"Know when to hold ‘em, know when to fold ‘em.”
-- Don Schiltz, “The Gambler,” 1976, Kenny Rogers's hit in 1978
“You work with risk all the time. What’s the deal with blockchain and bitcoins?”
I have long resisted these invitations. But enough reader inquiries prompt some thoughts – mostly skeptical and cautionary.
To start, I claim no expertise. Nor do I presume to offer recommendations from the fulsome library of available literature. That’s because I am a dedicated observer of the Dunning-Kruger effect, especially its most trenchant real-world application – that the less you know about a complex subject, the more likely you are to commit grave decisional errors based on a combination of ignorance and over-confidence.
My students in Risk Management love Dunning-Kruger. For homework they identify cases where the effect was handled either well or poorly. An example of my own was the decision to part company with a financial advisor, after I had done enough inquiry to appreciate that he knew no more than I did about the then-volatile state of the state of a market bubble.
The literature is wide and varied, in substance and quality. To those inspired to delve into either blockchain or the grab-bags of bitcoins – please be skeptical enough to resist believing that wisdom comes from those seeking to sell something, including advice.
Here then are a few things I believe I know:
One is that blockchain – very briefly, the recording of bi-party transactions on a secure and anonymized distributed ledger – will be transformative, highly disruptive and immensely valuable.
Why? Because leaps of this scale and long-term effects are rare but real. Think of the railroads – human flight – the transistor – and yes, the iPhone. Also more to this topic, the hugely reduced customer transaction costs and information arbitrage in such knowledge transfers as negotiated Wall Street fees and self-booked airline tickets, Uber and Lyft and Airbnb.
Where, when, and which players will emerge as winners? Too early to tell. There is no reason to believe that “Amara’s law” will not apply. That observation, hardly a “law,” is empirically observed -- basically, that the effects of a new technology are over-stated in the short run and under-stated in the long. (Compare the lift-off and flameouts of Webvan and Pets.com two decades ago with the current explosive growth of Instagram and WeWork.) At this early state of blockchain’s evolution it would be futile, and potentially very costly, for an amateur to try to pick the likely surviving successes.
As for Bitcoin and its coevals, JPMorgan Chase CEO Jamie Dimon’s characterization was of “a fraud…worse than tulip bulbs” -- which he only slightly walked back to say, “if you’re stupid enough to buy it, you’ll pay the price for it one day.”
It is observable that bitcoins fail to date to meet the definition of “money” – none of them satisfying all three conditions: a stable and widely-accepted unit of accounting, a medium for exchange transactions, and a credible store of value.
This does not de-legitimize their inclusion in the world of commodities, where trading markets and exotic financial instruments are based on everything from jet fuel and gold to pork bellies and orange juice concentrate. Except that for these and others, zero-sum trading eventually depends on real end users – whereas crypto trading markets and prices are hostage to a continuously-renewed supply of credulous new participants, to replace those busted out and left nursing their losses and their regrets.
It is true that the entire crypto adventure has transferred considerable real money from the later arrivals to the earlier, although the dramatic Bitcoin price run-up to nearly $ 20,000 last December, and its precipitous fall below $ 7000 last week, left many of the later sheep shorn to the buff. And the earlier punters, now optimistically holding onto unrealized gains, are at the mercy of price fragility with the refreshing supply of “greater fools” apparently dried up.
As for those looking to profit from the infrastructure of crypto trading, I invoke a family relative, a 19th century entrepreneur who made a fortune out of the California gold rush, not by prospecting or investing in the mines or claims, but by founding an import business to store and sell extravagantly priced fruits and vegetables to the miners and their camp followers. He did very well out of his customers’ pockets – like today’s authors of “how to” manuals on day-trading, as well as casino operators and sellers of lottery tickets.
A note in closing, to warn of the hazard built into the entire crypto universe, as third-party transaction support, custodial services and financing sprout up around the original world of two-party contracts.
That is, history is replete with schemes, sure to emerge with crypto’s evolution, that inhere in the ability to falsify and double-count inventory, multiply the pledging of collateral, and monetize fictitious client assets – from the bogus customers of Equity Funding and the Salad Oil scandal with its storage tanks of water five decades ago, to the unconfirmed mortgage portfolios at Colonial Bank in recent years.
As Citigroup CEO Chuck Prince put it colorfully in July 2007, only months before losing his job when the party ended at the bank, “as long as the music is playing, you’ve got to get up and dance.”
For myself, if all the same, I’ll be sitting this one out.
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