On the crypto blizzard

Money is the bubble that doesn't have to pop. But it *can* pop...

Since I told you, dear readers, six months ago about stagflation and a month and a half ago that the Fed was out of envelope, I feel entitled to be taken just slightly seriously, in addition to my other intellectual responsibilities, as a minor financial prophet. Sadly, my withered old nuts are the size of raisins and I have not properly profited from these insights (I will confess to a few SPY puts)—but this should not stop every hedge fund in Connecticut from buying a Gray Mirror subscription per Bloomberg seat. It’s cheap, guys.

The bubble theory of money

I hate to talk about it because I am not a beast and don’t need to rub my stink on everything. But I also am pretty sure I begat the theory known in the crypto world as “Bitcoin maximalism.” At least, when BTC was like $1 I said what I believe remains the best summary of this theory: “money is the bubble that doesn’t have to pop.”

Do you remember before “store of value” was the standard explanation of why useless crypto does not have to be economically worthless? People justified the price of BTC by transaction totals and other such silliness.

Weirdly, this seemed to change within a few months of me having a three-hour conversation with one of the founders of a big crypto company. I am honestly not sure if that had anything to do with this trend—and even if it worked, it only partly worked.

“Store of value” is a sort of “vulgar Marxism” version of my bubble theory of money—without any of its (still dubious) predictive power. If you are a serious person you will not have any difficulty in learning the real thing. Or what I think is the real thing.

FWIW, the bubble theory of money is only a minor take-off the classical Austrian Mises-Menger theory. I still think it’s worth knowing though.

“Bitcoin maximalism” is not really right—the bubble theory does not predict that Bitcoin, or any other coin, or a metal like gold, or even government equity or its derivatives (ie, fiat and stonks), will win the battle to be the standard store of value.

Bubble theory only sets the rules for this contest. By the theory, I do believe Bitcoin still has a chance. By the theory, its victory, even among coins, is by no means a certainty. By the theory, either all coins must perish and go to zero—or all but one.

The standard store of value

Isn’t it odd that it took till Darwin to invent evolution? Not to, like, blow my own horn or anything. But the BTM is as easy to derive as the theory of evolution—and as hard, some how, to both think of and explain. It relies on two principles.

One is the pool of savings—net demand to transfer purchasing power from the present to the future. (The existence of debt instruments does not change the demand for savings: once the loan is closed, the borrower now holds the savings of the lender.)

The demand for savings is the demand for money. The demand to move purchasing power from present future is a human universal. Imagine a human society which knew it was about to be destroyed by an asteroid in a week. In such a society, though exchange might continue, who would take money in exchange for anything?

Two is the standardization of money. This is a very simple Schelling point or collective agreement problem. The solution is a Nash equilibrium: choose the action which is best for you if everyone else chooses it. This is the famous Keynesian beauty contest.

Translated into English, you should bet on the money everyone else will be betting on. But you should bet on it first. This is why you should have bought Bitcoin in 2013.

And the worst strategy is to save in some money which has been levitated by bubble power above its nonmonetary level—partially monetized—then gets fully demonetized, and reverts to its intrinsic nonmonetary value.

This is what it will feel like if Bitcoin goes to zero—which is perfectly possible, I’m afraid. (After the paywall, I will even tell the adversary how to do it.)

The bubble theory does not say that Bitcoin will become the standard money of the 21st century. It says that either (a) present unstable conditions continue, or (b) Bitcoin goes to zero and is perceived in retrospect as a classic tulip-style financial bubble—it will be, probably for centuries, the textbook example of such a bubble—or (c) Bitcoin will take over the world.

Money is the bubble that doesn’t have to pop. But any bubble, no matter how well constructed, can pop. Or it can neither pop nor win—just stay unstable.

Alas, today there is no easy way to invest on this trichotomy. For instance, if some coin does win, it need not be (c) for Bitcoin—it could be (b) for Bitcoin, but (c) for ZCash or Ethereum or whatever. You should buy a Gray Mirror subscription anyway.

The bubble theory of crypto

The bubble theory of money suggests a simple investment strategy: distribute crypto savings across coins, proportional to their probability of winning—assuming that only one can win. Some have called this the “Highlander strategy.”

The Highlander strategy has a cool property: the more people know it, the better it works. The success of the meme renders the meme more accurate—since, as the meme propagates, holders of mere alts flee to Big Daddy. Once all the alts are fully demonetized, everyone in the market accepts the Highlander strategy as mere truth.

Ergo, if you believe in this strategy, you have a collective incentive to propagate it. Not quite the same thing as pumping your coin (yes, I do in a sense have a coin, but hell will freeze over before I mention it here), or even as pumping all coins, or even pumping some coin—but not too different, in terms of the collective strategy. (You have no individual incentive—unless you are some epic whale in the winning coin.)

In the end, it will be clear all along that only one could have won. And the winner, too, will look inevitable—but it is actually contingent. Logically, any coin could have won. Historically, only one can—just as VHS and Betamax could not coexist.

The VHS equilibrium is stable. No one in this situation will be able to launch an alt, regardless of its cool features, just as no one in 1985 could launch a new videotape format—regardless of its color gamut, resolution, etc.

Standards are sticky. Major alts like ZCash and Ethereum have awesome features which Bitcoin could certainly use. But one way to think of them is as the Dvorak keyboard of crypto.

I used a modified Dvorak keyboard at work for years. It sucked—I mean, it was awesome. You can really spit out code like a beast with four modifier keys and all the punctuation on your home row. But I couldn’t use anyone else’s computer, and no one else could use mine. This was only sometimes a security feature.

My weird-ass keyboard is significantly better than Dvorak. But I cannot imagine it defeating Dvorak and I cannot imagine Dvorak defeating Sholes (QWERTY).

It is not that features don’t matter—no maximalist, I can imagine Ethereum beating Bitcoin—but if it happens, that is certainly the fault of Bitcoin’s management. (Which is still management, even if it is decentralized management.) If it happens, it probably involves the Schelling-point logic not spreading well.

Crypto versus dollars

But why isn’t the standard dollars? It is dollars. The problem is, there are more dollars every year. This is obvious—but it needs to be understood in a rather subtle way.

Most people say “fiat.” This is a copout: it fails to understand the relationship of forex (non-dollar fiat currencies) and securities (stonks, bonds, etc) to the dollar. We include all these instruments in “dollars”—which is short for “dollars and dollar derivatives.” These dollar derivatives are what Mises called “money substitutes.” (Foreign exchange is fundamentally a derivative of the dollar because it is linked by a balance of trade.)

Regarding the dollar as a coin, which it is, the coin market cap of the dollar is not M0—it is HNW, what the Fed calls “household net worth.” This is just the total market price of all financial assets held by the private sector—the sum of all portfolios. For their spending behavior, it does not much matter what stonks their money is in—or even whether their portfolio is stonks, or bonds, or cash, or even crypto.

Whatever backs those assets, we can assume it is not changing much—there are some concrete advances in technology, some physical improvements to real estate, etc, but… we can therefore regard the expansion of money substitutes as basically artificial.

Thus, whenever household net worth expands, the government is printing money—this is monetary dilution. When people have more to spend, they spend more. Duh. And when the stock market goes up, the government is printing money—even if it does it in some causally obscure but logically predictable way, such as by low interest rates.

Price inflation, such as you see at the gas pump (prediction: when gas prices pass $10, gas stations will post prices in dimes), is a consequence of monetary dilution. Sadly, it is only one such consequence—and it can be caused by many other forces, such as the beast from the east, that vile, nation-eating monster, Herod of the “Slav squat,” Putin. Of course, when any two such forces are pushing together, they push even harder.

Monetary dilution in the dollar—basically, stonks going up—is the cause of the pressure for monetary standardization. The problem is that our economies are addicted to monetary dilution—they are like money-losing companies which fund ongoing operations by issuing and selling more stock.

You are losing money if your liabilities keep increasing. Ever seen a balance sheet? Equity is a liability. For an inefficient firm to even break even, a lot has to happen. This will not happen. Ergo, the dollar will continue to be diluted.

So the dollar, as a coin, is a very leaky coin. It is so leaky that this leakage seriously endangers its status as a winning monetary standard. And this leak cannot be fixed.

Of course, by allocating assets properly, it is possible to keep up with the dilution. If the stock market goes up, own stocks! This leads to the absurd, yet logical, practice of “passive investing.” In a sane financial system with a stable monetary standard, there would be no such thing as “passive investing.” No beta, only alpha. “Beta” investing is just how you avoid the monetary-dilution tax.

But sadly, the stock market can also go down. Monetary contraction is also a thing. But monetary contraction is not sustainable—because the economy is addicted to dilution.

The Fed will just have to learn to live with price inflation—which may take a while. But the US cannot sustain an HNW, the true market cap of the dollar, which is declining or even just flat. It cannot get un-addicted to monetary dilution.

Unlike in the Volcker era, when it was much healthier, the US cannot go cold turkey. It will simply die. Less metaphorically, the USG cannot sustain this posture. If it has to, it will drop “helicopter money” to restart the dilution engine.

From now until the rest of its life, the dollar will leak—making it vulnerable to a much less leaky (mining is still leakage; even mining for fees is leakage, since miners of fees are still forced sellers) coin.

To keep outside of these contractions, and inside the expansions, is a full-time job. Someone has to get diluted—and someone has to get contracted. This is why you should save in crypto instead, where neither of these things happens.

Or at least, neither should happen…

Explaining the crypto waves

When crypto also demonetizes in a monetary contraction, most of its advantage in stability, and especially inflation resistance, is lost. This makes the Highlander effect much less effective.

What just happened in the crypto markets?