if you started with nothing, is to have a productive capacity that exceeds the rate of interest bitcoin lenders charge. Should you be able to do so, you would become a wealth aggregator yourself. 

And so, you now see why I believe a fixed supply (scarce) currency may not be in the best interest of society. There may be another digital asset that can serve as a world currency, but it will need to have an adjustable supply in order to counteract the effects of wealth aggregation. 

The goal of this piece was to set forth an argument as to why bitcoin is not ideal to be a world currency. I explicitly did not comment on its other use cases. I have no plans to sell any bitcoins I own and remain confident in its ability to store value in a censorship resistant way. 

As I mentioned at the start of this piece, I am fully outside my circle of competence in discussing monetary systems and currencies. I am, however, very open to learning more about the topic. To that effect, I highly encourage you, dear reader, to make comments, send relevant reading recommendations, and for truth's sake, endeavor to impartially debate the topic. 

Musings on Token Offerings

There is absolutely an irrational exuberance happening right now in the market for cryptocurrencies. As I write this, the market capitalization for tokens and cryptocurrencies (for simplicity, I refer to the terminology "token" to represent both types of digital currencies) is roughly $111 billion, which for scale, lies somewhere between the market caps of Starbucks ($87 billion) and McDonald's ($125 billion). Whereas I can leave my Manhattan apartment now to pick up a coffee or burger from the latter two public companies, the derived value of tokens is largely propped up by speculation (greed), blind optimism (faith), and enticing storytelling (myth). There are, of course, legitimate companies using tokens as a mechanism to bring a decentralized network effect to their product, but even then, the valuation is not aligned to the value (current or expected). There is no better person to quote about value than Warren Buffet.

“For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.”

The message is simple: it's entirely possible to overpay for shares in a business, even if it's a spectacular business, because it will never be able to grow into the already sky-high valuation. While tokens don't represent equity ownership (at the moment), they are supposed to represent the future value of the underlying protocol or product. Right now, token holders seem to think that the future value of the protocols and products will be $111 billion. While I have no doubt that the market capitalization of decentralized protocols and applications will exceed that amount in the future, I do not believe this current iteration of tokens will be the generation to generate this kind of enormous value (to be explained in a future post).   

I will now admit to one other fact, and then give some miscellaneous and possibly confusingly organized list of thoughts on token offerings. Starting with the fact. I am an investor, and sometimes speculator, in tokens. This may confuse you, given what I mention in paragraphs above, but do not let it prevent you from missing the point of this piece: in this market, tokens are mispriced, misunderstood, and will inevitably crash at some point in time that I have no way of predicting, knowing, or attempting to explain. Having said that, the reason I partake in this highly inefficient and irrational market is threefold.

First -- you can start developing skills in token investing that will come in handy for second-generation tokens (after this bubble pops). Second -- having some sort of skin in the game makes you more likely to stay attuned to what is going on in this space. To quote the notorious Jesse Livermore, "the game taught me the game." The only way to play the game is to actually play it. Reading about tokens will only get you so far. The third and final reason -- purchasing tokens provides for good fun. You can buy and sell tokens seven days a week, twenty four hours a day. That's not always a good thing for an investor's psyche (friends may ask why you are suddenly anxious during a casual Saturday dinner), but it sure is entertaining. 

Now for the musings. Below are a collection of reflections I have gathered in the past few months after investing and speculating in various tokens. I do not aim for this to be comprehensive, fully correct (we are all figuring these things out as we go...anyone who thinks they have this stuff figured out is either delusional, lying, and possibly both), or any type of investment advice. 

  • With many newly minted token millionaires, it's easy to assume they have things figured out. As the recent Uber news showed us, success hides problems. Many token millionaires made their money not due to skill, a systematic process, or deep experience, but through the sheer luck of being at the right place at the right time. Don' be fooled by their randomness. Here, it's helpful to read the work of Michael Mauboussin on base rates. Just a short quote: "...when luck dominates the best prediction of the next outcome should stick closely to the base rate. For example, money management has a lot of luck, especially in the short run. So if a fund has a particularly good year, a reasonable forecast for the subsequent year would be a result closer to the average of all funds."
  • I believe the best investing analog for tokens is seed and angel investing. In seed and angel investments, the investor often has nothing to go by except a simple deck and an idea. Since these investors give founders money before product / market fit, they're really just betting on the founders' ability to execute. In short, they're betting on the team. Similarly, many token offerings raise money before any product is created. The only data points a token investor has before making the investing are the whitepaper, various code commit histories and community engagement, and the team (I do not recommend investing in undisclosed teams). The market, however, seems to over-index on the importance of whitepapers rather than on the importance of teams. The seed and angel analog for whitepapers would be pitch decks. I encourage you to look at the pitch decks for a few large companies / unicorns and compare their initial proposition to what the companies actually do now. You will find similarities in the originally stated goal of the company and the reality today, but most often, you will find many more differences. At all stages, but especially at early ones, a company needs to be flexible and course-correct when needed. Automobiles are course-corrected by the driver. Companies course-correct by the founders. My most profitable token investments have been those where I invested based on the strength of the team, not the whitepaper. How I evaluate teams will be a post somewhere down the line. 
  • It is my experience that the best investors often invest unemotionally. My biggest losers have been token investments that appealed to me emotionally. These investments would probably not have appealed to me in a rational state of mind. My biggest losers have also come from the investment choices I made when following the crowd. Academically, it is easy to digest that you should buy when others are fearful and sell when they are greedy. In practice, things are not always so simple, since you are fighting against the fear of missing out. You can read about these mental and emotional investing fallacies your whole life, but without actually riding the rollercoaster you won't fully absorb them. Charles Mackay knew this over 150 years ago: "Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one." I am very happy I have the freedom to make these mistakes in this generation of tokens rather than the second, much more lucrative generation. 
  • Bifurcation of tokens is the first necessary step. There are two types of tokens: those you want to buy and hold for the long-term, and those you may want to trade for short-term profit opportunities. For the latter, token markets are inefficient. For the most part, you are not dealing with sophisticated traders, which can make the competition quite surmountable, if you do your reading. Although I am still developing the mental model I am about to describe, I think it works well enough to use in practice. There are two sides to every market: buyers and sellers. Buyers can be sellers, and sellers can be buyers, but the level of sophistication of each person varies. I have noticed that the markets for certain tokens skew either higher or lower as to the average level of buyer, holder, and seller sophistication. Specifically, I look for token markets where the average level of buyer and holder sophistication is low, which gives me the ability to sell back into the market at higher prices. Ether, for example, had a run up in price as a result of retail investors flooding in after reading about initial coin offerings and not wanting to miss out. While ether has some very sophisticated buyers and holders, this flood of new and unexperienced investors lowered the average level of sophistication of the buyer and holder. What this means in practice is that the average holder of ether will react more slowly to news, giving you an edge to trade against. On the contrary, certain tokens have very sophisticated holders, some of which are whales with inside information. In an effort to skew the probabilities of winning in your favor, I recommend you avoid competing with them. 

I am still learning about the business of token investing, and I have no plans to stop. All markets contain information asymmetry, but this is especially true for new markets such as the one we spoke about here. I find that writing about my investment strategies helps me better think about and improve on them, so you can say I write this out of selfishness. Feedback is welcome; feedback to refute the above points even more-so. 

Banal Things and Epistemology

One of my favorite things to do in Manhattan is to walk the streets and take in the daily bustle of New Yorkers. We're an anxious and rambunctious folk relative to other city-dwellers, so it is an interesting thing for me to do and stop to watch the commotion in slow motion. 

The Subway Echo Chamber

Every day, I take the subway to work from the Upper East Side to the office or client site. As I walk into the subway station every day, I see people rush down to the train tracks when they hear the sound of an incoming train, only to be disappointed that the train is on the opposite side of the tracks. I thought about why this happens, and came up with a few reasons. Firstly, people can hear the train coming but they cannot see it; their field of vision is restricted, but their hearing isn't. Thus, they decide to take a gamble and rush down the stairs with limited knowledge of the situation. Another reason people run down the stairs to an empty track is contagion. They see other people running down, who see other people who see others yet; this contagion escalates all the way up to people just entering the subway since they think those down below saw the train coming. Every day, I see the same thing happen. In fact, I used to be one of the suckers entering the subway station, noticing the contagion, and joining in the rush only to be disappointed the train is on the other side of the tracks. This banal daily occurrence reminds me of the things you see in the world of investing, such as a hot IPO that initially attracts lots of money (FOMO, contagion, call it whatever you like) only to deliver disappointing results down the line. 

The Pedestrian Light

We've all been taught to cross the street when we see the pedestrian light turn green. What we should have been taught, however, is to cross the street as soon as the car traffic light turns red. That is, after all, a leading indicator of the pedestrian traffic light turning green. I think a lot of leading indicators in the world of behavioral economics and investing. I had to introduce a startup panel the other week, and I thought the traffic light analogy was a very appropriate one. By spending your time learning about what startups in a certain sector are doing, you are looking at a leading indicator on some of the technology, products, and business models that will trickle down into enterprise five to ten years down the line. 

The Whole Foods Checkout Counter

There is a Whole Foods near my office, and once or twice a week I pick up a lunch there. For the unacquainted, Whole Foods is packed during all but a few hours of the day, at least in Manhattan. It's a supermarket, but it also has a great selection of salad bar food choices, sandwiches, and pizza. The salad bar is by far the most popular to-go option, so the checkout line is always packed. The sandwich and pizza checkout lines, while still busy, tend to move more quickly. What I started doing is getting hot food in the salad bar and instead of waiting in the long salad bar checkout line, I started paying for the hot food in the much faster pizza or sandwich checkout counters. There are a lot of people using this shortcut, but they are still the minority. I'm not sure what this means about human behavior, but I think we assign rules to our daily lives just because we assume they should exist. Whole Foods has no rule that you have to pay for salad bar food in the salad bar checkout counter or for pizza in the pizza counter, but we just assume it does. How many other rules do we follow just because we assume they exist?

My Favorite Books - 2016 Edition

I am deeply jealous, albeit slightly confused, of people who read over fifty books a year. I try to read around fifteen, and even then, I have trouble remembering what I read a few months after the fact. This is normal, of course, as the act of remembering information is a proxy of instituting that information in your daily thinking. If you don't think about it, you forget it. That's why the amalgam morning headlines you read with your first cup of morning coffee are forgotten by the time you have your third cup. The information comes in one ear and comes out the other. What comes in easy goes out just as easy. 

But some things stay with you. Out of the few thousand articles I read this year, I can recall maybe three or four that had a lasting impact on my thinking. That makes you wonder: was it even worth reading all of those articles in the first place? For me, the answer is an unequivocal "probably not." As I've publicly stated before, going forward in 2017, I will decrease my time spent reading news and increase my time spent reading books. Time is limited, knowledge and information are not. Your goal as an intellectually curious person, I believe, is to maximize the gathering of knowledge and information while minimizing the time spent garnering it all. 

With that preamble out of the way, let us look at some of the books that are worth remembering, just as we did in 2015

The True Believer

Most books are too long and cover too little. This book is the opposite of that. If you had to cram as much wisdom per sentence, you would have a hard time matching The True Believer. The book is all about mass movements; how they form, what keeps them in power, and finally, why they eventually fail. What makes it especially interesting is the author, who was a self-educated drifter and longshoreman. You will not find any pseudo-intellectualism in his writing. Here are some quotes that resonated with me:

When a mass movement begins to attract people who are interested in their individual careers, it is a sign that it has passed its vigorous stage; that it is no longer engaged in molding a new world but in possessing and preserving the present. I ceases then to be a movement and becomes an enterprise. 

When people revolt in a totalitarian society, they rise not against the wickedness of the regime but its weakness.

[On what makes a good leader] What are the talents requisite for such a performance? Exceptional intelligence, noble character and originality seem neither indispensable nor perhaps desirable. The main requirements seem to be: audacity and joy in defiance; an iron will; a fanatical conviction that he is in possession of the one and only truth; faith in his destiny and luck; a capacity for passionate hatred; contempt for the present; a cunning estimate of human nature; a delight in symbols (spectacles and ceremonials); unbounded brazenness which finds expression in a disregard of consistency and fairness; a recognition that the innermost craving of a following for communion and that there can never be too much of it; a capacity for winning and holding the utmost loyalty of a group of able lieutenants. 

The knowledge in this book can be applied almost anywhere - markets, technology, or your own leadership.

The Lessons of History 

History is a collection of stories that help you pattern match. When we live in a world filled with social media echo chambers and filter bubbles, it is important to be able to take a step back from the news and take a deep look at what's really going on. History lets you do that because the outcomes of each event are known. The patterns (stories) are there to be absorbed, and the matching (making links to the present) you must do on your own. More often than not, pattern matching results in a successful decision, but there are times it can hurt (a deep background in history and patterns can make you jaded and hesitant to act, whereas naivety encourages participation, even if through sheer inexperience). The Lessons of History is a course on the patterns our society goes through, and I use it to think about today. 

So the first biological lesson of history is that life is competition. Competition is not only the life of trade, it is the trade of life - peaceful when food abounds, violent when the mouths outrun the food. Animals eat one another without qualm; civilized men consume one another by due process of law. Co-operation is real, and increases with social development, but mostly because it is a tool and form of competition; we co-operate in our group - our family, community, club, church, party, "race", or nation - in order to strengthen our group in its competition with other groups. 

Intellect is therefore a vital force in history, but it can also be a dissolvent and destructive power. Out of every hundred new ideas, ninety-nine or more will probably be inferior to the traditional responses which they propose to replace. No one man, however brilliant or well-informed, can come in one lifetime to such fullness of understanding as to safely judge and dismiss the customs or institutions of his society, for these are the wisdom of generations after centuries of experiment in the laboratory of history. 

So the conservative who resists change is as valuable as the radical who proposes it - perhaps as much more valuable as roots are more vital than grafts. It is good that new ideas should be heard, for the sake of the few that can be used; but it also good that new ideas should be compelled to go through the mill of objection, opposition, and contumely; this is the trial heat which innovations must survive before being allowed to enter the human race. 

Before I tackle any business decision, I try first to find some sort of historical precedent as to the outcome. If the outcome is beneficial in my favor, I proceed to think deeper about the problem. If the outcome is negative, I reevaluate whether the historical apology is an apt one, and if it is, whether this is a decision that is worth pursuing. History doesn't repeat itself but it often rhymes.

Fooled by Randomness 

We are often assigned books to read at an early age, with the ultimate goal of having these books teach us something about life. I believe this can actually be detrimental. For a book to be impactful, you must not only understand it from an academic perspective, but also be "ready" for it. Reading a book you are not ready for is detrimental as you are less likely to pick it up sometime again in the future if you did not appreciate it the first time around. When I first read Fooled by Randomness a few years ago, I didn't fully appreciate the lessons it told. For this reason, I decided to re-read it this year, despite it not resonating with me years ago. And I'm very glad I did, for it has changed the way I approach certain situations in my life. 

My lesson from Soros is to start every meeting at my boutique by convincing everyone that we are a bunch of idiots who know nothing and are mistake-prone, but happen to be endowed with the rare privilege of knowing it.

People do not realize that the media is paid to get your attention. For a journalist, silence rarely surpasses any word.

Lucky fools do not bear the slightest suspicion that they may be lucky fools - by definition, they do not know that they belong to such a category.

The first lesson I took away from Fooled by Randomness is that the magnitude of an event is far more important than the frequency with which it occurs. This is simple to understand in the case of investing. In the first scenario, let's say you have $100 to invest, and you do so by investing $1 in 100 companies. Each of these investments returns 5x the initial capital invested. In the second scenario, you still have $100 to invest, but ninety-nine of your investments fail, and only one returns 1000x. In scenario one you make a total of $500 ($1 x 100 x 5). In scenario two you make $1000 ($1 x 1000 x 1). Frequency is overrated; magnitude is underrated. There is another application of this very same idea to networking. For work, I often have to attend conferences and various meetups. In the past, I usually opted to having short conversations with a large amount of people. These conversations tended to be chit-chatty in nature, and very rarely led to any sort of lasting relationship. More recently, however, I have pivoted to speaking with only one or two people at a conference, but giving them much more time and attention. This has been incredibly beneficial, both from a relationship-building perspective, but also for building friendships. Again, the magnitude of conversation mattered much more than the frequency of it.

The second lesson comes in the form of how I view luck vs skill. Taking advice from successful people is a popular pastime. But is it possible to separate how much of their success is attributed to luck vs skill? This is a question to the answer of which I am still trying to determine. This much I have learned, however: do not take advice from people who have have gotten rich based on the outcome of one event (more likely than not that advice is not reproducible and was the result of luck); take advice from those who have a consecutive record of success (it is more likely than not that skill was involved rather than luck); be wary of the advice from experts as soon as that advice enters a field they have not been successful in (skill does not often translate well to other topics); luck can be increased by rolling the die more times (take chances, fail often, learn, and move on). 

And with that, let's mark an end to 2016 and look forward to a memorable 2017. I know I haven't been great at keeping this blog updated, but thanks always for reading and keeping subscribed.