I used to think crypto was just a meme. Just a fad. Just a phase.
But then something changed. I started to read. To watch. To listen.
I started to pay attention. And although I can’t bring myself to say that I “went down the rabbit hole”, that’s exactly what I did.
When I understood the potential applications, knowing how crap existing finance is, I was forced to acknowledge that the whole thing might not be just a trend.
How can you tell?
One way is to determine which category of innovation it belongs to:
- A speculative asset
- Financial engineering
- Technological innovation
Determining which of these 3 best describes crypto will help us answer our question.
The excitement around some “innovations” is baseless. A small group of investors buy-in because they think thing look pretty or it has “potential” or they think they can sell to suckers at higher prices later. For some reason, other, larger, stupider groups of people think the same thing. This cycle repeats until these “investors” run out of suckers to sell to and the price collapses.
These assets tend to be taste-driven. Think wine. Think art. Think watches. The underlying asset has minimal “intrinsic utility”: it can’t be used to do anything with, only consumed. The classic example of this is the Tulip mania of the early 17th century Dutch republic in which some bulbs were being traded for 10x the annual income of well-payed artists.
New financial toys
You could, however, categorise crypto as a purely financial innovation.
Sometimes these new financial instruments are created with a genuine use case in mind (futures contracts were designed to hedge price volatility of crops for farmers). And some of these instruments still serve a purpose. A purpose that isn’t categorised by trying to generate 5% extra return. For example, multinational organisations receive payments in a variety of currencies. It’s common to use foreign exchange instruments to hedge against changes in the value of these currencies.
But these genuine use-cases are not why these instruments are usually traded; typically, it’s banks and hedge funds trying to generate allusive alpha: to make their clients (and themselves) (lots of) money. Sure, sometimes this will result in increased returns for, say, a pension fund that will trickle down to, say, normal people. But most of the time this mechanism results in rich people getting richer. Those who own assets make money using those assets, allowing them to purchase more assets, etc. The gap between those who own assets and those who do not thus increases.
There are more concerning examples. Examples by which the creator or main distributor of the financial instrument knew the assets were garbage or had no idea of the risks associated with them. It seems that Michael Milken and his motley crew knew that the junk bonds they were peddling in the 80s were…junk. But they were making money hand over fist so didn’t care. Very few appreciated the consequences of a national house-price collapse would have on the price and credit rating of MBSs, CDOs, and CDSs in the run-up to the GFC of 2007/8. The banks were making so much money that they didn’t bother to check. Or simply dismissed this scenario as impossible.
Why do these disasters continue to happen?
First comes greed. When you’re making millions and millions of pounds, dollars, or yuan, you think you’re a genius. Your boss showers you with praise, your colleagues respect you (and are jealous of you), your neighbour compliments your new car (and is jealous of you), your kids think you’re cool, your wife seems to love you more, your friends think you’re the man, even you think you’re the man. You have less than 0 incentive to stop, step back, pause and investigate where this new money is actually coming from and what are the risks involved with making it.
Second comes ignorance. If you actually wanted to perform such an investigation, you might have a problem finding answers. These products are new and complicated. Even understanding the payoff structures under different scenarios is a struggle. Now add the fact that they exist within a complex global financial system, where relationships between entities and assets are constantly morphing. This can get very confusing very quickly. Even if you wanted to assess the risks involved with the new asset, often it’s just too difficult.
Real technological innovation
There are some new technologies that are different. Technologies that increase the size of the pie. Technologies that improve society and the lives of those who are part of it.
These innovations often have elements of the preceding categories contained within them. The development of the railroads in the UK in the mid-1800s resulted in the creation of the world’s premier rail network. But many lost small fortunes betting on railroad companies that never laid any track. The South Sea bubble was subject to wild speculation flamed by “the most extravagant rumours” of the products being imported from the New World. But the trade that actually occurred was hugely economically beneficial. The valuation of new-fangled internet companies famously collapsed en masse in the early 2000s. But the internet is what I’m using to point that out.
This means that although these technologies were successfully implemented in the long run, many got their fucking hearts ripped out investing in them in the short run.
Where does crypto belong?
There are elements of crypto that fit into each group.
NFTs are mostly, presently, in the short-run, art. Thus speculative. Some altcoins don’t even bother coming up with a USP, their selling point is that they are a meme. Speculative. Even charts of main assets look suspiciously bubbly. But you can’t lump all of crypto in with these small pockets. It’s not all about speculation.
Crypto is, however, part of the financial system. If you define financial engineering as the use of mathematical techniques to solve financial problems, crypto is financial engineering. Many of the innovations within the space are new and complicated with unknown or unappreciated risks associated with them. However, many of the disasters haven’t been caused by financial complexity or hidden financial risks. They have been because of either scams or hacks.
The greed associated with financial innovation is certainly present in crypto. What % of investors actually know where their yield comes from, have looked at the code in the smart contract, or have an understanding of the tokenomics? Browsing any crypto project discord will tell you the answer is less than 1. “wen launch?” jcpatin2973(3,3) asks, “will price be high?” questions 3974929248, “can the devs do something?” says Jimbo69.
Does it make a difference that the participants are people operating independently, rather than inside of institutions? It reduces the resources available to the innovators and therefore the scale of the damage they can possibly inflict. Normally operating independently would also put more skin in the game of participants. It’s easier, conscience-wise, to rip someone off if it’s Morgan Stanley doing the ripping, rather than Sam Jones. However, when Sam Jones is operating as Jimbo69, or jimbo.eth, or 0x58aCA645FbA9B2eEdcCd8b9D78cdaE98AA053Fc4, this skin in the game evaporates.
Even if crypto was a real technological innovation, that doesn’t mean that anything currently in existence will still exist in 2025. Most railroads went bankrupt, most new internet companies were no longer operational in 2005, and most new additions to the crypto ecosystem won’t last a year. But that doesn’t mean you shouldn’t invest. Real technological innovations come with massive opportunity. The utility of these new technologies is so high that someone is bound to make a profit. It may not be the original innovators, or even the early adopters, but someone, somewhere, at some point, will be making a boat-load courtesy of the new technology.