The Ethics Of Investing In Tokens

 

For today’s newsletter I want to give you a synopsis of a recent podcast featuring Chris Burniske, the author behind Cryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond, a fantastic book that I highly recommend.

 

Chris’ interview was produced by What Bitcoin Did, and you can listen to full thing here:

 

Listen: iTunes | Spotify | Stitcher | SoundCloud | YouTube | TuneIn

 

“If we are trying to take Bitcoin mainstream, that means the vast majority of users will not be educated about the merits of Bitcoin, they just won’t care, they will actually be turned away if they feel like they have this screaming mob asking why the hell they are using this other asset.”

— Chris Burniske

 

Peter McCormack: . . .  So let’s go to Bitcoin itself. I like to ask people in almost every interview now this same question. I’m always intrigued by the answer. It changes every time. But what is Bitcoin?

 

Chris Burniske: I think the easiest way to describe Bitcoin is; money over an Internet protocol. Just as voice over internet protocol, things like Skype and WhatsApp calls have revolutionized our ability to connect with anyone anywhere in the world for zero cost, Bitcoin as a money over Internet protocol, rips out all of the pre-existing sludge of our financial system, the interconnects and all of the things that take up time and cost. It just says, here’s this global network for communicating or transmitting value at low cost.

 

. . .  So this is where I think of money as a store value, means of exchange and unit of account. The crux of that progression first being a good store of value and we see Bitcoin doing just that. . . .  I think that if you follow the line of thinking within “The Bitcoin Standard” where… The argument there is that the world has been infected with inflationary assets and that we actually need to go back to deflationary assets. That sets up all the right spending and saving patterns and so on and so forth. I think it’s a very elegant thesis and enjoyed reading the book. I think something that I haven’t figured out for myself yet is what happens when the majority of the world still operates under an inflationary regime and Bitcoin is a significant store of value, but say not the majority store value. I think it’s very hard psychologically for people to spend something that is deflationary when the world is mostly inflationary. I’m talking about supply schedules here. So does that require us to assume that Bitcoin needs to get to majority value capture of the world’s assets or at least the world’s monetary basis in order to say have this… It’s really a behavioural switch, a psychological switch and that’s asking a lot. That could happen, but I don’t think I have enough information here and now in 2019 to say that that’s the likely outcome.

 

. . .  Everything’s a calculated investment and there’s the expected value being the probability multiplied by the reward. There’s so many things with Bitcoin. I guess where does my fundamental conviction in Bitcoin lie? I think it comes down to being maybe the most perfect instantiation of the commodity theory of money that we’ve seen, in terms of that it was the first crypto asset. Because of that, it priced every subsequent crypto asset and it was the most liquid crypto asset.

 

So it has become the bloodline of liquidity for the entire ecosystem and because it prices everything else, it is intractable. This isn’t a technology thing, this is a social thing and it’s not something that can be taken away from Bitcoin, but it is something that Bitcoin can lose. So when I approach Bitcoin, say from looking at the many competitors out there, I don’t think of those competitors as being able to take anything away from Bitcoin, because what Bitcoin built happened so organically and it’s so entrenched in the ecosystem. So that gives me a lot of conviction in the context of a retail hodler Bitcoin, it’s an amazing store value.

I think the other thing I’d layer in there is the type of scarcity that Bitcoin has, you could really only create that in a digital world. It is so artificially scarce and with the supply schedule that converges on a 0% rate of inflation, you can’t have that with physical commodity monies. So being set up as the perfectly scarce asset, I think that’s a fascinating psychological experiment that should be directionally positive for the price.

 

Peter McCormack: Okay. So let’s unwrap this. So let’s start with… Convince me that there is a model in the future for people to buy and use tokens in these networks.

 

Chris Burniske: Sure. I actually may not convince you of that, because I don’t know that the model is so much a demand-side focus model as much as the supply side focus model. That would be more the creators of the service as opposed to the consumers of the service. But stepping back for a moment, we just discussed Bitcoin and Bitcoin has proven that a purely digital asset on a decentralized ledger can be a store value. If you go back to 2015, the last bear market, that wasn’t a stronghold, an intellectual stronghold the way it is now. It’s hard to imagine now, the uncertainty that was there then. Even if you take traditional finance in that period, I was at different conferences where it was Blockchain not Bitcoin mania and was dismissed.

 

So just understanding that there are these psychological shifts that happen. In the early, especially in the first bear market that follows the creation of a new movement, it is natural that there would be a lot of uncertainty. I wrote a post on this called “the best time to build and buy tokens”, that really explains the psychological progression. So that’s the starter of say, okay, Bitcoin has made it through this journey of conviction and the other crypto assets are much earlier in their journey. Why do we think they fundamentally have value?

 

I would say that the majority of what we’re seeing in the market today is more an evolution and replacement for equity, than a replacement for currencies. Not Bitcoin. Bitcoin as we just discussed and some like it like Monero or Zcash and really hard proof of work based assets and we can come back to value accrual through proof of work in a moment. But those assets are focused on currencies. But a lot of the ones that are stake based or bonding based or whatever it may be, are actually organizing a supply side that is provisioning a service, a supernational service and enforcing the rules and governance and evolution of that service in such a way that, if it works out, the supply side that is holding that asset gets to claim to the value flows of that service.

 

That is actually very much a discounted value flow model, similar to how equity would be valued. It’s different from an equity in terms of the third party. If you go to the Howey test, the efforts of others and this third party is a very amorphous third party. It’s really this collective, who is the third party in this instance? It’s also very different from inequity in that with inequity you have a passive collection of dividends.

 

Whereas when you’re organizing the supply side, the crypto assets base is partially productive, partially value flow producing, partially nonproductive, partially a consumable transformable, which is where people kind of get stuck. So the productive base, you have to be an active participant in that network in order to get value flows, which from an egalitarian perspective is very important. Joel my partner has done a lot of great work thinking around how equity has led to some of the inequalities we see in the world today. But the fact that you have to be an active participant to get access to the value flows, is a very important component of any crypto asset.

 

So if I were to say lay forth a framework and I need to put out a piece on this soon, the framework coming from an evaluation perspective, you can think of broadly there being three superclasses of assets. Stop me if at any point this is unclear, but three superclasses of assets where there are capital assets, which are typically thought of as cashflow producing. So bonds, equities, income-producing real estate, those kinds of things. There are consumable transformable assets, which are more your typical commodities; oil, wheat, natural gas, metals. Then they’re your story value assets, so fine wines, arts, rare automobiles.

 

If you take something like gold, it can be both a consumable transformable and a store value asset. Bitcoin I would argue is the same. Holding a Bitcoin doesn’t give you a claim on any value flows. You can’t stake a Bitcoin to be a participant in the network. So I actually think the best way to value those assets is still through the equation of exchange, Mv=Pq, which is what I put out in 2017. But interestingly enough, the majority of crypto assets are shaping up to be capital assets.

 

To be things that organize and are useful predominantly to the supply side. So I think that the majority of value accrual for those assets will be through a discounted value flow model. What’s really interesting is there’s overlap though where let’s say Ethereum goes to proof of stake. It is predominantly a capital asset, but where it’s used to pay for Gas, it’s a consumable transformable. So I think it becomes a sum of the parts valuation where it’s predominantly discounted value flow for the supply-siders.

 

But there’s a little bit of value capture through Mv=Pq and as I discussed with the original evaluation piece, velocity becomes a problem and all of those considerations taken into account. But I lay the framework to really try again, as I did originally with the book, try to piece apart how different these systems are and therefore the value capture will be so that we can stop bickering over, “your approach is bad because it’s different from my approach”. It’s not that at all. It’s just they’re fundamentally different approaches trying to solve different things.

 

. . . I think that thus far in Bitcoin’s journey, it has needed to be defended in this way and with say extreme conviction in ideology. Part of my point is Bitcoin is like a tree or like a child, in that it grows, it starts off green and it needs to be protected. But as it unfurls it enters different stages.

 

If we really are committed to the mainstream and then the rhetoric either needs to change or it will be buried in the wires such that it’s irrelevant. I actually think the latter is probably more likely, which is why I don’t beat the drum on this too much and I just let it be where it is because social media is not a constructive place to have these conversations anyway. It’s too nuanced and social media is just going to want the emotion in the fire.

 

But I think that we have to encourage the community to be mindful about the progression of what’s necessary and to not alienate people who are just thoughtfully raising questions. Another way to think of it is every community is going to have governance or maybe better put as every community has to make decisions. There’s always going to have to be a choice about the pathway for how those decisions are made and not setting up a framework is a decision in itself.

That is the choice of governance.

 

I understand governance is a loaded word, but just using it as the best example we have now, taking that into account and understanding, okay, so this is Bitcoin’s chosen form of governance. I think also for Bitcoin, it moves faster than people think it moves. But I don’t think it needs to say move as fast as say Ethereum does, just because of the value proposition that it provides to the world.