uncomfortable realities regarding the future value of crypto projects

The world of blockchain, cryptocurrencies, and other Digital Assets is one of progress, innovation, growth, and advancement. There is no doubt to the inclusion of these platforms, technologies, and assets in our futures worldwide. There is doubt however over how these will be valued both in the near and the long term.

Blockchain Cannot Fail

The technological advances brought on through Bitcoin then other blockchain platforms has already hit levels of “success” by most standards. Albeit early stage success, there are many S & P 500 companies investing heavily and many offering enterprise blockchain systems and solutions. There are hundreds of billions of dollars invested in “public markets” of digital assets. There are multiple cryptocurrencies in use in struggling countries such as Venezuela and in Africa. Many businesses in the U.S., Canada, Japan, Europe, and other first world regions accept payment in the form of cryptocurrencies, although this currently only occurs in very low volume relative to fiat payments. There have been votes for public office (Switzerland), biometric based digital IDs for refugees (Microsoft), large scale supply chain logistics tracking (Walmart, Kroger, Unilever, IBM, etc.), and many more “mainstream” examples of successful blockchain endeavors in use today.

The objective of this overall assessment is not to weigh the risks or opportunities of failure or success for blockchain technology or any of it’s spawn. The one relevant question and only concern for this writing is that of value. This relates on one hand to the value, or importance and benefit, of a project or coin as to whether or not it has a purpose that shouldn’t be fulfilled by other means. More importantly for many, and more generally applicable, is the question of value in the sense of comparative price, dearness, or purchasing power. Attempts will be made to remind the reader of this goal but one would be served well to endeavor to keep this distinction as a filter throughout this writing. Again, the question of value is that of which we seek, not the question of success under any other appraisal.

I hereby disclose that I have some holdings in the Digital Asset space and believe that these are well placed investments for myself in my particular position. Nothing written here is financial advice or investment recommendation but is rather meant for the purposes of education, entertainment, and intellectual pondering. As a result of disclosing my holdings, I hope to encourage the reader that despite all the risks, problems, and headwinds mentioned here, I still believe that there will be crypto assets that do in fact grow in value both practically and in price.

Cryptocurrencies Should Prevail

Cryptocurrencies should by all means take the place of or at a minimum compete with fiat moneys. These new currencies have many more features available and have been created from scratch with much more history, education, and resources to build with. The weakness of not being backed directly by any nation state is also one of the biggest strengths. These currencies will succeed or fail on their own merits and by the assessment of users, not by the means of force, coercion, or lack of competition as most or all fiat currencies have. At the very least, there will be nations that simply make a digital version of their local fiat money and use this in their jurisdiction, as well as likely abroad, thus creating a successful new cryptocurrency through these means.

Money Problems

The general adoption of an independent currency would likely cause an economic downturn or failure throughout the top world powers. Hopefully, this would be minor and isolated to the nation who’s fiat is in direct competition with the new currency but this is doubtful. Most likely, there would be a chain reaction that would have far reaching results and most likely the new competitive currency would be worldwide and independent thus competing with every or nearly every fiat currency in use. Let’s pretend that a new cryptocurrency, named “newcash” is gaining support and is beginning to compete on a large scale with fiat.

The disruption to the flow of fiat would be the first cause of negative economic effects. As legitimacy and acception of newcash grew, more and more people would be spending and relieving themselves of the fiat money they had while holding onto the “better” currency (newcash) until they were free from their fiat holdings. This dumping of fiat would eventually meet demand for said fiat and from that point on would drive down the relative value due to the lack of demand and abundance of supply. Usage would be down since at this point some or many individuals would be using other currencies and a chain reaction would likely occur.

The fiat in reference, or if this were to be a worldwide event, most fiat currencies in existence, would inevitable drop in value relative to newcash. The perception of stability or increased value of the newcash currency along with the perception of negative volatility or decreased value of fiat would incentivize even more people to exchange their fiat to newcash. Since most transactions, loans, holdings, etc. are denominated in fiat, these would inherently loose value or become more expensive during this competition. Since transactions, loans, holdings, etc. involve individuals, corporations, and governments, all of these effected parties would be negatively impacted by these changes. If newcash simply stabilizes at this point and remains a minor, but not insignificant, competitor to fiat and no other factors come into play then the impact would be negative but may not be not disastrous. If newcash began to gain more acceptance than any one or more fiat currency then the effect would be much greater.

As newcash gains adoption, governments will loose control over the supply and flow of money in their territories. The government would not have the power to use monetary policy to control the economy to the same degree they did before the arrival of newcash. Free market principles would begin to battle with Keynesian economic theory and regardless of the result, the competition would increase volatility and therefore uncertainty which in turn will increase disruption in the economy. Whether this be localized to a specific country or involve the world markets, the interconnected aspect of world wide trade would spread some amount of disruption to many markets.

The reaction of governments effected will be a major risk to the economy. If a government attempted to censor or shut down newcash, this would probably increase the value and demand for newcash by giving it legitimacy and stirring up anti government, pro competition, and individual freedom sentiment. On the other hand, if the government fully supported the monetary competition of newcash then this also will increase public acceptance through legitimization and friendly regulation. This will also increase scrutiny, knowledge, and comparison of the fiat in question which will increase uncertainty, fear, and doubt thus decreasing demand further and likely also increasing newcash demand further. Likely, newcash will be independent and worldwide and as such will receive many different responses from many different governments. This would likely ensure that some further legitimacy and acceptance will occur somewhere which no doubt will effect global legitimacy and acceptance worldwide as a result.

Regardless of the size and scope of the effect of newcash on the world economy, just the risk of any such effect that is listed above will incentivize governments to beware of such a scenario. In the same manner, corporations will also be hesitant to such a disruption despite the long term advantages of such currency competition. Finally, individuals will, in a general sense, not respond favorably if they believe that economic downturn will be an effect of newcash adoption. With every party involved being wary of newcash, there will likely not be any swift acceptance but rather will likely be headwinds from all parties involved due to these risks.

Another major headwind to acceptance of newcash or any other independent cryptocurrency is criminal behavior. Criminal behavior not only is possible but is much easier with the availability of cryptocurrencies for transactions. Although this behavior is possible otherwise and will always find a way to occur, the rise of cryptocurrencies has given a better method of transaction in a way contrary to the law. The rise of acceptance will be linked to a rise in criminal use of the currencies of reference. Criminals use money and any rise in use of a currency will inherently raise the total accounts of criminal use but with a currency that is even more efficient and effective to use in criminal activity, the rise of criminal use will raise faster and greater than the rise of said currency use in general. This will draw government attention in a negative fashion and will bring about negative PR that will effect public perception as well. There are many solutions and strategies to help mitigate these headwinds but they will exist to some degree no matter the response, whether it be proactive or reactive.

The overall point of headwinds to acceptance is again not a matter of success but rather a matter of value. The competition of a cryptocurrency with fiat would raise the relative value of the former in relation to the latter but these previously mentioned headwinds impede this form of value increase. Whether the new currency competes as a spendable currency or as a store of value, the result is the same or similar. This is not to say that cryptocurrencies can’t appreciate in value but it is to say that there are some headwinds fighting this in the long run.

On the flip side, let’s say newcash successfully gains a large worldwide market share and is one of the most widely used currencies. According to most models and theories, when a currency is used in this way and has this level of adoption, it becomes very stable in value. This is fairly necessary for use as a spendable currency in general and could precede the rise of adoption and use as well as be a result of them. Regardless the effect is the same, that of price stability, and thus is contrary to the desire of some to have an asset that is increasing in value at an outpaced rate than that of other similar investment opportunities.

Protocol Issues

The balance of power and the incentive structures in cryptocurrencies generally revolve around either Proof of Work (PoW) or Proof of Stake (PoS) systems. Although there are a few exceptions, most projects are purely one or the other, some hybrid of both, or a slight variation on the basic premise. Although these models are very solid and genius, there are a few questions raised in both forms over how they could affect the value of the currencies in the long run.

Proof of Work

Proof of Work systems started it all and therefore will receive the first critique. These systems rely on mining to secure the network and process transactions. This security is designed to come from the decentralization of the minors such that collusion does not occur. As time goes on, there is a risk of mining companies, pools, or consortiums working together to break this security. The incentive would be for them to do so in a way that does not risk discovery but does benefit all involved. Any action of this sort will likely come to light at some point and ruin or devalue the project involved along with any other project of a similar nature and at least ones with a similar risk of collusion.

Another risk comes from the most important resource required for mining… that of energy. Fluctuations in energy prices will not generally effect PoW projects in a detrimental way but the risk of free or near free energy worldwide could. With the rate of technological advancement, it is definitely possible. Another possibility is that the hardware cost to run a PoW network is drastically reduced which could also effect the value of the project.

On the positive side, free energy for all worldwide, or at least a large extent of the world, would likely have the effect of making PoW systems even more decentralized. Anyone with the hardware and an internet connection could compete for mining rewards and the advantage of local energy costs would disappear. The same is true of lower hardware costs. Anyone with an internet connection and cheap energy can compete with the “big dogs” without much up front investment. This would lower fees drastically on many networks as well which brings us to the negative aspect.

Low investment costs would drive down the cost miners would charge to the point where fees would be near zero. This would also drive down the network mining rewards or increase the competition to the point that it would have the same effect of making mining so negligibly profitable as to drastically lower miner incentives. This could increase the risk of a league of miners working together to game the system. Although the greater decentralization aspect mentioned previously is likely, these new and more diverse miners are not incentavized to any great degree towards loyalty, perseverance, upgrades, etc. from which could spring security risks if a consortium took advantage of such aspects. In blockchain networks with unalterable fee and/ or reward structures, the issue of lowering the resources required to mine by eliminating an energy cost and/ or hardware costs could cause some conflicts between the intended security model and the new reality of the equation.

Continuing the issue of value, of course a breach in security of the network would lower the value of said asset. Also, lowering the mining resources required could have an effect of increasing supply without necessarily increasing demand proportionally and thus lowering the value in this way. If mining is cheap and easy, more individuals are incentavized to mine and thus create more coins through the mining rewards, thus diluting the asset supply. In addition, if the resources required to mine are very low, then there isn’t a large deterrent to malicious actors against attacking the system. They wouldn’t have much capital tied up in the network anyway so if their attack somehow damaged the value or structure of the network, it wouldn’t be as much of a loss to them but if they succeeded, their reward could be great.

A common argument on the flip side is that regardless of energy costs, the energy consumption will rise with the rise of PoW networks and could get so high as to effect energy markets, mining participation, government backlash, and/ or public participation and protest. The flip side for hardware is that hardware needed to meaningfully compete will become so specialized and/ or expensive that it lowers decentralization and increases the power and concentration of mining companies which could give them enough power to game the system. Any of these affects could negatively affect the overall value of the coin.

In addition to low resource costs effecting the security model, it also lowers the inherent value of the asset. One of the benefits of a PoW model is that the coin always has a minimum intrinsic value of the cost to create and bring to market. In general the coin will never drop below this intrinsic value, or if it does it should come back to this value in a reasonable amount of time assuming a reasonable market. By lowering one of only two components that make up this intrinsic value equation without changing the other, the equation will always yield the result of a lower intrinsic value. This does not necessarily lower the market value of the coin but it is very reasonable to say that it could. If both inputs to the intrinsic value equation, energy and hardware costs, are lowered then the intrinsic value itself will be all the more lowered.

For a more subjective argument, PoW systems involve a great deal of computational power and thus energy and hardware requirements. This does create the desired security for the network but may not be necessary. Other models, such as PoS, could offer the same security for the network without the need for like investments in hardware and energy. If this proves true then the incentive to use PoW models is much lower due the now arbitrary nature of the PoW system combined with the not arbitrary but now comparatively very expensive nature of the cost to secure. These realities would lower the value of PoW networks relative to the value of other more efficient models. Additionally, even if the PoW model is the only model that provides this level of security and assurance, many doubt if the overall cost is worth it given a scenario of this sort.

Proof of Stake

Proof of Stake avoids most of the potential and real weaknesses of PoW models but has it’s own unique questions over it’s affect on value assessment. The model of PoS security involves relatively low costs to run the network. Energy use is low and the required hardware is much simpler and cheaper. The higher input cost in PoS systems is the invested capital. One usually must “stake” their supply, thus locking it up from free movement, in order to receive the rewards of inflation, dividends, fees, etc.

This is a much more efficient model than PoW but the intrinsic value of PoS assets are much lower than PoW since their creation is much cheaper. There is no need for the asset value to be high because there is little investment cost to recoup for network participants. Participants are also incentavized to hold their coins verses trading them which can help greatly with stability but may not be very useful for value creation and appreciation. Also, why would individuals pay a large premium to hold an asset that simply acts as a savings account, giving them a small “interest” payment for locking up their coins. It could be more likely that the asset would keep a stable value which is good for the network and practical usage but not for an investor looking for better than average rewards on their investment.

Supply and Demand

Capped supply coins are praised by many in the space for the deflationary attribute associated and the hard line that they draw over total supply. This answers the previously rhetorical question of why one would pay a premium for an asset that simply acts as a savings account. With deflationary value creation added to the original rewards, this becomes more plausible. The issue with these coins is that if they are successful, then at some point maximum supply will be reached. This will then shift mining rewards from coming from new coins being created to strictly fee based. This raises fees associated with transactions which could have a lowering effect on value. Also, with no more supply, the incentives will align more with store of value use cases than spending. This is perfect for a store of value asset but may not work well with this particular asset due to the very low intrinsic value aspect. Scarcity and ease of use become the driving factors for increased value which is a great aspect for the foundation of a store of value asset but may not be enough if lacking the intrinsic value variable to avoid high volatility or a loss of faith in the asset itself at some point.

The only way to attain this store of value will be to buy it on the open market. These markets could have relatively low volume which usually increases volatility. A store of value that has volatile price swings is not ideal. There will be a risk of price manipulation as well just like there is with any low volume asset on free market exchanges. Since there is no intrinsic value and there is no way to attain more outside of markets, there will always be a risk of failure. If a sell off occurs for any reason, there could definitely be a cascading effect that crashes the value of the asset to or below it’s intrinsic value. There is no real floor to stop the decline in value aside from sentiment which in this scenario would not be one to rely on. Just the slight risk of these events occurring lowers the value of a store of value asset due to the risk of the value being stored declining which is contrary to the whole point of a store of value. On the flip side, if markets had a high volume than this would signify something else is off from the intent as a store of value because in general, a store of value shouldn’t be traded often if it is fulfilling it’s intended purpose. There has never been an asset like this before and therefore these risks, theories, and the effect on the value of this asset is unknown. These are plausible scenarios however and therefore should be considered.

Platforms and Utility Tokens

There are many blockchain platforms in existence currently with many more under development as well. These platforms are already successful by most assessments and will continue to be so. The value of the native token involved in these blockchain platforms however is not secure. Their main purpose is typically to secure the network and facilitate transactions within said network.

In most cases, there is no need for the tokens to have any more value than a non zero amount. This will prevent spam and payments can be scaled up infinitely to fit any value desired. If $100 worth of the token is needed, there is no difference to the network whether this $100 is .001 of a token or 1000 tokens. The network and market dynamics involved will decide the needed value for the token but from the perspective of relative value, this could be very small and still facilitate a massively successful platform.

Another possibility is that the native token is unecessary completely. Many projects built on the Ethereum platform for example may be able to use Ether for this purpose or another digital asset. Often many cryptocurrencies could conceivable be used for transactions within a platform or DAPP (Decentralized APPlication). Often the other functions desired for a platform such as voting and governance, permission states, proof of identity, etc. could be performed using tokens or digital assets that may not necessarily need to have monetary value or if they did, this value also could be trivial and non rising. Also, some functions such as identity could be done through using cross platform tokens already in existence.

One of the largest downsides from an investment perspective with utility tokens is that they contain no equity in the project. The binary success and level of that success theoretically will have a positive impact on the utility token itself but this isn’t necessary. The platform could be the largest, best, and even only platform in the world but still have a native token with a very low relative value or declining value. As long as the token performs the needed requirements within the network, value is arbitrary.

Oculus, the virtual reality headset maker is a great example. The company first raised a large amount of capital on the Kickstarter platform to the amount of around 2.5 million dollars. The company was soon after purchased by Facebook for roughly 2 billion dollars. Individuals who gave money to the Kickstarter campaign for Oculus had not actually purchased any equity in the company itself so even though the company and equity investors saw life changing gains, the supporters who gave the original 2.5 million for the company to reach their success saw no gains. They later received a free headset if they had given over $275 to the campaign which is around a 100% gain for some and a loss for others but in no case is this anywhere near the return that the company received from the capital they were given.

Corporations currently control the majority of transactions, data flow, and value creation. It is doubtful they will willingly allow independent platforms to take away market share or opportunities from them without a fight. Most corporations have the funds and access to capital to compete very well with “public” platforms. They can even release their own public platforms if desired and have or can acquire top talent worldwide to do so. They also have the advantage of being able to operate at a loss so long as their other ventures or future prospects make up for that loss and the future reward seems worth the expense. Public networks don’t have this luxury. Nor do they have the existing networks to leverage, the pre built infrastructure, the access to talent and capital, the longstanding reputation, the trust, or many of the other qualities that give corporations their usual leverage against upstarts. Corporations can’t stop the blockchain revolution but they can dominate market share and be a strong headwind against independent networks trying to compete with them.

The Masses

One of the biggest challenges to creating value with cryptocurrencies and tokens is the “mass effect”. “The masses” referred to here are the common, average, normal individuals going about their lives with little knowledge or care about the blockchain world. They will use products enabled and improved by the technology. They will use cryptocurrencies as money if it seems convenient and useful. They will support the idea of decentralization and independent ventures. They generally will not go out of their way for any of these features however.

Many people say they don’t trust the government or corporations with their data and funds but take little to no action in regards to this conviction. Many support the crypto movement but have no desire to give any significant amount of time, money, or resources to tangibly support it. Let’s look at Facebook who makes money by collecting all their data they can, selling portions of this data to unknown companies, targets individuals for ads and propaganda, has had multiple security breaches, etc. Say there is another social media platform with all the features Facebook has but with the security, privacy, and decentralized nature offered through blockchain technology. This second company is obviously the best choice but would inevitably fail to be more successful than Facebook because most people don’t care enough about these aspects to deal with the hassle of moving their digital life to a new location with a much smaller network of others on it and the hassle of learning the differences in interacting with this new platform. The same would likely be true of a cryptocurrency.

If the masses are not interested in expending effort to make crypto and blockchain projects succeed, then these projects must be so much better than all other current options as to draw the masses away from the traditional and expend the effort required to switch or implement the new. This is not to say that everyone is ignorant or the general public is unintelligent but rather to simply observe that it is rare for new technologies, products, or platforms to gain widespread adoption over incumbent actors easily or commonly. It has happened many times but has failed more times than not. Betamax is a great example of a product that was better than the competition that overtook it in the market. The best product does not always win.

Aside from other forms of value appreciation, speculation has been a dominant driver of price increases thus far. This makes sense since the technology, platforms, and currencies involved generally aren’t even finished yet and thus they are in the “investment” stages of development. As stated before, however, the investment in these projects through buying the native asset is not an investment of equity in the project and therefore needs to be assessed differently as well. Another negative to speculation is it’s instability and volatility. Nothing should be needed in way of explanation here. Finally, speculation does not last forever and even if value is driven up through this means, it will end. It could possibly even be wiped out. At this point, the projects must gain value and be assessed by other means such as intrinsic value, scarcity, use cases, and other means of value assessment.

There is definitely great potential for crypto and blockchain projects to succeed but will the victors be decentralized? Will they be permissionless? Will they be free from censorship and control? Will they uphold the principles that started the movement? Will they be worth more in the future than they are now? Will they even be the projects being invested in today?

If you are interested in an audio format, the podcast Our Foundations did a series on blockchain and cryptocurrencies (Episodes 41–46) that hits on similar topics. It can be found on any podcast player or through the website: https://ourfoundations.podbean.com/

TLDR; Conclusion

Digital Assets, whether cryptocurrencies, utility tokens, or other blockchain enabled applications, will undoubtedly underlie the future of our societies. There will be infrastructure, governments, as well as end use applications all driven by blockchain technology. What current projects will still exist and what value will they have? Will they be practically valuable to their markets with low monetary value? Assessing these questions is necessary for anyone in the space in any capacity. The answer is already known… we don’t know… and thus the questions are all the more important to analyze, prepare for, hedge against, and take advantage of.