Biggest crypto fantasy of them all

  • “Spend cash, invest in Bitcoin. Cash is trash.” – A ‘bon mot’ from one of the Winklevosses
  • “As of the end of Q2, we have converted approximately 75% of our Bitcoin purchases into fiat currency,” – Tesla Quarterly Earnings Statement (July 2022)
  • “Bad coin and good coin cannot circulate together.” – A version of Gresham’s Law

This week brought news of “The Merge” – a purportedly momentous singularity in the history of humankind, or at least a big new loop in the tangled story of crypto-currency. We are told that, from now on, Ethereum (the second most popular crypto offering) will no longer be based on “Proof of Work” but rather on “Proof of Stake” (whatever that turns out to mean). The big selling point of the Merge is that the cost of “mining” the stuff will be reduced. In fact, mining won’t even have to happen anymore (too bad for Nvidia, by the way, which has floated its market capitalization on sales of the mining hardware – its share price is 92.88% correlated with the price of Bitcoin since November 2021).

In any case, “Merge parties” are said to have broken out world-wide, live-streaming from every time zone. Meanwhile, the hedge fund world has crowded into the options market to trade on the volatility that they expect.

  • “‘A lot of smart money [is] buy’… Outstanding options contracts rose from 1.2 million at the start of the year to more than 4.6 million on Wednesday. About 80 percent of those contracts are call options… It’s a sign of ‘massive bullish sentiment.

Of course, the existence of “massive bullish sentiment” would normally signal a market decline (investor sentiment is usually a contrarian indicator). The next few weeks will reveal how the merger will unfold for speculators. But we already know that in practical terms, it will make no difference to the fundamental long-term outlook for crypto.

The flaws of the model

There are so many things wrong with cryptocurrency that it’s hard to know where to start. Get rid of that piñata of mistakes and false hopes, and the mush that squirts out. The ugly stuff has to do with what might be called the “moral flaws” of the crypto model: the facilitation of illicit transactions, money laundering, ransomware extortion, drug trafficking, pornography, and heaven knows. what. Then there is the amazing wastefulness of the mining process by which crypto tokens are “created”. Before The Merge, Ethereum’s carbon footprint was said to be “roughly equivalent to that of Finland.Bitcoin’s climate damage price is obviously a bit higher, on par with the total energy budget of Bitcoin. Sweden. Add to that dozens of hacking scandals and put it all into context with the pain suffered by naïve investors meddling in the totally unregulated crypto market. The global Ponzi-ish nature of the phenomenon has been clear from the start. (A typical Bitcoin come-on was one offered by Bitcoin Savings and Trust – in 2011-2012 – which promised investors up to 7% weekly interest. It ended predictably and badly.) Today, even crypto proponents admit that the “value” of their holdings is based on the Big Fool showing up when they need him. Last fall, the GF disappeared – and the price of Bitcoin fell 70% (but not as bad as the Chinese stock market – another dream realm – demonstrating that centralized and decentralized economies can match each other in terms of value destruction).

Future Historians will publish the “What Were They Thinking” accounts of the cryptocurrency bubble alongside Dutch Tulip Mania and Bernie Madoff in the Gallery of Scandal and Madness.

But aside from all that, there is a deeper problem. Crypto does not work. It does not and cannot serve a valid economic purpose. Not as a store of value, of course (see previous chart). Not as an inflation hedge. It also cannot compete with the dollar, nominal or inflation-adjusted. Fiat money beats DeFi hands down.

But the most important failure of cryptocurrency, however, is its most practical failure: as a potential medium of exchange.

Can we buy things with it?

The short answer: you really can’t. For two reasons.

First of all, the question of “support”. Where can one actually pay for a real-world product (not just another crypto-object) with bitcoin or similar? There’s a lot of noise about this, and there are reportedly workarounds for vendors like Amazon that won’t directly accept bitcoin. But the thing is, after a decade of cryptocurrency promises inasmuch as currency is still not truly fungible. It is greatly reduced in the few transactions where it can ostensibly be used.

Currency that cannot be exchanged, cannot be spent, meets the definition of “bad coin” under Gresham’s Law. In the presence of “good coin” (e.g. US dollar), crypto cannot circulate. Even in El Salvador, which declared Bitcoin its national currency, and even in “Bitcoin City” – which is El Salvador’s showcase for the crypto-economy – the Barrons reporter who went to check things out found that “the money was almost useless; only 3 out of 10 merchants we met in Bitcoin City would accept payment in Bitcoin. Crypto remains a speculative vehicle, with extremely limited convertibility to the real economy.

Even that’s not the worst. One could imagine, or at least argue, that over time the adoption of crypto by merchants in the real economy might improve in some way, perhaps with some safeguards. This is the premise of the Stablecoin concept, where crypto values ​​are allegedly backed by a link to real money, i.e. the US dollar. Kind of like the relationship between the dollar and gold in the old days.

But there is a flaw in the crypto framework that neither the Merge nor the Stablecoin kluge do anything to fix. It’s the extremely low transaction processing capacity underlying blockchains that support Bitcoin and Ethereum. For Bitcoin, the limit seems to be around 7 transactions per second – for the entire planet. For Ethereum, the limit would be around 15-20 transactions per second.

Apple sells about 10 iPhones every second. This would use bitcoin’s capacity here. On Amazon, the average number of transactions is 18.5 per second throughout the day – much higher during peak hours. Or maybe it’s 100 commands per second. During the Christmas period, the volume reaches 300 orders per second. Walmart processes something in the range of 100 to 200 transactions per second. No cryptocurrency could even cope with the current level of activity from Walmart or Amazon, let alone transactions from tens of millions of other vendors around the world.

Extremely low transaction processing capacity limits for Crypto translate to higher costs and long delays. Barrons’ journalist discovered that even a simple transfer of funds with Bitcoin took six hours execute. (Consider how long you could wait for a credit card transaction to be confirmed at the supermarket before losing your patience.) As for cost, Ethereum transaction fees have averaged around $2.00 recently – but earlier this year the fees were tens of dollars per transaction. with odd peaks reaching up to $200. (It’s not clear that the merger will change that.)

Current reality-based payment systems like Mastercard, Visa and American Express process around 1250 transactions per second on average. Peak volumes can be much higher and these real systems are designed to handle them. Visa is said to be able to process up to 65,000 transactions per second. Alipay (Alibaba’s version) is said to have achieved actual payment volumes as high as 250,000 to 500,000 transactions per second during some of China’s major shopping days.

Crypto promoters have their answers, in the form of future plans. In the next big change to Ethereum, something called “sharding” will be introduced – which will split the blockchain into multiple chunks and increase the tps rate to 1000, supposedly. The next modification may involve additional rebuilding of the ecosystem, with “roll-ups” – and will bless the waiting world with volumes of up to 100,000 tps. Then there’s Solana, who supposedly has a “proof of history” mechanism to validate her blockchain, and says she can achieve much higher throughput:

  • “Solana is gaining momentum… Its blockchain processes 50,000 transactions per second and its average cost per transaction is $0.00025, according to its website. Ethereum can only handle around 13 transactions per second and transaction fees are significantly more expensive than on Solana. But the last year and a half has laid bare [Solana’s] compromised as the blockchain network suffered multiple outages. Most recently, on May 1, Solana locked herself for several hours before being similarly brought back online after her network of validators restarted.

Outages have multiplied:

  • “On September 14, 2021, the Solana blockchain went offline after a flurry of transactions caused the network to fork and different validators had different views of the state of the network. The Solana blockchain was taken offline again on May 1, 2022 and May 31, 2022. The [first] the shutdown lasted 7 hours, and the [second] one lasted 4.5 hours. On August 3, 2022, the Solana ecosystem was targeted by hackers, affecting 9,231 Solana wallets [stealing] $4.1 million in total from victims. On July 1, 2022, a class action lawsuit was filed against Solana. (Wikipedia)

It would be interesting to know the extent of the disruptive “breaking wave” that seems to have broken the Solana system.

Blockchain is not designed for this

No cryptocurrency has the ability to serve as a medium of exchange in the modern retail economy. Blockchain is an interesting and useful technology suitable for small, centrally administered networks that require fast and reliable execution on high-value transactions. The Onyx system developed by JP Morgan for the settlement of wholesale interbank repo transactions is an example that appears to be a success. But blockchain currently cannot meet the capacity needs of massive retail payment systems.

Neither Bitcoin nor Ethereum as is can serve as a medium of exchange. The merger, whatever the value, does not change that.

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