Although trillions of dollars of value have already been successfully exchanged using public blockchains, meaningful disruption has yet to occur. The crux of the matter is that although blockchain technology is solid and disruption is possible, it is not profitable. Disruption is not profitable for traditional financial organizations or for governments, and paradoxically, and most importantly, it is not profitable for cryptocurrency holders themselves.
But aren’t cryptocurrency holders betting on disruption? It is true that some forward thinkers are buying cryptocurrencies to speculate on blockchains’ disrupting traditional finance. Their theory is that if crypto is disruptive, value will move from traditional finance into cryptocurrencies, and these digital coins will increase in value.
I see a disconnect: cryptocurrency investors care more about increasing the value of their holdings than ushering in a disruptive future. A truly disruptive future is not necessarily associated with higher prices. This is the profitability problem. We can better understand this problem through the exploration of an easy-to-understand crypto pricing model.
Crypto Pricing Model
In our simple crypto pricing model, the price of cryptocurrency is viewed as a function of “fair value” plus an avant-garde premium, a speculation premium, and a byzantine premium:
Price = Fair Value + Avant-Garde Premium + Speculation Premium + Byzantine Premium
I believe that while fair value would increase with disruption, the three premiums would decrease substantially more and result in lower prices.2 Let’s now take a look at each one.
Fair value is derived from the actual transactional utility that cryptocurrencies provide as mediums of exchange and is largely a function of the number of entities willing to spend or accept a given cryptocurrency as well as other fundamental concerns. While fair value should be greater in a post-disruption world than it is today (a larger network should increase fair value), the fair value is small compared to the three premiums. We have plenty of ways to send value and information over the internet without using a blockchain; very few people purchase cryptocurrencies for this purpose.
The avant-garde premium arises from the social utility associated with being a member of the experimental and innovative (i.e., avant-garde) crypto community as well as, for some, simply conspicuous consumption. In a disrupted future, however, cryptocurrency would be commonplace, no longer avant-garde, with crypto ownership void of its original cachet. The result would be a much diminished, potentially even zero, avant-garde premium.
The speculation premium can be thought of as a lottery ticket that provides the chance for a massive upside return, which is the main attraction for many cryptocurrency purchasers. Cryptocurrency prices are bid up during periods of speculative mania in anticipation of disruption at some later, unknown date, and a desire by investors to purchase ahead of that date. The speculation premium will likely decrease once disruption arrives, as investors will no longer have an appetite to bet on disruption in a post-disruption world. Investors are constantly looking to the future; they want to invest in the technology of the future, not the technology of the present.
Crypto prices can quickly appreciate (and depreciate) with little to no change in the underlying fundamentals, supporting the conclusion that a large percentage of the price can be attributed to the speculation premium. I posit that changes in investor sentiment drive changes in the speculation premium and are similarly a large driver of cryptocurrency volatility. When sentiment is at positive extremes, the speculation premium is large—the lottery ticket is in high demand and as such is expensive. Similarly, when sentiment is at negative extremes, the speculation premium is low and the price is cheap. But in a post-disruption world, the speculation premium would likely approach zero as investors move on to speculate on the next big thing.
The byzantine premium arises because of confusion around the apparent complexities of blockchain. (The appendix offers a straightforward explanation of blockchain for interested readers.) Investors read confusing, jargon-laden articles and become convinced that smarter people than themselves are investing, so they should too. Simplicity does not inspire investment in the way that complexity does.
A good understanding of blockchain does not support a byzantine premium. In a post-disruption world where cryptocurrencies and blockchain are commonplace and demystified, investors’ knowledge should increase and in turn reduce the byzantine premium. Said another way, uninformed investment will decrease. Therefore, in order to maintain and potentially increase the byzantine premium, it is in the interest of cryptocurrency investors to delay large-scale blockchain disruption indefinitely into the future, while continuing to make blockchain difficult to understand.
Disincentives for Disruption to Protect Cryptos’ Speculative Potential
Disincentives to disruption serve to protect and expand the three premiums. While the larger network/market in a post-disruption world should increase fair value, it will unlikely compensate for decreases in the three premiums, in particular, the speculation premium.
Great sums of money can be made from speculation if cryptos perpetually have the potential for disruption, but never actually disrupt anything. As a result, more time, money, and energy has been focused on the proliferation and strengthening of disruption memes versus actual work toward real disruption.
With the benefit of hindsight, I estimate that this shift in focus began in 2014 or 2015. Around that time the “Bitcoin is a store of value” meme started to gain traction. Subsequently, the grassroots effort to get mom-and-pop stores to accept BTC as a medium of exchange ended. I believe this retreat was the beginning of the end of the threat to traditional financial institutions posed by cryptocurrencies.