The past decade has seen the rise of “digital assets,” purely virtual investments whose value is untethered to physical, tangible things. Cryptocurrency boosters reported huge gains—the “Bitcoin billionaire” of myth and legend—and there has been a gold rush into NFTs, “non-fungible tokens,” also referred to as “digital collectibles.” But the past few months have seen a crash in the value of these assets. Is the primacy of tangible reality finally reasserting itself?
Cryptocurrencies can be thought of as a computer simulation of the gold standard, by way of an algorithm that requires power-hungry computer “mining” to produce new virtual coins. In theory, this prevents the cryptocurrency from being debased through the unlimited production of new coins. But cryptocurrencies have the same fundamental disadvantage as fiat currencies, which is that they are based on no underlying asset. Gold can be used as currency (and until 1971 U.S. dollars were backed by gold), but it is also a rare and valuable commodity in its own right. These days, a normal fiat currency is backed only by the authority (and revenues) of a government. A bitcoin or dogecoin or ethereum is valuable only so long as others agree to treat it as if it has value—and can suddenly and precipitously lose its value if they don’t.
The problem is that this fails to serve the basic functions of a currency: to be a stable measure of value, to be a store of value, and to be universally accepted as a medium of exchange. Bitcoin, by contrast, is accepted only in a subset of online transactions, and its value has fluctuated wildly, making it a speculative asset rather than a stable one—precisely what you don’t want in a currency. If bitcoin is speculative, what are its buyers speculating on? Well, I guess they’re speculating on the fact that more and more people will agree to accept it. In other words, it is speculation on the mass psychology of cryptocurrency itself, and the wild fluctuations represent the uncertainty in that outcome.
The best story about this speculative roller coaster is probably the experiment undertaken by El Salvador’s populist strongman Nayib Bukele, who calls himself the “coolest dictator in the world” and is only partly joking. Presenting himself as a hip futurist, Bukele tried to make bitcoin into legal tender in El Salvador, without success. What he did succeed in doing was to get his government to buy a bunch of bitcoin at its peak. Speculating on bitcoin was apparently designed to bail his government out from financial problems caused by corruption and mismanagement. It will end up plunging El Salvador further into crisis; the country’s $40 million (so far) in bitcoin losses is slightly larger than an upcoming payment on its foreign debt.
Perhaps an even better illustration of the perils of digital assets is the event that helped drive this most recent cryptocurrency downturn: the collapse of the TerraUSD and Luna “stablecoins.” A stablecoin is a cryptocurrency that is supposed to be pegged to a regular currency such as the dollar. The idea is to allow people to make dollar transactions more easily and cheaply and in larger amounts, which is attractive for people trying to transfer money overseas or for high-volume traders who want to move money in and out of various cryptocurrencies while feeling as if they hold it in cash in between.
Except that they didn’t actually hold it in cash. A “stablecoin” has to be set up according to strict rules to ensure it is capable of redeeming coins for dollars. Terra was backed by a dodgy algorithm instead, and it crashed to zero. This is a throwback to the 19th-century era of “wildcat banking,” when rural banks issued their own currencies, often backed by insufficient reserves.
Digital Beanie Babies
The most insubstantial shadow in this realm of shadows is the “non-fungible token” or NFT, a kind of digital certificate connected to a digital asset—usually some kind of image—and propagated by the same decentralized internet technology behind bitcoin. But what does this certificate certify, exactly? In some cases, it includes the copyrights to the associated image—though usually in cases where there is no clear value or revenue stream that flows from the copyrights.
In most cases, what you get when you own an NFT is, well, the ability to say you own the NFT. That’s it. You don’t get revenue, you don’t even get a physical copy of the image to frame and put on your wall—you have to do that on your own—and you have no enforceable way to prevent other people from using the image. Elon Musk, in his usual strange combination of world’s richest man and Twitter troll, rubbed that in by posting a collage of NFT images with the comment, “seems kind of fungible.”
In short, Silicon Valley has found a way to monetize bragging rights. NFTs are the ultimate product of the digital hall of mirrors. They are literally selling nothing.
I don’t find this objectionable when NFTs are used by artists or charities, where donors are often seeking nothing more than bragging rights, anyway. But as an actual financial asset, NFTs make Beanie Babies look like a sure bet. Here, according to CNBC, is what the NFT crash looks like so far.
The NFT of the first tweet by Twitter co-founder Jack Dorsey on the micro-blogging site was first auctioned for $2.9 million to Sina Estavi, CEO of Malaysia-based blockchain company Bridge Oracle, in March 2021. But when Estavi put it up for auction again earlier this year, he did not receive any bid above $14,000 …
Similarly, in early April, another NFT buyer had bought Doggy #4292, a Snoop Dogg curated NFT, for about $32,000 worth of the cryptocurrency ether. The asset was up for auction later with an asking price of $25.5 million. By May 3, the NFT had received the highest bid of 0.0743 ether, or about $210.
There is no need to explain why NFTs are collapsing in value because there is no explanation for why they had any value in the first place.
Pets.com Without the Pets
The digital hall of mirrors has even been working its way back into the traditional stock market, by way of “meme stocks.” This is a buying frenzy directed at a particular stock, not because of the underlying value of the company, but because buying it has become an internet meme.
Last year, investors bid up the share price of an obscure and almost dead company, GameStop—the Blockbuster Video of gaming—just because it became a craze in online investing chat groups. As Fortune reports:
The meme stock era propelled the share prices of formerly unloved, and mostly unprofitable, names like GameStop to new heights in the first few months of 2021. The video game retailer eventually saw its shares jump over 2,000% to a short-lived record high of $483 by January 28.
Leading up to that record, the number of unique accounts trading GameStop on a given day increased from fewer than 10,000 at the beginning of the year to nearly 900,000 by the end of January, according to a Securities and Exchange Commission report.
The lure was that by all ganging together to drive this stock up well above any sane value, individual investors would get revenge on the big hedge funds by making money at their expense. It hasn’t worked out that way. According to one study, the average meme stock investor has already lost all of their gains. Bloomberg reports:
Nursing losses in 2022 that are worse than the rest of the market’s, amateur investors who jumped in when the lockdown began have now given back all of their once-prodigious gains, according to an estimate by Morgan Stanley. The calculation is based on trades placed by new entrants since the start of 2020 and uses exchange and public price-feed data to tally overall profits and losses….
It’s an epic fall from 2021, when at-home traders shot to fame after banding together on WallStreetBets forums to try to squeeze professional investors out of short positions and otherwise overthrow the Wall Street order. Retail investors accounted for roughly 24% of the total stock trading at one point, according to an estimate from Bloomberg Intelligence. Their influence made Reddit blogs and Stocktwits posts must-read material for anyone gathering intel on markets.
This is reminiscent of the late-1990s dot-com bubble, but at least that was based on companies that were trying to sell real actual things, like pet food. While many stocks crashed, it wasn’t because the idea of selling goods online and delivering them to people at home failed to take off. It’s because we wanted to buy those goods from somebody else, and oddly enough it turned out to be the place that sells books.
But meme stocks were such an easily foreseeable collapse because their gains were not based even on a mistaken view of the companies’ prospects for future profits. They were based purely on the mass psychology of social media forums.
The Devil’s Workshop
From “tulip mania” in the 17th century to the housing crash of 2008, every era has its enthusiasms, manias and bubbles. In a digital era, it is natural that ours should be digital—the first pure cyberspace bubble.
But this particular mania is also part of the destructive cost of our attempt to stimulate our way out of the pandemic. Cryptocurrencies, NFTs and meme stocks are the playthings of an economy with too much cash in too many idle hands, and a Federal Reserve that is hellbent on pumping out money to maintain the value of every asset, no matter what. That this would inflate a financial bubble is no surprise, even if the form the bubble took is technologically new.
Both for investors and for the Fed, reality will inevitably reassert itself. Financial “assets” based on nothing but the mass psychology of the internet will eventually have to prove they are providing something of actual value.
Heck, at least with the tulips, we got some lovely flowers out of it.