A new set of topics is up for debate around investing and finance, including whether crypto assets should be treated as money, property, a security or something else as there is no clear regulatory designation set at this point. Perhaps it could be something completely new, sui generis if you will. When thinking about this new technology and the changing landscape of finance, it may help to explore the significance of the island of Yap and its historical background regarding some similar issues. It was about a thousand years ago that an island and its society decided it needed a currency system. Since neither silver nor gold was available to the islanders, they naturally used shells and what they had available to them. Until, they began creating wheels called “rai stones” that would be carved out of limestone and that sometimes were so large they could dwarf a modern car (see above). The coin wheels served as a store of value, a form of money, a form of property that someone could use in special situations such as a daughter’s dowry, insurance for loss of income such as crop destruction, or traded for food, goods, or services.
These rai stones were not meant to serve as a form of currency that changed hands regularly but the islanders viewed them as an easily divisible, portable, and secure means of exchanging value. This made how people felt about money especially exceptional, this idea paved the way for money becoming abstract. Ownership for these limestone wheels had to be broadcasted to the villagers since they could not easily change hands or even sometimes never moved at all. They could also give out rights to proportions of the rai stones if they sought fit too. It’s been said that a newly commissioned giant wheel while moving between islands had sunken off the coast after its vessel capsized. Yet, it continued to hold its value and trade owners according to their oral tradition since the crew and rest of the island knew about it. This system continued as trust was maintained and relied upon, even when the physical assets were not present or seen. Milton Friedman has famously used this island in an essay to compare their rai stone monetary system to that of the gold standard policy. Its historical significance and economic theory illuminates the mystery and phenomena around money and seems very relevant to the times in which we are living.
Contemplating this history brings to light the subject of monetary commodities. Money has traditionally been regarded as something that has scarcity, fungibility, divisibility, transferability, and durability. These satisfied the islanders with their stone money, but to the wider world society it needed a more advanced and sophisticated means to address those qualities. Around the globe monetary policy used to be managed by issuing currency backed by commodities. Often it was gold, the archetypal form of commodity money. Since that time, the world has continued to evolve and now relies on government entities and central banks to manage fiat currencies, interest rates, and so on. Using history as our guide, it does not seem as though our system will likely last forever. It’s human nature to make meaning out of something that is nothing, which is not always rational. With money though, it’s something that is deeply personal and so interwoven into our society that people’s lives revolve around it because they naturally ascribe meaning to it. It’s key to keep in mind that technology changes, economic laws do not.
Today, investors and portfolio managers are facing an ever more burdensome task of finding investments that offer both high returns and low correlations relative to their other assets. Recently having entered the mainstream discussion, crypto assets are developing a unique opportunity for investment professionals to enter an emerging asset class that checks both of those boxes. By complementing their other strategies and positions with crypto assets, this new asset class is demonstrating better performance and risk management qualities for investors with exposure to them relative to other major asset classes like equities, bonds, real estate, commodities, emerging markets and currencies. By spreading out risk further and idiosyncratically with an allocation in this new crypto asset class, managers will have the benefit from both black or white swan events. The white swan if the internet continues to expand and synergize with crypto assets, and the black swan if an economic collapse in capital markets results in restrictions and boundaries set for capital flows across borders since these assets are free from government control. They also may offer a valuable protection against hyperinflation should an event like that arise from economic instability and/or political unrest.
Investing in crypto assets rather than companies or commodities alone may add additional layers of risk, but being a unique asset class it distributes it out into a rational approach that justifies it. As an investment, tokens, networks, and protocols in the blockchain space are under similar constraints compared to traditional technology companies, but they also remove two major layers of risk that the conventional technology companies cannot. Those exceptions are that the company must execute well for their ultimate success, and secondarily that the investor base must hold until a liquidity event occurs. Striping these elements out reduces the normal layers of risk from these assets and only leaves the remaining layer of risk that the underlying assets themselves must appreciate to be successful. A major setback for their adoption exists though, as they are highly technical assets and widely misunderstood likely due to their complexity delving into topics of cryptography, computer science, economics, and game theory.
It is not only their intricacies that make these new assets difficult to follow, but the buying mania over the past year led to price swings over short periods and volatility that normally would churn the stomachs of investors. Also, the fact that there are also over 1300 currencies listed on the website CoinMarketCap makes performing due diligence tough. To confidently assess the market can be quite tricky, aside from tracking the valuations and pricing for these crypto assets. As investments they are not for those who are unversed, inexperienced, or unprepared for the worst. As hedges against inflation or as means of utility enabling people to make more efficient cross-border payments, supply-chains, trade settlements, and transactions. These are all fair arguments for the value of blockchains and crypto assets, though, many brilliant minds are rightfully contesting that those aspects do not fully capture the scope of their capabilities and fundamental value.
Monetary value follows from belief, and its always hard to believe in something new; especially something as complicated and convoluted as crypto assets. With a few lines of code, companies now can issue and sell tokens to a secondary market instead of registering as a Delaware C Corp and restricting fundraising to domestic accredited investors. Ethereum, the programmable internet crypto asset has allowed this to occur and leads the space as a programmable crypto asset. Over the last year, initial coin offerings caused a stir among investors as some projects capitalized millions of dollars in a matter of minutes or hours! Each day these crypto assets continue to transact, add users, and grow their networks, it counts as another day that people familiarize themselves with them. Future generations will look back and see that crypto assets were a logical choice for a monetary commodity since they are akin to the rai stones of Yap and has resemblances to the gold standard that predated the fiat currency system.
Technology and economics will inexorably be linked together if these trends persist and the crypto asset ecosystem continues to grow. It is foreseeable that in the future that one without the other will not offer as much value without the other considering the current advancements in the financial system’s infrastructure. Blockchain technology will be to economics as a bottle is to wine; technology will be the packaging that will allow the value to flow, be stored, or transferred. In short, we are seeing the beginning of a new technological infrastructure being built for the internet of value in order to make currency, capital, credit and prosperity more accessible and hence more valuable. A fact that needs to be realized is that the Internet was meant to be an information superhighway, as opposed to an informational resource. The recent US elections, fake news, and social media advertising fiascos can be great examples of this point.
More than 3.5 billion people in the world have limited access to the financial system, which is more than half the population. This technology has the power to do more than the Internet ever could before being the conduit for the people outside the financial system so long as they can reach getting a smartphone and/or assess to the Internet. New innovative technologies such as blockchain have led to the rise of digital currencies and other distributed technologies for instantaneous and secure peer-to-peer transfers that realize massive cost savings relative to their conventional counterparts, attributable to the disintermediation. Venmo and other similar mobile banking or payment applications have become popular, but are only small patches to an otherwise archaic practically analog financial system. Crypto assets are unique in that they provide inexpensive yet precious services to the individuals and users while incentivizing the founders and developers, and still offering benefits to the businesses, partners, and early adopting investors who also may be able to capitalize on their implicit value from the disruptive impact they pose and rapid user expansion on top of their networks.
In the beginning of 1998, HTML had as much text on the world wide web as about 1.5 million books, but there were university libraries around the world that had over 10 times the number of book volumes with much higher quality and more meaningful content. Once people realized technology would facilitate more “useful” information being repackaged and hosted online, its infrastructure grew with its userbase and provided end users easier, quicker, and cheaper access to information. By adding more simplicity and quality, it incentivized users as well as augmented its value. Now, the world is seeing a similar infrastructure being built. Rather than being for information, this time it is for money, capital, wealth and value in general. The emergence of blockchain technology may displace some technologies and disrupt some industries, but switching to this new infrastructure can dramatically increase security and cost savings, pose tremendous investment upside, and create new options and strategies for people and firms in its innovative economy.
Improved technological infrastructure can vastly increase our ability to store, spend, receive, sort, filter, and distribute value thereby enhancing the value of the blockchain technology itself. In an environment that has political uncertainty, rising interest rates, and economic policy debate, crypto assets as unique forms of digital monetary commodities will likely only gain more attention and users as its infrastructure improves and scales for mainstream adoption. It may not be likely that a new sort of monetary policy will be enacted anytime soon, but it may not be crazy to imagine that crypto assets are used for a new type of gold standard system. Compared to the total market of gold at this moment, they only account for about 0.3% of the yellow metal’s value. Thus far, crypto assets have presented themselves as a more capable type of monetary commodity with extremely more upside and potential. They have a long way to go to create a widespread positive belief for this opinion. In the end, it all comes down to network effects.