Discover more from Learning by Proxy with Vivek Srinivasan
Exaggerated Stock Market
Crypto has been moving in tandem with the stock market. It just sways a lot more than the stock market making it great for speculators but not for investors
When Clinton moved into office in 1992, the homeownership rate had been falling in the United States. Home Ownership was the cornerstone of American prosperity since the Second World War. The administration came up with the Community Reinvestment Act which gave banks higher ratings for home loans made in “credit-deprived” areas. One of the things that this policy did was to lower the downpayment requirement from 20% to 3%. This was done in 1995.
A home loan is considered securitised or backed by collateral, which is the house itself. Therefore, the rates of interest tend to be lower on such loans because it comes with lesser risk.
If you provide such a loan, the return on capital is lower. The repayment is usually stretched out over years. If that capital can be released by relinquishing some of the returns, it becomes possible to redeploy the capital. So instead of earning 4% interest on capital of USD 1 Million, I decide to part with 2% and recover the capital for redeployment.
Thus was born the Collateralised Debt Obligation (CDO). An institution could take thousands of loans and bundle them into a CDO. The CDO would provide the holder with a fixed annuity (guaranteed monthly payment). This was a great instrument for pension funds which had to deploy the capital and pay an annuity to the pensioners.
The combination of the fact that it only took a 3% downpayment to buy a house and the organisation giving out the loan did not care about its recovery since they would bundle it in a CDO and get rid of it; gave us the collapse of 2008. The quality of due diligence went down substantially.
A group of geeks pissed with the banking system and the catastrophe that it wrought over the rest of the planet came up with decentralised currencies. The first of those was Bitcoin. The supply of Bitcoin was controlled by a computer algorithm. The problems that needed to be solved would get increasingly difficult, raising the value of the Bitcoin.
The 2010s were a time when consumer internet startups were on a high. Everything was to be decentralised. The gig economy was born and many of the gig economy founders were just plain breaking the law. You need 123 licenses to start a hotel in Bangalore, but nothing to get started with Airbnb. You needed a million-dollar taxi medallion to drive a cab in New York, but the Uber driver got going with nothing more than a car.
Some investors thought well… What if we had our own money?
The Winklevoss twins had shaken out a few hundred million from Mark Zuckerberg and they thought owning the “new money” would be great and plunged headlong into it. That attracted further interest and the little supply that was available was snapped up real quick pushing prices up incredibly. Speculation attracts more speculation and got a lot of the rich people who could afford to lose money into the market. This further escalated value.
Mr Anderson is a very wealthy person. He has a huge ranch where his family goes to stay often. Mr Anderson has his own currency on the ranch. The currency is in the form of cards that are valued at 5 units. When his two sons came to the ranch they were given 20 cards. They did not care much for it and tossed it in the corner of their rooms.
When they went to have dinner, they realised that they would be needed to pay for the dinner in cards. They needed 5 units to get dinner. They could also earn cards by doing some work on the ranch. Their need to survive meant they needed to do work on the ranch and ensure that they had enough cards to get all the food they wanted.
The government routinely takes our money in the form of taxes. The money that the government prints and circulates would be of no particular value but of the fact that you needed to pay taxes only in that currency. Much like the cards in the example above, the currency comes to life because of the taxes. Without taxes, a currency would have no power and no value.
Many felt they missed out on Bitcoin. So they went one abstraction layer higher and looked at what else might be possible under crypto currency. Over the last 8 years, there has been a cornucopia of crypto-currencies issued by a plethora of organisations with myriad advantages for each. This was the equivalent of explorers trying to own a piece of the new world and stamp their authority on that land.
The new world had resources to offer. One could extract those resources and export them. The new crypto-currencies were counting on the “network effect”. The thing that made Facebook valuable. If many people use something, it becomes valuable because of dependence. But then, given that there was no basis for the value of these crypto-currencies, it was only the rich that went on to hoard it all.
In 2018, when the Dow Jones went from 26000 to 23000, Bitcoin crashed from 20000 to 4000.
Source: Google Finance
When the pandemic unleashed itself, the stimulus package put a lot of money in the hands of the rich. All that money promptly went into hoarding more cryptocurrency. Bitcoin went from a low of 8000 to 63000 while at the same time the Dow Jones climbed from 21000 to 36000.
In the past 4 months, as the effects of the financial war waged by the west have played out, the Dow has fallen from 36000 to 31000, at the same time, Bitcoin has gone from 46000 to 19000.
Cryptocurrency is not a currency. That is a complete misnomer. Cryptocurrency is just ongoing gambling on a fictitious digital token with no apparent underlying value. If at all anything it is proving to be an exaggerated stock market.
Only, in the stock market, there is an underlying asset and an associated value that you can recoup in the event of bankruptcy. In the case of cryptocurrencies, there is zero underlying value. Nothing illustrated this better than Luna which was a cryptocurrency issued by Terra.
When the rout started a couple of months ago, the currency crashed to zero at a record pace. The coin had gone from $7 a year ago to a high of over $100 in just 10 months.
The geeks were wrong. They did not create an alternate financial system. They just created one that is even more open to manipulation and one that has a complete absence of any safeguards.
In 1920, it was normal in the US for partnerships to be founded to pool resources explicitly with the intention of undertaking a “pump and dump”. The share that was most prone to such manipulation was RCA. Laws were created after 1930, that made this practice illegal. Crypto is in the 1920s but there is no way to police it given its architecture.
Now imagine you are the owner of a company. You are the richest person in the world because of the share price of the car company. You have been posting profits not because of the operational efficiency of your car business but because of the crypto profits you have been making. Would you have reason to manipulate the market?