I honestly didn’t think I’d ever write this. I thought the cryptocurrency bubble burst in 2022 would have been the end of the story and there would be no need to write it.
Whenever there’s a hype bubble fueling rampant, wildly irresponsible speculalation divorced from any sort of mooring to market principles, what follows is either an end of that market or at least a reckoning that only those with solid business models & fundamentals survive. But not cryptocurrency. The hype is back.
Everything around the hype for Bitcoin, Ethereum, and other cryptocurrencies frames them as an investment. You can invest, watch the price go up and down, further invest in complex derivative products, and eventually cash out for a profit (or loss) — just like the stock market, right?
But the market for Bitcoin isn’t truly the same as other investment vehicles.
If you were to buy 100 shares of Toyota at a certain price or if you were to buy contracts in frozen concentrated orange juice futures, what the cash you invest is ultimately going toward is some combination of capitalizing the costs of building an actual thing people want to buy and of financing others’ profits/losses through speculation around the future value of the equity. And when you sell those shares or futures contracts, the cash you recover is ultimately derived from some combination of profits made from providing value to customers (in this case, cars or a delicious part of your balanced breakfast) and from others financing your profits/losses through speculation around the future value of the equity.
There are of course layers and layers of abstraction in between, but ultimately these are the inputs and outputs: speculation about future supply & demand, and the brass-tacks of capitalizing business activities that create perceptible consumer value in the present moment or immediate future.
Across any particular stock, bond, commodity, or other investment, there’s a different breakdown of how much is speculation and how much is value creation.
IBM’s stock, for example, is an example of one where value creation is the primary driver of the stock’s present value. Every quarter IBM issues a dividend to its shareholders, and it has increased the size of this dividend every quarter since 1995. As IBM profits from its business activities, it distributes a portion of those profits to its shareholders. As a result, those shareholders tend to buy IBM and hold it over the long term, and as a result its stock remains fairly stable, only shifting when there’s material business information released that shifts its business fundamentals; for most of the last five years, it has remained somewhere in the $120 - $150 range (and more strongly this year).
Conversely, Tesla’s stock is an example of one where speculation and hype are the primary driver’s of the stock’s present value. Whereas other car companies like Toyota or General Motors had 2024 P/E ratios — the ratio of the stock’s price to the business’ earnings per share — of 8.04 and 6.24 respectively, as of today’s opening bell, Tesla’s was 63.70; that means at present earning levels, it would take until the year 2088 before the company’s earnings would pay for that purchase price. The stock price is almost entirely based upon speculation around future earnings, be those from robotaxis, robots, or other artificial intelligence offerings promised at some date in the future. As a result, its stock price is highly volatile, shifting almost every time Elon Musk tweets something. Over the last five years, it has swung wildly up and down and back again in the $100 - $400 range.
There’s something that feels “better” about a stock or asset whose value is tied to actually creating economic value in this world. It feels more in-line with the bargain of capitalism: that the way to make money is to create things that people want, that help people live life better, and that solve problems people actually have. Otherwise, it’s just gambling. The meme-stock phenomenons around Gamestop or AMC Entertainment feel like nothing but scams — frenzied speculation rushes, sending prices skyrocketing under thundering herds of demand, trying to capitalize before the stock inevitably crashes and wipes out those left holding the shares. Besides, there’s a term we have for an investment scheme whose appreciation doesn’t derive from creating any actual real value, one where one investor’s gains are only ever financed by others’ present or future losses: a Ponzi scheme.
So what about Bitcoin and other cryptocurrencies? What part of the price of a Bitcoin is based on speculation and hype, and what part is built on value creation of a business in an economy?
Certainly some large amount of it is based on speculation and hype. The bubble got so large we had celebrities featured in Super Bowl ads encouraging people to buy-in, crypto-businesses like Nexo and BlockFi were offering up to 12% fixed interest to keep the cash flowing in, and Elon Musk’s antics in promoting Dogecoin looked so much like a classic pump-and-dump that he was sued for a quarter-billion dollars. And unlike Toyota or IBM, Bitcoin’s value isn’t obviously tied to providing goods-and-services like cars or mainframe computers. Even though “currency” is right there in the name, Cryptocurrency isn’t useful for buying things you can with US dollars or Euros or British pounds, largely because it can take 10-20 minutes for a transaction to be verified as complete.
So there’s a good case to be made that it’s functionally a Ponzi scheme. The various attempts to create legitimate value derived from cryptocurrencies, from NFTs to Web3 application platforms, were all solutions looking for a problem. Predictably, they failed to provide any meaningful customer value.
I certainly argued for years that Bitcoin was a Ponzi scheme, because I couldn’t see a business whose operational success and profit would drive it’s value. I was wrong.
Bitcoin and cryptocurrency are investments: they’re commodities futures contracts for “crime.” Investing in Bitcoin is capitalizing future criminal activity, and profiting from it is taking your cut of crime’s ill-gotten gains.
There’s so much crime. The crime that made the headlines was old-fashioned financial fraud, most visibly brought to light by the bankruptcy of FTX and prosecution of Sam Bankman-Fried. But since the beginning, the most visible players in the cryptocurrency bubble were speed-running the gilded age financial crimes that necessitated the federal financial regulatory agencies like the SEC in the first place.
And beginning with the notorious Silk Road, the Dark Web Markets have been likened to Amazon.com but for drugs, providing escrow-backed anonymized marketplaces where people can buy and sell illegal drugs, stolen credit cards, and other illicit commodities.
But those pale in comparison to the shadowier forms of crime leveraging Bitcoin for money laundering: child pornography, ransomware, and scams.
We can only speculate how much money is laundered through cryptocurrency exchanges. One analysis by a block chain forensics company puts it in the $20-$30 billion per year range. We do know that Changpeng Zhao, the founder of the world’s largest cryptocurrency exchange, Binance, pled guilty to a $4.3 billion fine to the US government for facilitating money laundering on its exchange. Bitcoin and other cryptocurrencies provide a vehicle for organized crime syndicates, embargoed nations like North Korea, and drug cartels to move money across borders and into cash, sidestepping world governments’ enforcement mechanisms in the banking system.
Some large proportion of it comes from ransomware attacks, over $1 billion of it, largely orchestrated by Russian organized crime. Hackers, in penetrating network-connected computer systems, encrypt their contents so as to make them unusable to the owners, demanding a ransom paid in cryptocurrency for the decryption keys. The impact can have tremendous secondary effects, from a hospital network losing access to its electronic health records for six weeks this spring to a fuel pipeline company unable to move its product, sending gas prices skyrocketing and disrupting airline travel.
The United Stated Financial Crimes Enforcement Network, or FinCEN, estimated that the commercial exchange of CSAM (the legal term for child pornography) was $411 million in 2020 and 2021. Using the same mutually anonymized dark web, the spread of exploitative images and videos has flourished through using cryptocurrency to facilitate monetary exchange without one’s name attached.
And since COVID, organized crime syndicates in southeast Asia have found tremendous success at scamming westerners out of their life savings using cryptocurrency, using a scamming technique called “pig butchering”. If you’ve ever had a random text message seemingly misaddressed (for example, one I received just this morning read: “Hi dear! How have you been? Do you have any plans with your family tomorrow or not?”) or had a random person follow you on social media and strike up a conversation, you may been being probed for such a confidence scam. They successfully convince westerners to plow their life savings into buying cryptocurrency, believing they’re doing so through a reputable exchange, only to find that they’ve simply handed their money over to criminals with no intention of returning it. It’s estimated the scam technique has pulled in at least $75 billion so far.
This puts the SEC’s approval of Bitcoin-backed ETF securities in a completely new light. It allows institutional investors to prop up organized crime syndicates and money laundering operations from a safe distance so as to retain the appearance of legitimacy.
So, at best, Bitcoin is a Ponzi scheme. At worst, it’s an investment vehicle to fund organized crime and child exploitation.
And it does all of this while simultaneously accelerating climate change. Because Bitcoin’s ledger is decentralized, it uses cryptographic functions to validate transactions and ensure the integrity of the ledger from tampering. To do this, it relies on a math problem that’s very computationally expensive to solve but very computationally cheap to verify. Because it’s so expensive to produce the cryptographic solution, whomever does so is rewarded with a commission of some of the Bitcoin in the validated transactions, and for each block in the blockchain, whomever solves the problem first gets the commission. This is called “bitcoin mining.”
Bitcoin mining is now dominated by a handful of large firms with enormous farms of computers running top of the line GPUs racing to solve the cryptographic puzzle for each transactional block. This requires a lot of electricity and water to cool these hot-running compute rigs. Bitcoin mining energy consumption doubled in 2023, growing to 141.2 terrawatt hours. That’s more energy use than the entire country of Ukraine in 2021 (before the Russian invasion). If cryptocurrency were a country, it would be among the top 25 largest consumers of electricity.
Every single way you look at it, Bitcoin is awful. It has no redeeming value or legitimate purpose. The people pushing it are either deluded or themselves awful, and in neither case should you trust them with your investment decisions.
Every investment in our ridiculous capitalist society has negative externalities, so it’s impossible to be purely ethical while taking part in capital markets. But it’s really hard to be any more unethical as a capitalist than by investing in Bitcoin and other cryptocurrencies.
Note: I have no personal holdings in IBM, Tesla, or Bitcoin. All of my personal holdings are in managed and broad indexed funds. I am a former IBM employee and received RSUs which I have long since sold.