Getting Real About Crypto Investing

Looking beyond the current hype cycles, it’s time more investors were exposed to real companies building real products that solve real problems in the real world. Our economic future depends on it.

Many of you reading this title and subheader might be ‘crypto rich’ and thinking: “What the hell is this guy talking about?”

We can all agree that crypto trading and investing in underlying blockchain or DLT structures are related but not nearly the same things from an investment standpoint. If ICOs have taught us anything, it’s that hype and reality are doing a strange dance, perhaps even more bizarre than what we witnessed during the Web 1.0 days or the early days of social media.

In my firm’s case, we talk to a range of high-net worth and high networked investors daily — funds, family offices, large private players, what have you — who have very fundamental questions about the crypto space and seriously question where things are headed from a capitalization, sustained value and asset perspective.

Many of these same individuals and groups are trading cryptos and are making lots of money… and they’re also not believing the hype around the longer term prospects.

Seem market familiar?

Truth is, whether we’re talking about blockchains, distributed ledger technologies or cryptocurrencies, we are still in the very nascent stages of this phenomenon called ‘crypto’. This is a good thing, as we’ll explore in cursory steps here.

Let’s look at all of this through the lens of assets, and the demand around them.

Revisiting the Theory of Asset Demand

The Theory of Asset Demand states that as wealth increases, the demand of financial assets also increases.

There are four main predicates for this demand in financial assets:

an increase in wealth

an increase in RETe ­

a decrease in riskiness

an increase in liquidity­

There are two types of financial assets — necessity assets such as cash and checking accounts and luxury assets such as stocks and bonds.

According to the Theory of Asset Demand, the government declares tax exemptions on bond returns. This results in an increase in quantity, an increase in the price of the bond and a decrease in the interest rate of the bonds. As we’ll see in short order, current economic preconditions along with crypto adoption are turning these dynamics on their head. (source: Prateek Agarwal, Intelligent Economist)

As the graphic suggests, price and quantity mechanics are correlated to economic fluctuations, changes in expected inflation, and tax cuts. All of it implies that investment opportunities would increase in a boom or a market upcycle. Depending on where you sit in the market landscape, booms or upcycles are, of course, relative.

What’s interesting about this is the fact that both necessity and luxury asset classes are being significantly disrupted by blockchain and distributed ledger technologies. There’s also quite an analog to this: An institution like Bank of America holds at least 43 known blockchain patents.

BofA is not alone — dozens upon dozens of companies spread across industries such as insurance, healthcare, retail, logistics, and of course banking and finance, have joined the bandwagon. They’ve drastically cut down their costs to capital, while creating significant new operational efficiencies.

What this tells us is that frictionless payment, optimized supply chain and alternative investment systems are becoming standardized. But at what cost to economic growth?

You see, there is a major caveat: Their efficacy and sustained value are predicated on another mitigating factor, which is the availability of vital resources that people need to live and work better. Reality is that nearly half of all U.S. families are struggling just to pay rent and buy food. This does not bode well for economic stability. Or shall we say that economic instability does not bode well for a large swath of the population.

More on that in a moment.

So, it seems that what we’ve come to understand as necessity assets and luxury assets are being replaced or seriously augmented by crypto assets.

Crypto assets can be defined as units of value that work exclusively on the Internet by using a network of computers that lend their processing power to verify and register all the transactions made. In return for their work, computers are rewarded with a payment in the form of tokens. The system that allows for this to happen is known as the blockchain or a distributed ledger technology (they are related but not the same things), and it is the fundamental force behind any crypto asset.

And again, at what cost to economic growth?

The Implications of Asset Demand with Crypto

Diving deeper into the Theory of Asset Demand, we can now look at Expected Return (RETe), Relative Risk, and Relative Liquidity.

With expected returns, the Demand for Assets is relative to RETe (real returns expected after taxes) on other assets. A higher RETe results in an increase in demand for assets, and therefore demand for other assets goes down.

Relative risk simply means that when the risk of an asset goes up, demand for one asset goes down, thus increasing demand for other assets.

Relative liquidity means that capital can move into assets or asset classes that are increasing in value, thus putting limitations on other assets or asset classes seeking capital from similar or related sources. So, if liquidity goes up, then demand goes up for that asset, thus demand falls for the other assets.

What’s interesting here is the idea that liquidity, risk and return are inversely proportional; in reality, they aren’t necessarily.

One of the great monetary mechanisms of cryptocurrencies, particularly altcoins, is that network scarcity holds perceived value somewhat in check.

Sure, there can be mining and consensus issues, as well as hacking across wallets, but the trustless party aspect solves for things like double spend, and fiat phenomena like quantitative easing are removed. To boot, it is often the case that when a crypto like Bitcoin or Ethereum rallies, so do many of the altcoins in the market, as do the altcoins in a particular ecosystem.

This seems to defy the mechanics of relative risk and relative liquidity, and throws a curious wrench in expected real returns. This also defies most scenarios with fiat currency trading in that currency values are inversely proportional. Capping all this off is that currently, stock and bond performance are not inversely proportional, contrary to what we’ve seen historically.

The great challenge for cryptos in this sense is that they are still tethered to fiat — whether pundits want to accept this or not — which means that asset value is still hyperspeculative. (Let’s ignore, for the moment, that fiat is also digital money.)

Relevant Macroeconomics

From a macroeconomic perspective, we are witnessing three unprecedented preconditions:

Fiat is in aggregate decline; We are experiencing Net Energy Decline; Bonds have been experiencing inverse yields.

For those of you who are unfamiliar with Net Energy Decline: Net energy can be defined as the energy left over after subtracting the energy used to attain energy — i.e. the energy used during the process of extraction, harvesting and transportation of energy. Net energy is critical because it alone powers the non-energy sectors of the global economy. (source: Jonathan Rutherford, Insurge Intelligence)

What this means, in a nutshell, is that we actually have an oversupply problem — there is enough oil in North America alone to last us 200–300 years. When supply is not commensurate with demand (which it isn’t), then we have price drops and subsequent drops in overall value.

As we all know, oil contracts back fiat, like the USD. These contracts are speculative and essentially rigged via OPEC standards. As of today (March 20, 2018), price-per-barrel for crude oil is hovering around $80 and could spike even higher, but this is temporary given that the physical markets in which oil and gas are sold have a storage problem (oversupply). This means that these same speculative contracts will be unable to sustain the value of crude, thereby affecting the value of the USD and other western fiats.

So, the implications of the above trifecta are enormous.

A declining or struggling dollar implies that the U.S. no longer has global reserve status, and that western economies do not enjoy de facto standards in trade. The massive sell-offs in U.S. treasuries by countries like China are perhaps the strongest signal of this. And given that the U.S. and other western countries have imposed trade embargos with powerhouses like China, means that we must create new, fungible value in the middle markets — the places where productivity is the greatest and where export value is revitalized.

Another factor is labor force participation, a key element in the stabilization and growth of any economy. While government figures tout the lowest unemployment rates since 2000, reality is that more companies in aggregate are laying off workers, in part due to automation. As well, the more important figure of underemployment (a metric which can be referred to in what is coined as the ‘gig economy’) is misrepresented, which is closer to 23% in the U.S., and youth underemployment is as a high as 38% in the U.S., and over 50% in some European countries.

When people aren’t working, they’re not producing. When they’re not producing, tax revenues aren’t being generated.

Remember RETe?

A basic marker for economic health is deficit spending against tax receipts. We have a serious issue or gap in terms of real, after tax expected return, simply because fewer people are working and producing fewer assets which means we have declining tax revenues.

Hence, the reason why Democrats want to tax the rich, Republicans want to shelter tax havens for the rich, many Libertarians want flat taxes, and few seem to realize that tax revenues from durable assets — land, energy, water, precious metals, etc. — are essential to the bigger economic picture.

The Importance of Real Utility & Infrastructure

As the creation and redistribution of durable assets proliferate, wage growth is attained when assets in the form of real utilities are developed, thereby supplying jobs, filling skills gaps, and forming new vocational areas.

In other words, when we produce things with real utility value — things people actually need — the people managing those resources have jobs.

This also means that those same utilities must be maintained, necessitating the replenishment or revitalization of said resources. Utility infrastructures, such as next generation microgrid systems or regenerative agriculture systems, therefore, offer up the most promise in terms of regenerating investment value and returns.