The Stunning Truth Behind the Brutal Crash of Cryptocurrencies

Since their peak late last year, cryptocurrencies crashed by a staggering 70%. Although not nearly as large in scale (2.9 trillion vs. 6.7), this rivaled the percentage fall of the dotcom bust¹. And similar to the dotcom bust, many investors in crypto had no clue what they were buying.

I remember joking that if a company could spell the word ‘internet’, it could get rich with an IPO (initial public offering). These days, even so-called ‘shit-coins’ raised billions with ICOs (initial coin offerings)². In both cases, investor purchased overvalued assets with typical bubble euphoria: 1) this time is different, and 2) the price can never go down. It’s the same logic that people convinced themselves of during the housing boom of 2003-2007.

The Mother of All Bubbles

But unlike the dotcom crash, this crash has only just begun. The Fed just recently started raising interest rates and rates remain relatively low. Also, calling this a crypto crash is a little misleading. All assets are struggling: housing, stocks, bonds and crypto. The blame for this whole mess is squarely at the feet of the Federal Reserve, not idealistic crypto enthusiasts.

However, the benefits of crypto are wildly exaggerated. Many crypto currencies are solutions looking for a problem. Even cryptos with legitimate uses are buried in a sea of hype and misinformation. Similar to the dotcom bust, the technology that backs crypto is inaccessible to the average person. I have no doubt many people purchased crypto with little to no understanding of blockchain, cryptology or internet protocols.

Time for a Cleansing

Of course, a crash isn’t the worst thing that can happen. It took fifteen years, but eventually the Nasdaq reached levels from 2000³. The market-cap for all crypto was around $2.9 trillion at the end of last year⁴. Now it is around $0.9 trillion and it would be foolish to think the market can’t eventually rebound.

When it does, however, I suspect it will look vastly different than it does now. Just like the top stocks of the Nasdaq are different now compared to the dotcom bubble⁵. Crashes and recessions are part of a market economy, even an economy heavily distorted by Fed policy. It’s the cleansing process that shakes out over leveraged speculators and overhyped stocks/cryptos.

Currently, Bitcoin (BTC) has a market-cap of around $500 billion, which is almost as much as all other coins combined⁶. I would be shocked if that is the case 10 or 20 years from now. If history tells us anything, market leaders are doomed to be replaced by better, stronger competitors⁷.

Why Bitcoin is Ripe for Competition

If you believe in cryptocurrencies as a technology, then it is extremely important to realize that innovation is not a stopped clock. For all of BTCs benefits, there are plenty of alternative coins with its qualities and more. The truth is BTC is an old technology and will likely be replaced by faster, larger (block chain), more efficient alternatives.

A primary reason why this is almost certainly assured is due to the open-source nature of the software. One the major selling points of BTC is its trustless network⁸. There isn’t a single authority or set of servers that runs the network. It is a beautiful design and has thus far successfully circumvented regulations and government boundaries. But in order to achieve this, the software itself must be open-source, which means anybody may view, change and improve on its design.

Interestingly enough, this has already happened. There are dozens of well known forks of Bitcoin⁹. And other coins exist that use their own unique designs, like Ethereum¹⁰. I wish I could tell which will win, but I think it is safe to assume any market worth trillions will have competition. This foundational insight seems lost on self described “Bitcoin Maximalists”¹¹.

Limitations of Cryto

They are called cryptocurrencies, but none of them are actually used as currencies. Sure, you can send digital coins to anybody on the planet. Well, anybody with a computer and an internet connection. And that is powerful. But there is a difference between being able to do something and actually doing it. The simple fact is that most people don’t need cryptocurrencies for anything. For everyday transactions, using dollars, credit cards, and electronic banking is simpler and less expensive.

One of the obstacles is the transaction fee, which is currently around $1-2 per BTC transaction¹². With fees that large, you certainly wouldn’t buy a burger or coffee with BTC. Further, the time to validate a transaction is slow, typically around 5-10 minutes¹³. There is simply no way something that slow could function as a day-to-day currency.

On the flip side, these fees and validation times are trivial for large, international settlements. In fact, there is a paper that shows using BTC is superior to standard currency exchanges. So, there are practical uses of crypto, just not as everyday currencies, at least not yet.

Maximum Horsepower

Another limitation for BTC, is the maximum number of transaction per day. Estimates place it around 5-10 transaction per second, which is nowhere near enough to act as a global currency¹⁴. This doesn’t mean that BTC is useless, it just means it has real limitations than can only be overcome by alternative technologies or secondary layers.

On the alternative side, there are plenty of other coins that promise to shatter some of BTC’s limitations. A forked version of BTC, called BSV, can consistently perform thousands of transactions per second¹⁵. Others like EOS can validate transactions in a couple of seconds¹⁶.

Another solution to some of BTC’s limitation is to use a secondary layer. Instead of using the block chain directly, smaller transaction occur off-chain. One such network is called the Lightning Network¹⁷. This secondary layer is an interesting idea, but has issues of its own. For my two cents, if a secondary layer is needed, then what value does the base layer offer? Why not use other cryptocurrencies as the base layer, since consumer value is derived from the secondary layer?

Investment or Speculation

With this background of crypto in mind, the real question for me is whether they are good investments. As shown above, they are not (currently) acting like currency. This doesn’t necessarily make them bad investments, but it doesn’t help. After all, without real-world uses what good are they? Up until recently, they were excellent for speculators. But is there a future for crypto investments?

Miners keep the network running. And even with the crash, crypto miners remain profitable, although not as profitable¹⁸. This is a good sign because there is no block chain without miners.

As for buying and holding crypto coins, I just don’t get it. I certainly understand the purpose of a bond or a stock, but I would never buy and hold a regular currency. The only condition under which buying and holding makes any sense is if you believe more buyers will enter the market (like a Ponzi scheme). For most of crypto’s existence, that was a given. Looking forward, however, I don’t see why that would be the case. Especially not for any specific crypto.

With a deep recession likely, I can easily see many people selling their coins to buy food and fuel. And they won’t use crypto. Instead, they will use plain-old, boring dollars. After the recession, so many people will have losses from the crash that they will be reluctant to jump back into the market. This is exactly what happened after the dotcom bubble. Even though there were incredible buying opportunities, most retail investors passed.

When Will Cryptocurrencies Go Mainstream

Until these digital currencies overcoming their roadblocks, I believe they will remain a niche market and nothing more than a curiosity for speculators. But there is real long term potential for cryptocurrencies, especially as fiat government money struggles. So what will it take to go mainstream?

The first block to widespread adoption is flexibility. I am old enough to remember the 80’s PC wars. I used to go to Radio Shack with my dad and dream of all the different computers I could buy. Ultimately we purchased a Commodore 64. Several years later we upgraded to a Commodore 128. I distinctly remember how disappointed I was with the new PC. Nobody made software for it. To run anything meaningful, I had reboot the computer in 64k mode, which literally ran only half the hardware.

So who won the PC wars of the 80s? It was the IBM compatible PCs. Not because they were more powerful or cheaper, but because they had an architecture that you could easily upgrade with OUT the need for new software. I think we are in a similar epoch with crypto. I believe the ultimate winner(s) of the pending crypto wars will have designs that allow for improvements over time without starting from scratch.

Real Currency

I think it goes without saying, but apparently people haven’t figured out this vital point. Crypto will never go mainstream if it is difficult or expensive. The ideal crypto currency will have fast transaction verifications, like less than 1 second. It will be able to handle many thousands of transactions per second. And it will have some way to stabilize versus other major currencies. When that happens, crypto will easily replace all shitty fiat currencies of the world.

We are not there yet, but don’t give up hope. When automobiles were first invented, there was a battle between electric cars and combustion engines¹⁹. Ironically, it was the electric starter that solidified the dominance of combustion engine cars. I suspect a similar revolutionary invention will occur in the crypto space that eventually seals the doom of government money.

Legality

Speaking of the government, one last major roadblock exists for crypto, legality. Most governments have been silent on the issue thus far. But if these currencies really challenge their ability to print money, I guarantee they will try to shut them down. The absolute brilliance of the trustless network is that physically shutting it down is virtually impossible. There isn’t a single physical server that can be shutdown. Instead there are hundreds of thousands servers spread across the globe.

But don’t be fooled. Governments will try to outlaw crypto. When they wanted to remove gold from circulation, the US government confiscated personal holdings²⁰. Anything that competes with the printing press will either be regulated, taxed, or outlawed. My best guess is that governments will simply fine big corporations for using crypto. It would be easy to enforce and would prevent mass adoption.

Conclusion

Despite my negative short term outlook for cryptos, I believe the future is bright. Governments are so corrupt and their money is so rigged against the common person that free-market alternatives are only a matter of time. Until they address all their obvious shortcomings, however, I think they will remain a niche asset.

On the bright side, I believe crypto technology will continue to advance to the point that current day coins are obsolete. In the long term, newer better systems will replace not only today’s crypto currencies, but also government’s fiat currencies.

Besides mining, which has been a lucrative business, I treat the crypto market like a casino. If I win, great. If I lose, it was with disposable money. I’ve been in the software industry for 30 years, and the one constant is that everything changes with time. I see no reason why crypto currencies will be any different.