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Cryptocurrencies Unplugged

Cryptocurrencies Unplugged

Stay away [from cryptocurrencies].  I can say almost with certainty that they will come to a bad ending.

Warren Buffett

Issues to be addressed in this research paper

When, in early 2021,  I first wrote about cryptocurrencies, bitcoin (BTC) traded around $31,500, and I was widely criticised for being overly negative.  “You don’t know what you are talking about” was one of the kinder responses in the armada of emails I received.  Now, a couple of years later, with BTC trading almost 50% lower at approx. $16,800 (as at 7/12/2022 – see Exhibit 1), I think it is fair to say that maybe I do know one or two things.

Exhibit 1: Price of Bitcoin (in US dollars)

One of the objectives of this paper is to challenge the view of the crypto diehards that BTC is most definitely the currency of the future.  It is only a question of time, they argue.  In this paper, you’ll see that I emphatically disagree with that view, but is that a problem?  Is that a cause not to invest in cryptocurrencies?  I don’t think so.  I merely argue that the cryptocurrency brigade are doing their very best to make cryptocurrencies out to be something they aren’t.  Allow me to repeat one of my conclusions from January 2021:

“This doesn’t imply that cryptocurrencies as an investment opportunity are doomed – not at all.  Cryptocurrencies could gradually replace gold as a store of value, and demographics support that argument, or they could continue to trade as they do now – as a risk-on, only modestly correlated, esoteric asset class which increasingly carves out a slice of investment portfolios.”

The other reason I want to provide an update now has to do with the mayhem caused by FTX Trading Limited’s chapter 11 filing in early November.  FTX is, or rather was, a major crypto exchange.  According to Financial Times, at the time of the meltdown, the company had $9Bn of liabilities but only $900Mn of short-term assets.  FTX started to disintegrate when its rival, Binance,  which is the world’s largest crypto exchange, pulled out of a deal to acquire the company.  FTX was already on shaky ground, and Binance’s change of heart caused investors to pull their money out of FTX.  Within a day or two, it became obvious that the company stood no chance of meeting all those redemption requests.

Financial Times posted its first article on the collapse immediately after the chapter 11 filing, but the new management team has since located more cash, bringing the total up to $1.24Bn; however, there is a long way to go before all liabilities can be met.  According to lawyers involved in the case – but this has not been proven yet – a substantial amount of crypto assets may actually have been stolen (source: Forbes).  That episode deserves a few hours of my time.

How has the crypto market evolved since early 2021?

Let’s begin with a brief update on events since early 2021, when we published our first paper on cryptocurrencies.  When that paper was released, total market capitalisation in the cryptocurrency market was a tad over $900Bn.  Today, the number is virtually unchanged (source: CoinGecko) with more than 20,000 cryptocurrencies making up the total (source:  In other words, despite thousands of new cryptocurrencies having been launched in the last two years, the aggregate market capitalisation is no higher today than it was a couple of years ago.

A list of the most significant crypto events of 2021 would include Biden’s infrastructure bill, which included provisions to impose a tax on cryptocurrency trading.  Even more radically, China introduced a blanket ban on all crypto trading last year – a ban that is still in effect.  The Indian government also toyed with a ban but, in the end, didn’t do it.

This year, much of the crypto talk has been about the excessive use of electricity by crypto miners.  Take for example BTC.  It uses about 200 TWh of electricity every year, equal to the annual power consumption of Thailand (source:  It didn’t go down very well, when it became public knowledge how climate-unfriendly crypto-currency mining actually is.

On a more upbeat note, blockchain, a technology that was initially developed to support BTC, has received a lot of positive attention this year.  All this attention has been used by many crypto believers to argue why cryptocurrencies have come to stay, but that is a silly argument.  Blockchain has assumed a life of its own independently of the crypto market and has become an important technology, whether we have cryptocurrencies or not.  Therefore, I don’t think the link between blockchain and the crypto market is that relevant, if the purpose is to look for reasons why cryptocurrencies are with us to stay.

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Why cryptocurrencies will never become proper currencies

Currencies are issued by sovereigns, and currency issuance forms an important part of monetary policy almost everywhere.  Do you honestly believe governments are prepared to relinquish that policy tool?  If  cryptocurrencies begin to look like a serious threat to the existing monetary system, the political leadership will have to take action.  Cryptocurrencies will at best be regulated, at worst banned, as has already happened in China.  Having said that, it is only a question of time before most sovereigns have their own digital currency.  Some countries have already started.

On the other hand, I have no reason to believe cryptocurrencies will completely disappear.  There are plenty of risk-on assets that live a somewhat esoteric life, but there is still a role for them in many portfolios.  The reason I struggle to get enthusiastic about this asset class is that the intrinsic value is zilch.  Whether you invest in equities, fixed income, commodities, land or anything else, there is almost always an intrinsic value associated with the investment, which you can fall back on in difficult times.  The intrinsic value in cryptocurrencies is non-existing.  In my opinion, BTC is software – a digital phenomenon which has captured the world – nothing else.

How to value cryptocurrencies

If the intrinsic value of cryptocurrencies is non-existing, could one argue that they are effectively worthless?  Yes and no.  Let me explain.  To begin with, it is important to understand that valuing crypto assets is art rather than science.  The argument in favour of worthlessness is simple, the argument in favour of worthiness far more complicated.  If it were worthless, one could argue that, apart from all the poor souls who have invested in the asset class, it would have little effect, should cryptocurrencies disappear.

On the other hand, if we assume there is some value attached, we have to agree on which valuation model to use, as there are several.  One of the most frequently used is based on Metcalfe’s law, which states that the value of a telecommunications network is proportional to the square of the number of connected users of the system.  Metcalfe’s law is often used to value social networks like Facebook and Twitter, and one can argue that the same approach could be applied here.  I found this presentation on YouTube, which offers a comprehensive review of the Metcalfe approach, quite  interesting.

A second valuation approach is based on the quantity theory of money, or MV = PQ, where M is the money supply, V the velocity of money, P the price level and Q the transaction volume (output), all in a given time period.  According to this model, if you double the money supply (M), assuming V and Q remain constant, the price level will also double.  This is why monetarists have warned for years that the dramatic post-GFC rise in M can only end badly, and they have certainly been vindicated more recently.

A third valuation methodology assumes crypto assets are a store of value – effectively a risk-off asset class competing with gold for risk-averse investors’ attention.  People typically invest in gold, because they see the precious metal as a solid store of value.  The thinking here is that investors will increasingly walk away from gold and instead use cryptocurrencies as the primary store of value.

Exhibit 2: BTC vs. gold
Source: Bloomberg

The argument should not be dismissed out of hand. Many BTC investors (the Millennials) were not even born the last time gold was a major store of value (around 1980) and are, on average, reluctant to invest in gold.  Investing in BTC, on the other hand, comes natural to them.  With the BTC/gold ratio hovering around 10, BTC is now the cheapest it has been relative to gold since late 2020 (Exhibit 2).

I would have a great deal of sympathy for this argument, if aggregate crypto supplies could be controlled, but they can’t.  The innovators behind BTC have done it by introducing the halving principle and by limiting the total number of coins being issued but, as long as we have more than 20,000 cryptocurrencies in circulation and hundreds of new ones being launched every month, we are effectively talking about unlimited supplies – unlike gold.

A few other valuation methodologies are also applied from time to time, but there is no one generally accepted methodology.  Instead, most pundits choose the model that provides the best support for their views, which is why I don’t assign much credibility to most of the work conducted in this area.  As a consequence of the numerous ways to value cryptocurrencies, it is virtually impossible to say whether they are undervalued or overvalued.  It very much depends on the choice of model.  Having said that, the intrinsic value is certainly nil, and that is enough for me to stay on the side line for now.

The FTX debacle

“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.”  

Those were the words of John J. Ray III, a veteran of the Enron bankruptcy who, in the early morning hours of the 11th of November, agreed to take on the not-so-enviable position as clean-up CEO of FTX Trading Limited, just like he did in 2001, when he sorted out the mess left behind by Enron management.  Ray has a difficult job lined up.  It is pretty hard even to explain what FTX actually did, as they did an awful lot of things.  In Ray’s own words, FTX consisted of four silos:

1. A non-US crypto exchange called

2. A US crypto exchange called

3. A trading firm called Alameda Research LLC.

4. A VC firm called FTX Venture Capital.

It is now Ray’s job to sort out the mess left behind by Sam Bankman-Fried and his cronies who, for a while, thought they had found the keys to wonderland.  Bankman-Fried has demonstrated an uncanny ability to mix with the rich and famous, and that talent has allowed him to attract substantial amounts of business to FTX.  More than once has he posed in photoshoots with the Prime Minister of the Bahamas and, in a conference on crypto investing in Nassau, held in April of this year, he mingled with a couple of well-known gentlemen who, by the way, have been busy distancing themselves from Bankman-Fried since the chapter 11 filing (Exhibit 3).

Exhibit 3: Sam Bankman-Fried on stage with a few of his ‘friends’

As my grandad used to say, if it looks like a fish and smells like a fist, then it probably is a fish.  For that reason, I am tempted to categorise the FTX saga as a fraud, although no proof is on the table yet.  Having said that, whether it was a fraud or not, it is rather disconcerting that a company of this size could operate without having any idea of its assets, let alone its liabilities.  I bring this up, as it could, quite possibly, mark the end of the crypto golden era.  For years, the faithful would smile every time someone reminded them this could end in tears but, now, even the most faithful are shaken to the core.

The collapse of FTX has highlighted the need to regulate crypto activities and, the sooner, the better.  Some sort of legislation is underway in both the US, EU and UK, but regulating an industry that has purposefully set itself up outside heavily regulated regimes is rather difficult.  Smaller jurisdictions like the Bahamas, offering a light-touch regulatory approach, have provided a harbour for crypto operators.  And, in today’s highly digitised world, prospective investors in heavily regulated regimes are only a click away.  That is problematic but, unless the most powerful jurisdictions take decisive action, charlatans and fraudsters (note sure which of the two categories Sam Bankman-Fried comes under) will continue to proliferate.

The bottom line

If you believe the most bullish estimates, one BTC will be worth well in excess of $1Mn by 2030.  On the other hand, if you think Warren Buffet is correct, BTC will be going the same way as Sam Bankman-Fried.  That is a heck of a spread.  I will openly admit that I have little intelligence to support either of those two views.  I therefore see an investment in cryptocurrencies as pure and simple speculation.  And, yes, I do speculate from time to time but, when I do, I never put more money on the table than I can comfortably lose and still go to bed with a smile on my face.  I would strongly advise you to follow the same principle.

In the 2021 paper, I concluded that, should you decide to invest in cryptocurrencies, you should follow a simple set of rules, and those rules still apply:

1. Never invest more than you can afford to lose.  The crypto concept has not yet been proven beyond doubt.

2. From the outset, set a (modest) target allocation (say 2.5%) but do not invest it all on Day One. There is plenty of volatility in cryptocurrencies, and it would be foolish not to take advantage of that.

3. Once you have reached your planned allocation, rebalance regularly (at least quarterly).  Don’t allow yourself to get carried away during good times as you’ll pay the price when the market corrects.

If you follow those rules, you’ll be exposed to a fascinating asset class without running the risk of losing everything dear to you.  Will I invest?  No!

Niels C. Jensen

7 December 2022

About the Author

Niels Clemen Jensen founded Absolute Return Partners in 2002 and is Chief Investment Officer. He has over 30 years of investment banking and investment management experience and is author of The Absolute Return Letter.

In 2018, Harriman House published The End of Indexing, Niels' first book.