Crypto Winter, or Crypto Ice Age?

Last year I was talking to a student who was writing her dissertation on cryptocurrency and blockchains. She was extremely bright and well informed about the legal issues, and she was also an investor, which ignited her interest on the subject. Needless to say, she had completely bought in to the whole thing, often repeating lines that those of us familiar with the space, and yet was cognisant with many of the regulatory aspects.

This was an extremely interesting conversation, she couldn’t understand why I was such a sceptic when it was clear that I knew so much about the subject. “I don’t get it, what’s your portfolio strategy?” she asked. There were a few interesting assumptions on her part at the start, it was clear that she had never met anyone over 40 who understood crypto, and was surprised that I knew not only the main platforms and players, but also that I could speak the language. It was also evident that there was a strong belief that crypto prices would continue going up, and that not investing close to every money you had would be a mistake. We were talking during a small downturn, yet she kept saying that the price was going to bounce back, because it always did.

I tried to dig a bit more on the source of her confidence and knowledge, and she directed me to a couple of YouTubers. “They say that we’re in a bull market again, and that there won’t be another bear market for the next two years, and they know what they’re talking about because they’re always right”.

There were many other interesting parts to the conversation, I specifically warned her to get all her money out of Binance, and to be careful not to invest in shitcoins, and even suggested a couple of what I thought seemed like sensible projects (I felt like a parent telling their kids to do drugs safely, but I digress). She replied that she would never invest in those coins, “too slow! I want big gains!”

I haven’t heard back from the student, and I hope she made it out of the Big Crash in one piece. The conversation was typical of one that I have had with many other students who are interested in crypto. A lot of them want to write their essays and dissertations on the subject, and they tend to gravitate towards me as the resident crypto nerd. Some send one email, and after realising that I’m an Unbeliever, they sometimes never contact me again.

There is usually an interesting undercurrent in some conversations, there’s often an age gap between crypto enthusiasts and non-believers, although many developers and crypto personalities are Gen-Xers and Old Millenials (X-enials? Geriatric Millennials?). Age often comes up against those raising their voices in making criticism of rampant fraud and dodgy business practices in the blockchain and cryptocurrency space. Read any Twitter thread by anyone older that 35: Nassim Nicholas Taleb, Paul Krugman, Nouriel Roubini, Jorge Stolfi, Amy Castor, David Gerard, Grady Booch, and you’ll find a litany of “OK Boomer” put-downs, and the ever-present “Old man yells at cloud” meme.

“You’re just old and tired and you just don’t get it.”

The funny thing is that we really do get it. We have always gotten it, and often understand crypto better than many of its proponents, and certainly better than the army of influencers selling dreams on nothing more than their dubious claims, good looks, and charming on-camera persona. The current crash came as no surprise to the growing army of sceptics who have been sounding the alarm for years, often followed by mockery and derision from believers. We’ve heard the pro-crypto arguments before, oh so many times! Here are just a few:

• “Blockchain is just like the early internet”. No, it isn’t. Satoshi Nakamoto’s paper was published in October 2008, and the first version of Bitcoin was released in 2009. For context, the iPhone was launched in 2007… and it immediately changed society as we know it. These companies and products are younger or the same age as the blockchain: Android, Uber, Airbnb, the iPad, Tesla’s Model S… and also, many of us were there at the start of the Web, it was evident that it was going to change the world, and it was usable from the start.
• “The banking system spends more energy than Bitcoin”. That may be true, but that is a system that supports tens of thousands of transactions per seconds. The Bitcoin network can handle between 3-7 transactions per second at an energy expenditure of 707 kilowatt-hours (kWh) of electricity per transaction. To put that in context, you can run over 970k Visa transactions with that amount of power.
• “Slow transactions and high costs can be bypassed thanks to Lightning and other second layer networks”. Bitcoin and Ethereum are reliably unreliable, any increase in use tends to translate in low transactions per second, long verification times, and higher transaction costs. As a response, crypto has developed so-called second layer (or L2) networks that sit on top of the slower ones. There are centralisation and technical problems with these solutions, but let’s ignore those for now, and call these systems for what they are. Second layers act as a reminder that the original networks cannot scale, and need a second network on top of the network to operate. This is an admission of failure.
• “The environmental cost can be offset with clean energy, and/or Bitcoin is going green”. There’s little evidence that Bitcoin and other cryptocurrencies are going green, and on the contrary, they continue to encourage the recommissioning of fossil-fuel plants. This makes the current energy crisis worse, just this week Bitcoin mining had to be stopped in Texas.
• “Bitcoin is digital gold”. It isn’t, gold is gold, it requires no maintenance fee, once it’s mined, it can still be valuable. Bitcoin and other cryptocurrencies need to be maintained by miners using electricity, so there’s always a need for funds to continue flooding into the network, at least to keep the mining running. So it’s not at all like digital gold.
• “You just hate success/decentralization; you’re a shill for the government/banks, you’re afraid that the financial system will fall”. Nope, I would love for a decentralized system to emerge, I’ve been an advocate of decentralization for 20 years. But crypto ain’t it. It’s highly centralized, and it has a propensity for inequality that makes capitalist economies look like anarchist communes.
• “Ethereum will move to proof of stake this year”. Please do so, we’ve been hearing that for the past 2 years.
• “Have fun staying poor”. Thanks, I am. Likewise.
• “ngmi”. If you mean that I won’t make it to the Crypto Galt’s Gulch Libertarian Utopian Compound or Crypto Island, then sure, I’m not gonna make it.

So it is really frustrating to be a critic and get constantly ignored, I never get invited to the glitzy events than blockchain believers do. The bubble was in part fuelled by a cult-like certainty on the tenets of the new crypto religion, and no criticism was allowed. But in the end critics have been right, and even if you’re a crypto enthusiast, it would be a good idea to listen to the sceptics from time to time, because often we may be right.

This brings me to the main topic of this blog post, which is to see whether the current crash is temporary, or if there’s something more substantial happening that is affecting the viability of cryptocurrencies. The current crash came as a result of various elements. The first one is that as the system requires constant energy expenditure, the network can only increase in value if there is money coming in, to achieve this crypto needs investment, but most importantly, it requires people buying it to keep the money flowing. If this inflow decreases, then prices start to fall.

So far so normal, this is something that has happened in previous downturns where interest dwindled, and then bounced back. But this time there are interesting differences. A big one is that the bubble run was in large part enhanced by the creation of several derivatives, lending firms, and stablecoins, which started making the environment more interdependent. Algorithmic stablecoins were created promising 20% returns, so investors immediately started pumping money into those, including some very large investors, exchangers, and lenders. When a big stablecoin ended up being nothing more than a Ponzi (the Terra/Luna system), then lots of firms that were invested in that lost their funds, so we experienced a domino effect, were other companies started folding.

There are rumours that there is seriously lack of liquidity in the entire system, and that many companies are running on fumes, being propped up by other firms, or by VC who are already heavily invested in the system.

So this crash feels different, it’s almost as if lots of people are finally realising that the Emperor has no clothes. All of the firms pushing blockchain use no blockchhains. NFTs have emerged as exceptionally dodgy investments easy to steal, and there is an rather nasty stench emerging from many companies that appear to be engaged in fraudulent activities. But most importantly, a lot of the crypto economy still operates like a pyramid. In order for people to make money from crypto, they need a person to buy their coins at a higher price than what they paid. This is why lots of people who bought in early did make a lot of money, which fuelled the FOMO from the wider population. Hey, this guy got rich, maybe I can get rich too!

But of course, this is just the “greater fool” theory of finance, at some point you run out of greater fools, and you’re left holding the bag. Critics have been stating this for years.

Concluding, will crypto die? Not likely, these things are like vampires, they seem to always rise up again from the dead. But at least this bear market could finally be the wake up call that many people need. But who am I kidding? The second the prices start going up again, we may witness the same thing again.

And we will still be here to warn you. For now, stay safe, and don’t invest in shitcoins. Anything endorsed by Elon Musk is a meme coin that deserves to be sent to the fiery chasm from whence it came.