Despite what the title implies, I really like ideas behind crypto-currencies. More specifically, I like blockchain technology, but its usage in currency raises a lot of questions. Why wouldn't it? We're talking about a new technology. Hell, it's an entirely new way of thinking about money. As far as we know, fiat money was invented in 13th century China and has been pretty much the only kind of currency of any utility for the century or so prior to Bitcoin's debut. Does that make it the best way to go? No, but it does make it something we have a lot of history with. The ways that fiat currency operate in the world are a little less inscrutable, which is to say they are more scrutable. Yes, "scrutable" is a word even though my spell check doesn't recognize it.
My point is, cryptocurrencies are nothing short of revolutionary. We ought to have questions, even if it is the wave of the future and an unmitigated improvement on our existing currency system. I find it troubling that many of its supporters are so zealous that they fall into age old dichotomous thinking whenever they encounter skepticism. Any negative critique is painted as sympathy for our evil authoritarian government overlords or merely the rambles of an irredeemable fuddy duddy who just doesn't get it.
Meh, maybe I am. Regardless, one of the many questions that comes to mind is whether it is possible to invest in cryptocurrencies rationally. Strike that. Currencies are not an investment to begin with. This is just as true for fiats as it is for ethereals. An investment is something that produces value using the money you put into it. Buying a new Thneed snitching machine allows you to produce Thneeds more efficiently, thus allowing you to sell them for more than the cost of the original machine. Or you could just buy stock in the Once-ler's business and get the same effect when he uses that money to buy the machines. Conversely, houses and gold and currencies are not investments by this definition.
Wait - houses? Yes, but I didn't say that real estate is a bad place for your money, just that it isn't an investment, at least not exactly by my definition. At the very least, home ownership is a hedge against inflation for most moms and pops. But that's not an investment and if all you do is simply buy a house that is not otherwise linked to a business of some kind, then you shouldn't expect its price to increase beyond the rate of inflation. Of course, that often doesn't happen. Government policies, population growth, and gentrification - among other things - have all contributed to rapid price increase in certain US regions. I'm sure the same phenomenon happens around the world. However, none of these factors have anything to do with the houses themselves. Like the price of oil, housing prices have fluctuated on the basis of supply and demand. Attempting to make large sums of money off the real estate market is therefore speculation, which is sometimes just referred to as another form of investing, but regardless of what words we use it is important to understand the distinction. It is important enough that many institutional portfolios, such as pension funds, have explicit prohibitions in their charters against speculation.
Currencies do not produce value in and of themselves. They can't. If they do, then something is wrong. But people can buy and sell currencies for some of the same reasons they buy and sell real estate, or for that matter gold. Perhaps they want a hedge against inflation or instability in their country. Perhaps they are speculating. Let's not forget in this day and age of forexes that are accessible to any third grader with a piggy bank that currency speculation is the most complex and volatile form of speculation there is besides cock fighting. Cryptos certainly don't change that. But I digress.
One thing that traditional investing and speculation share in common is their scrutability (again - it's a word!) in the face of analysis. There are fundamentals underlying both. We look at the balance sheet of a business and its return on investment. We can measure supply and demand and the various market forces that might affect commodity prices in the near future. We can create models of all these things and try to predict what a rational actor might do. Modern portfolio theory rests on the notion that this is possible and that the market in aggregate is rational. That last point is probably false, but I think it is safe to say that it is nonetheless possible. Perhaps if the entire market were driven by perfectly rational robots, then modern portfolio theory would become valid.
Rational market principles are applicable to fiat currencies. Yes, governments manipulate them, but it is possible to see the manipulation happen and make some rational arguments about its effects. US dollar and Euro values are affected by policy and by the economic fundamentals of the countries that issue them. That is they are tied to the events in specific countries. Of course, they are also tied to world events outside the control of countries, but my point is that at least there is something there to analyze and it is reasonable to argue that most of a currency's value is tied to a specific country or group of countries and what they do, whether good or bad. The big question for me is: what underlies the value of cryptocurrency?
Is there any way to predict what a rational actor would do in a given situation? Are there any fundamentals of any kind to analyze, beside trade volume? Put simply: what drives crypto values besides the purest form of supply and demand: psychological supply and demand? Sure, fiat currencies and commodities and real estate and antiques and just about everything else a person might buy into is susceptible to pure psychological supply and demand. However, there are many other factors besides. With cryptos, it seems to this uneducated person, that there is nothing else besides. There are no assets to consider, no history of return on investment measurements, no earnings per share, no physical supply and demand, nothing else of that sort. The value could sky-rocket or evaporate overnight and we would have no way of seeing it coming, even if we expect every crypto trader to act like perfectly rational market robots. Because if they are perfectly rational: what would be the basis of their judgements?
I would love to hear honest answers to this question. I am really fascinated by what a modern portfolio theory for crypto-currencies might look like.
