Prediction: There is a zero percent chance that cryptocurrencies do not get regulated and/or outlawed entirely by most sovereign governments in the near future.
Retail investors are flocking to the asset class en masse. Are they aware of the inherent risks of the assets that they are buying? Any company that launches its own cryptocurrency or coin-based offering has the potential to reach 1990’s-esque dot.com valuations. Investment capital these days seems to be limitless and free. Wolves at large financial institutions and family offices are getting in on the game, looking for arbitrage. All of this will not continue unchecked.
The Voices Against Cryptos Have Weight
Warren Buffett has stated that “Bitcoin is probably rat poison squared.” Charlie Munger, Buffet’s long-time business partner, goes even further to say the following when referring to his aversion to investing in Bitcoin: “I’m proud of the fact I’ve avoided it . . . it’s like some venereal disease.” JP Morgan’s patriarch, Jamie Dimon, stated that “cryptocurrency has no intrinsic value.”
These three individuals are obviously well-known. Nearly every reader almost surely immediately recognizes them. They are actively recruited to help educate congress and financial regulators on matters affecting the U.S. and global economy, along with many other CEOs and Board Members of large U.S. financial institutions. All have been invited by former U.S. Presidents to act as subject matter experts on economic issues. The executive and legislative branches look to them directly for their advice. If U.S. regulators consult with them again here on whether cryptocurrencies should be regulated and if foreign regulators are listening, the likely result is relatively predictable.
Leaders Will Not Cede Power To Decentralized Currencies
Several countries have been in the news recently about outlawing cryptocurrencies. China, perhaps the most famous “banner” of anything contrary to centralized authority, has gotten a lot of this press. Another recent article citing the central bank of India´s response is interesting. The article highlights India’s Central Bank statement that “crypto currency is akin to a ponzi scheme”, and that “cryptocurrencies can “wreck” the currency system, the monetary authority, the banking system and in general the government’s ability to control the economy.”
I’ve bolded and italicized the most important part of that statement. In my view, this is the concern that every crypto investor should have with regards to the ultimate viability of cryptocurrencies as an investable asset class: any challenge to centralized control based on monetary control will just be eliminated.
Central bank officials, while historically slow to react to market changes with endless scenario analysis, may just now be recognizing the challenge to their authority that cryptocurrencies pose. Or maybe now they are just in the news staking their discontent. But, either way, the tension is transparent.
To be more blunt, any financial transaction in cryptocurrency rather than fiat is a direct and correlating decrease in power allocated to central bank officials and governments. It is literally a 1:1 correlation. Although central bank officials are disguised as private company employees, in a substantive manner, really they are agents of the State. The administration of monetary policy is a material economic matter of the State, period. It is one of the most powerful mechanisms the State has to control and influence their populaces. Although I despise the current system of state monetary control, I’m ultimately a realist. I fully expect more and more central bank officials will be forthcoming in recognizing this contradiction and will be looking to do something about it as more resources flow into these non-traditional sectors like cryptocurrencies.
Financial Regulators Are Going to Start Swinging At Cryptos
Vice recently posted a piece blasting the Super Bowl advertisement of Coinbase from this year´s game titled “Coinbase Swears This All Isn’t Like the Dotcom Bubble After Super Bowl Ad SNAFU.” The article reports that Coinbase spent $16 million on a QR ad during the Super Bowl that directed viewers who scanned the code to a Coinbase landing page. Coinbase was offering $15.00 in Bitcoin for signing up as well as a chance to enter a contest to win one of three prizes for $1.0 million worth of Bitcoin, all just for scanning and registering. It turns out that 20 million people scanned the code, enough so that Coinbase’s website and landing page immediately crashed. This “fail” was actually a win for Coinbase with the attention it brought. But, we expect these means of easy access to financial instruments are going to invite regulation.
“To Coinbase . . . the ad was a success. In a blog post congratulating itself on the advertisement and interviewing Coinbase Chief Marketing Officer Kate Rouch about why the ad was so good, the company revealed it saw ´20M+ hits on our landing page in one minute which led to us temporarily throttling our systems.´” Chief executive Brian Armstrong took to Twitter to gloat about the ad: ranked #1 by AdWeek and peaking at #2 in the Apple App Store, just ahead of apps for the Pepsi Super Bowl Halftime Show and the NFL.
The above gives a perfect use-case as to why the Securities & Exchange Commission (SEC) and corresponding foreign securities regulators are going to step into the crypto markets.
In reality, the SEC is most concerned with protecting the “small guy,” or, in SEC terminology: a “non-accredited investor.” The “small guy” is the one that the SEC views as being most susceptible to fraud and aggressive selling tactics (i.e., the one not capable of managing his or her own money or not smart enough to understand risk). Essentially, if you’re a “small guy,” regulators should be wary about the financial products sold to you. Small guys are high risk from a regulatory perspective and thus a government-benefits perspective. If they lose money, they can become government-dependent. Things like venture capital, private placements and other typically higher yielding asset classes are basically off-limits to this group as a preventative measure.
Basically, what we are saying here is that there is a “protected class” of persons that the SEC is most interested in because they cannot “fend for themselves”. If the rich guys (i.e., “accredited investors”) lose their shirts and it’s not due to fraud or other malicious acts the SEC could care less, it’s on them. But, if you sell investments to someone who could be materially affected by a negative outcome, the SEC will bring consequences.
With this context and circling back to Coinbase´s Super Bowl ad, you can’t tell me that all of those 20 million QR code scanners were accredited investors. That is impossible. Many of these folks will have no idea how cryptocurrencies work when they enter the market, but Coinbase and others will take their money on the back of a free $15.00 of Bitcoin to get them started in cryptos – that’s a fact. If things go sour in crypto markets, that could materially affect the small guy who the SEC is worried about. Coinbase and others rely massively on the trading volumes of non-accredited retail “investors” to build their businesses. As the old cliche goes: when your taxi driver starts giving you stock tips of securities you own, it’s time to sell. I would say the same theme prevails for our discussion – when the taxi drivers are investing in big numbers in an unregulated asset class, expect the SEC to come knocking.
Conclusions and Final Words
Anytime there is an era of seemingly “free money” on the table, financial regulators are going to start looking as soon as any material amount of capital outlay is at-play. In my personal view of the market, we are at such a point financially and Dollars are riding fast and loose. Retail “investors” see no risk in the crypto asset class. It can only seemingly go up. An entire generation of retail investors are putting their entire life savings in crypto assets. Historically smart money, the likes of Warren Buffett and Jamie Dimon, are definitely whispering in the ears of the highest level politicians that these assets are potentially poisonous. There is a structural dichotomy and battle for power that exists between the fiat and crypto world with no resolution in sight. We expect to see more friction in the near future.
Expect certain jurisdictions to outlaw, or heavily restrict, cryptos: Examples of countries that have outlawed cryptos are China, Egypt and Qatar. What do all these countries have in common? Authoritarian or semi-authoritarian regimes. Expect that governments that expect to retain heavy, or near complete, control over domestic financial systems to outlaw cryptocurrencies in the near-term. Any would-be dictator or centralized control apparatus would be foolish to let cryptocurrencies prevail within their borders. They will lose an incredible amount of power as a result.
We would expect the more “westernized” nations to lead on cryptocurrencies with regulation. Disincentives like aggressive tax burdens (imagine tax policy relating to the non-deductibility of capital losses on gambling activities to the full taxability on earnings in current U.S. tax code) could also potentially come into play if governments want to disincentivize the activity rather than stir a legal battle over banishment.
Any regulatory change, implementation or otherwise will directly affect cryptocurrency valuations: Edward Snowden and others have speculated that “China’s crypto ban has made bitcoin stronger.” This seems like the wrong way to think about the asset class in the long-term. I see the idea above, really, as nonsense. China is showing the rational behavior of what you’d see from any self-interested government who is looking at retaining power, not ceding it out. China currently holds 18% of the world’s population. All I see from the above is a potential audience for full global adoption of crypto decreasing by 18% because they are banned from participating. I would expect the blue-sky valuation portion of current crypto asset pricing (however subjective that may be) to be throttled by these full illegality measures rather than valuations increasing as a result. Why would an asset’s value go up if 18% less people could buy it?
Upcoming regulation from western nations will likely further hinder these valuations, and I would fully expect certain digital assets to be removed from trading altogether, rendering these assets worthless. To summarize: Beware ye who enter here.
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