What’s at the bottom of The Crypto Rabbit Hole? (Part 1)

The $90 billion IPO of Coinbase last week was a landmark in finance.

Coinbase is to cryptocurrencies what Paypal is to money transfer.

Both are disruptive start ups that use the internet to simplify the process of handling money.

Paypal links the legacy banking system to the email system.

Coinbase links the legacy banking system to a crypto exchange and custodial function (crypto wallets).

Both are incredibly easy to use. The user interfaces of both are elegantly simple. With first mover advantage and network effects, they can get away with charging outrageously high fees.

I did not buy any Coinbase shares. My guess is that Coinbase will face tougher competition in future. As a stock picker, I avoid the hottest IPOs in the hottest sectors as they tend to be over-rated. As an index investor, I will get a small piece of the action over time.

But the fact that the Coinbase IPO was allowed to proceed is important: the American government has signalled that it is not going to ban or regulate crypto out of existence. This is the dog that did not bark.

A series of experiments is being run. Turkey has gone the other route and has just banned the use of crypto for payments. This will stifle innovation in Turkey and will probably be futile…but when did that ever stop a government deciding that Something Must Be Done and then doing something stupid?

In a world of tribalism, I don’t identify either as a Bitcoin believer or disbeliever. I don’t have laser beam eyes. I try to stay open-minded and update my beliefs as the world changes and we get new information. As part of this learning process, I bought a very small amount of crypto this week.

I’m late to this party because what’s at the top of the rabbit hole is very different to what’s at the bottom of the rabbit hole.

At the top of the rabbit hole we have a good old fashioned speculative frenzy: a Festival of Frankies. It’s all mad gainz and easy money with many of the characteristics of a Ponzi scheme. The memez are fantastic though:

I regret to inform you that this put me off Bitcoin for a long time.

My failure to participate is particularly ironic given that I was first told about cyptocurrencies in 1990…a full 18 years before Satoshi Nakamato published the Bitcoin white paper in 2008.

Picture the scene. The year is 1990. The Young Escape Artist is at university in an economics lecture. The lecturer (a libertarian economist) boldly predicts that the private sector will invent new currencies that compete with and displace the £ / $ and other government-issued currencies.

Me and all the other Not-So-Kool Kidz laughed at this science fiction…obviously bullshit…plus the lecturer looked like a socially awkward nerd who got his clothes from a charity shop.

Annoyingly, it turns out he was right and I was wrong.

Fast forward to 2021: that lecturer is now tenured professor of economics at a leading university who has upgraded his wardrobe and his public speaking game. Worse than that, Bitcoin crosses $50,000 and my BTC profits are a big fat zero. What’s my point? 20 year olds are idiots. As I’m fond of saying: the only thing dumber than a 20 year old girl is a 20 year old guy. The older you get, the more you realise you don’t know.

Yes I know that Warren Buffett and Charlie Munger don’t do Bitcoin and I’m not saying I’m smarter than them…

…but do you remember Warren Buffett warning everyone about technology stocks before backing up the truck and filling it with Apple stock?

One thing that put me off was my natural suspicion of fads, frenzies and the latest new shiny thing. But each year that goes by provides greater proof of concept for Bitcoin and other cryptocurrencies. Time is the great test for anything new. Time sorts the weak from the strong and the fragile from the robust.

An important concept here is the idea of The Lindy Effect. In the book Antifragile, Nasim Taleb explains the Lindy concept:

If a book has been in print for forty years, I can expect it to be in print for another forty years. But, and that is the main difference, if it survives another decade, then it will be expected to be in print another fifty years.

Every year that passes without extinction doubles the additional life expectancy. This is an indicator of some robustness. The robustness of an item is proportional to its life

Nasim Taleb, Antifragile

So each year that goes by should add to the expected life of Bitcoin.

It seems to me that there are 3 problems with Bitcoin. Firstly the energy consumption looks obscene. Some say that if they were inventing Bitcoin today Satoshi Nakamato would replace the Proof of Work concept (where high powered computers solve problems to validate the network and mine new coin) with Proof of Stake (where participants put up tokens as collateral to back validation of the ledger and which uses much less energy).

Secondly, according to the very same economics professor that I referred to above, there is a flaw built in to the economic structure of Bitcoin. Bitcoin miners compete to validate transactions in reward for new coins. Competition between miners maintains the integrity of the system. If the miners combine / merge forces, the whole idea of a de-centralised self-regulating network is undermined.

Thirdly you still have the risk that governments block / regulate / tax the on/off ramps to crypto: the exchanges, custodians and bank accounts that most use to buy and sell and convert to / from government issued currency.

So it’s not clear to me whether or not Bitcoin will be around in 10, 20 or 50 years in its present form. Bitcoin is an experiment and most experiments fail. It would be surprising if they got it perfectly right first time. But the genie is out of the bottle now. Ideas that catch the imagination of the world do not get uninvented; they get upgraded and/or replaced.

The government response to CV-19 revealed the existence of The Magic Money Tree. Politicians love spending other people’s money and it seems like they are gonna print money until something breaks. In contrast, the Bitcoin money supply is capped and after a certain point, no more can be mined or printed. People want inflation-proof assets and crypto is supplying some of that demand.

If you go past Bitcoin further down the rabbit hole you find super-smart people predicting a whole new generation of the internet. If Web 1.0 was simple HTML sites linked by dial-up and Web 2.0 was Broadband / Google / Mobile, then blockchains and decentralised finance promise to be the basis of Web 3.0.

Bitcoin started the ball rolling by providing a form of digital gold. The fact that no one has been able to hack Bitcoin provided proof of concept. Now, the Ethereum, Polkadot and other blockchain protocols are being built out as the early stage “roads and rail” infrastructure of decentralised finance. You could think of these protocols as Bitcoin upgrades that allow digital currency units to contain smart contracts.

This concept of programmable digital money plus smart contracts opens up the possibility of migrating or replacing the entire financial system onto blockchain technologies. This will allow people all over the world to lend, borrow, insure assets, hedge risks, make payments, trade and do business without friction or delay or traditional bank fees and without using the legacy banking system.

If you prefer your metaphors in coffee form, the price action is the milky froth and the real world use cases are the double espresso shots in this crypto latte.

Ever since 2008 we’ve all sensed that something is wrong with the centralised financial system. We’ve seen a series of bubbles, busts and then bailouts. The suppression of interest rates has encouraged debt, penalised savers and inflated house prices beyond the reach of first time buyers.

Image credit : Memex 1+1

Bitcoin was designed as part of a reaction to bankers who crashed the world economy being bailed out by politicians and central banks. It was right to protect depositors money but it was a crime unfortunate that most bank management teams survived the 2008/09 without paying with their jobs, bonuses and stock incentives.

This sparked the Occupy Wall Street protests where a bunch of earnest soapdodgers protestors camped in tents in the financial districts of London and New York and achieved little other than feeling good about themselves. Their heart may have been in the right place but they were ineffective.

But they were onto something.

De-Fi (decentralised finance) is like the paramilitary (or should that be paratechnology?) wing of the Occupy Wall Street movement. You could say that De-Fi will be The Revenge Of The Nerds. They have Wall Street in their sights and see a sector that is ripe for disruption.

A small bunch of highly intelligent software programmers are changing the world from the PC in their studio flats / shared workspaces / Mom’s basement. Some of this is already operational. In De-Fi world, you can earn 5-10% a year interest rates on your money right now.

My guess is that the software engineers will change the world and topple Wall Street from the position where financial services sector takes ~20% of GDP. Big changes are coming and if you work in financial services or fintech or software engineering you need to sit up and take notice.

People who understand this new world better than me say that where decentralised finance is now is the equivalent of where the internet was back in 1995-97 with clunky dial-up modems and most people unaware of the tidal wave about to hit markets, the economy and broader society.

They say that decentralised finance is going to change everything and they might just be right.



I bought an amount of cryptocurrency so small I would not care if it were confiscated tomorrow. Please invest responsibly and always do your own research.

Everything in this post was stolen from someone smarter than me (see Naval Ravikant, Balaji Srinivasan, Vitalik Buterin, Gavin Wood, Keld van Schreven and many others)

I am not interested in internet fights about who is Right / Wrong / Smarter but I will always correct any factual errors pointed out to me. I reserve the right to be wrong and to correct my own sloppy drafting. 🙂


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9 comments

  1. The tax is fun in the UK, mining more than 1k, that’s income tax please, oh you do it as a hobby right, well then you can’t claim the 7k’s worth of GPU cost back. Not as a hobby? Let’s get some NI from you, and if you scale up a bit that’ll be 40% income tax please. You say the market crashed and your risky investment went to zero, tax please! The market went well, in that case cap gains my friend, hand it over!

    I sell hash power to an exchange, other people bid on it and mine with it, I technically do not mine anything but am paid in BTC. So, I get to work the day job, pay tax and VAT, buy goods, build system, sell compute, earn income, pay income tax and NI. Am paid in BTC, but must convert the amount into GBP equiv for income tax purposes every time I’m paid (4h-ly), then am deemed to have bought BTC and invested it (no transaction took place), cap gains etc from there. WOW – talk about cake and eat it HMRC.

  2. TEA, I consider you a voice of reason in a sea of silly. So let me ask you a question: With everything else being the same, would you have bought Bitcoin if it were $1? And how do you think that would change the current frenzy? I’m guessing that practically no one would care about it, regardless of all the benefits etc.

    1. Yes, there are positive feedback loops going on…the higher the price goes, the more new people get interested. So if that went into reverse from $50,000 to $1, the momentum buyers and speculators would run for the hills!

  3. Welcome to the club! My partner spent nearly a decade trying to convince me that a portion of our shared budget should be allocated into crypto (he bought 100 bitcoin at $0.10 around 2009 and eagerly sold at $1.00). I finally relented last year when talks of the second stimulus began, simply because it may sense with the Fed’s magic money tree and the potential for hyperinflation. I initially shared your concerned but, surprisingly, I’ve found that the more I research, the more I *believe* in bitcoin. A year ago, it was a financial investment in “imaginary libertarian nerd money”, but today it feels like a vote for change–it symbolizes individual sovereignty, decentralization, and hope for a better future. It could go to zero and I would still appreciate what it represents. Have fun tumbling down the rabbit hole!

  4. Hi TEA – your analysis did not include the significant impact of Tether on the crypto market. Worth looking into if you haven’t already. Tether is the largest stablecoin and has nearly $50bn outstanding. It is widely believed to have been printing newly minted coins without any $ backing and using them to artificially pump crypto prices. The “backing” that this ~$50bn has, is actually not hard USD but volatile cryptocurrencies and loans to other entities. New issuance has become exponential now – it’s a ticking timebomb.

  5. Hi, if my understanding is right – and i’m happy to be corrected – bitcoin mining depends basically, on a computer solving a complex puzzle. Is it not a rule of computing that every 2 years the computer chip doubles in power ?. So if it takes a computer today 4 hours to solve the puzzle which earns a BTC, then in 2 years, with a more powerful chip, it will take 2 hours, and 2 years later – 1 hour, then 30 minutes etc. Then surely if the effort required, in energy consumption alone is less, does it not follow that the value of BTC is halved everytime ???.

  6. I am very interested to see how Coinbase performs in the next year. Will the stock itself always be tied to the fluctuations of cryptocurrency prices? Will the value of Coinbase itself always be second to the health of the crypto markets?

  7. Tarquin · · Reply

    Grace, Marketwatch published a pretty comprehensive takedown of coinbase for prospective investors, it’s based on fundamentals and well worth a read. It put me off anyway!

  8. […] Clearly I should have waited for the clear sign we’d hit the top of the bubble which was when The Escape Artist finally got involved […]

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