Poker, Cryptocurrency and Unicorns

In my previous post of 2018 WSOP predictions, I predicted that profits harvested by cryptocurrency speculators will be one factor driving an increased turnout for this year’s WSOP Main Event.  I also promised a follow-up post explaining my negative outlook on cryptocurrency.  Maybe I was too harsh is pledging to “trash this bullshit.”  It’s just unsustainable.

What is cryptocurrency?  The first and best known cryptocurrency is Bitcoin, created in 2009.  Quoting Wikipedia (so I can disclaim any responsibility for describing this incorrectly when the crypto-knives come out):

A cryptocurrency (or crypto currency) is a digital asset designed to work as a medium of exchange that uses cryptography to secure its transactions, to control the creation of additional units, and to verify the transfer of assets.  Cryptocurrencies are a type of digital currencies, alternative currencies and virtual currencies. Cryptocurrencies use decentralized control as opposed to centralized electronic money and central banking systems.  The decentralized control of each cryptocurrency works through a blockchain, which is a public transaction database, functioning as a distributed ledger.

Got that?  Think of cryptocurrency as imaginary money, using computers to keep track of a series of barter transactions.  In its early days, Bitcoin gained popularity in illegal, black markets.  Say I want to sell you some stolen weapons, for which you’ll pay me at some unspecified later date with stolen credit cards.  Instead of an IOU, you give me four Bitcoins.  If you don’t come through with the stolen credit cards, or I get tired of waiting or get a better offer, I can use the Bitcoins to buy illegal drugs or pay for the services of a tech-savvy prostitute.  If the exchange value of Bitcoin doubles, I might be able to get laid for only two Bitcoins instead of four and use the other two Bitcoins for Canadian Viagra.  Not that I would actually do this; I’m just trying to illustrate how it works.  The blockchain technology time and date stamps each transaction, while anonymizing the sordid details.  For one of these transactions, that would be a “tramp stamp.”

All transactions are essentially a form of barter.  In the world of legal transactions, we have an established way of keeping track of our activity.  It’s called cash.  I have some clients who give me cash for business consulting advice.  When I play poker, I exchange part of that cash for poker chips.  A group of 7-10 like-minded folks does the same and we use these chips as token pieces in a sometimes fun / sometimes stressful game.  Like Monopoly money, these token pieces have value within the context of the game.  Some of the players end up with more, others less.  If I do well in the game, I can exchange my larger cache of poker chips for more cash, without worrying that I’ll get less cash along with an explanation that the poker chip-to-cash exchange rate changed while I was playing the game.  I’ll be hungry, however, so I can take the cash to a nearby restaurant and negotiate to exchange some of it for a delicious meal.

Cash money is really just pieces of otherwise valueless rectangular pieces of paper (or circular coins), except society has mutually agreed on a meaning to the different pictures, markings and figures on each rectangular piece of paper (or coin).  Everything we obtain with cash is a form of indirect barter.  Inside the poker room, we can use poker chips instead of cash to purchase a massage or snack or tip the dealer, as long as there is mutual agreement as the value of each chip.  Direct barter would occur if we went to the grocery store and offered to exchange some extra tomatoes from our backyard garden for some bread and milk.  That’s impractical.  So we exchange cash, then the grocer exchanges our cash for tomatoes from a produce distributor.  Checks, debit cards and credit cards, PayPal and Venmo are among the conveniences that have developed out of a mature society to make these exchanges even more indirect.  Cryptocurrency is intangible or “virtual” cash, tracked by a series of networked computers controlled by… does anybody really know?

What makes cryptocurrency valuable?  Cryptocurrency prices have gone on a wild ride in the last 18 months.  At the beginning of 2013, you could purchase one Bitcoin for $13.39.  By March 2017, you might pay $1,160.  Then it went crazy, surging to $18,109 per Bitcoin on December 13, 2017, falling to $7,951 on February 5, 2018, then rising again.  At this writing, one Bitcoin is $10,706.  Other cryptocurrencies have had similar gyrations.  Here is a chart showing the values of hundreds of cryptocurrencies over time.

The driving factor in cryptocurrency markets is scarcity.  More accurately, it’s perceived scarcity.  Only so many units of each currency exist.  Some of the newer currencies may have fancier features or better security.  You better get some before they are all gone.  FOMO does wonders for speculative investing.  Perception is the mother of reality.

Scarcity (more specifically, perceived scarcity) drives up prices.  It’s like when you offer two different candy bars to two kids.  Let’s say one is Almond Joy and the other is Milky Way.  You tell the first kid to pick whichever one she wants, and her brother will get the other one.  The first kid hesitates.  She doesn’t care for either one and would much rather have a Kit Kat, but that’s not why she’s hesitating; she’s trying to get inside her brother’s head to figure out which one he wants.  If she can figure it out she’s going to pick that one, as it now has scarcity value.  If she picks the Milky Way and her brother says “great!  I wanted Almond Joy all along” she’ll be totally pissed.

Many valuation bubbles happen this way.  Remember beanie babies in the mid 1990’s, the tulip mania of 1637 or the South Sea bubble of 1720?  Ever play Monopoly?

As kids, my brother and I played Monopoly a lot.  For purposes of this blog, I’ll call him “Ken.”  When you land on an unsold property and refuse to pay the list price, the property is auctioned off to the highest bidder.  In a 2-person game, these auctions can turn into psychological warfare.  I remember landing on a railroad with a list price of $200.  Being cash poor, I let it go to auction.  Ken bid $10 or $20, so I bid a little bit more – partly because I’d be happy to have it at the discounted price and partly because I didn’t want him to get it so cheap.  Eventually, we bid it up to $280 and he stopped bidding.  I thought he would go as high as $300, and ended up paying an $80 premium when he left me hanging.  Ken destroyed me in that Monopoly game and usually ended up with the better candy bar.

Cryptocurrency speculators who invested early have made many small fortunes, essentially betting (correctly) that prices will rise because other people will want to own cryptocurrencies.  Note that this speculative desire has nothing to do with using cryptocurrency as currency; the scarcity value is unhinged from any notion of practical usefulness of cryptocurrency.

Why are cryptocurrency valuations unsustainable?  This is the crux of the matter.  There are three main problems:

1. Transactional permanence
2. Scarcity is a mirage
3. Success will cause failure

Transaction permanence sounds nice at first, but isn’t.  When cryptocurrency is used as currency instead of as an investment, the transactions are irreversible and final and contain no consumer protections.  There is no fraud department.  If someone offers you something you want, you pay for it with cryptocurrency, and they deliver a pile of shit, you are stuck with that pile of shit unless you can persuade the seller to voluntarily refund your crypto.  You don’t have the protections of a credit or debit card issuer or a government agency or court system if you get screwed.  Cryptocurrency fans will point out features like arbitration and support for multi-signatory transactions, which all sounds nice until you get screwed.  Then you’re screwed!

Permanence can also be a problem when black market transactions are deanonymized.  The main reason people use cryptocurrency instead of cash is to buy things they don’t want anyone to know about.  When there is a permanent record, one should assume there are no secrets.

The scarcity of cryptocurrencies is a mirage.  I just did a google search for How Many Cryptocurrencies are There?  The first answer (from about a year ago, at Quora.com) pointed to Coin Market Cap’s listing of 876 cryptocurrencies.  So I went to Coin Market Cap’s website and the list has grown to 1,541 cryptocurrencies.   That’s a two-a-day increase, so by the time you read this there’s probably more.  And these trade on over 190 crypto-exchanges.  That’s too many – the opposite of scarcity!  Even if you knew who’s playing Wizard of Oz behind the curtain of each currency or exchange, making decisions about which cryptocurrency to use for transactions or to invest in for speculative purposes with so many choices is nearly impossible for human beings, who struggle with long division.  Don’t just take my word; economist Richard Thaler won a Nobel Prize last year for his research into irrational behavior and paralysis in the face of too many choices.

If somebody writes or blogs or posts a YouTube video telling you they’ve done the research and offers to share some wisdom about the distinctions between one cryptocurrency and another, grab your cash or poker chips and run the other way.  Better yet, let me explain how I’ve created and securitized a financial instrument based on a retroactive futures market in beanie babies, tulips, subprime mortgages, and pet rocks.  I’m planning to use blockchain technology and call it KKingCoin, and will be marketing this as the perfect gift for grandparents to give their millennial aged grandkids.  Can’t miss.  Sign here.

Lastly, cryptocurrency success will cause failure.  The process of creating new units of cryptocurrency is called “mining.”  It’s not so much a matter of creation as it is a competitive techie process for which the Wizards of Oz award new units of crypto to the winners.  As each unit of crypto becomes (is perceived to be) more valuable, more competitive effort can be justified.  From Vox’s Umair Irfan (specifically referring to Bitcoin):

Every Bitcoin user conducts transactions in a public ledger, but since that ledger is distributed across thousands of computers, it’s immensely tedious to reconcile and verify transactions across the network. Transactions are grouped together in blocks that require finding a cryptographic key to verify.

[T]his process is like finding solutions to complicated math problems that become progressively more difficult. It’s a competitive process, with one miner receiving the award, currently 12.5 bitcoins, roughly every 10 minutes, so there’s a strong incentive to throw as much processor power — and thereby electricity — at the mining effort.

Or, as the Guardian’s Alex Hern wrote, it’s “a competition to waste the most electricity possible by doing pointless arithmetic quintillions of times a second.”

In Bitcoin’s early days in 2009, there were few computers, few transactions, and a price of $2 per coin, so mining was something you could do on your home computer.

Now with a global market cap of more than $122 billion, it demands specialized hardware called application-specific integrated circuit miners, and mining operations now use tens of thousands of these power-hungry boxes crammed into expansive warehouses to extract more coins.

This is unsustainable.  Another tech writer describes Bitcoin’s energy consumption as insane.  Yet another projected that Bitcoin alone (ignoring for a moment the other 1,540 different cryptocurrencies) – at current growth rates – would use as much energy by 2020 as the entire world was using just a few months ago.  Making projections of any kind using “current growth rates” is a badly flawed methodology; but the overarching point is still valid.

The cryptocurrency model only works as a novelty.  True success will transfer the perceived scarcity of cryptocurrencies to a very real and potentially massive energy scarcity, forcing governments to get involved… the very thing most crypto buffs despise the most.  Success inevitably leads to failure.

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