The Biggest Crypto Fantasy of All – Forbes | Jewelry Dukan

  • “Spend cash, invest in bitcoin. Cash is trash.” – A ‘bon mot’ from one of the Winklevosses
  • “As of the end of Q2, we have converted approximately 75% of our bitcoin purchases into fiat currency,” – Tesla Quarterly Earnings Statement (July 2022)
  • “Bad coin and good coin cannot circulate together.” – A version of Gresham’s Law

This week brought news of “the merge”—a purportedly momentous singularity in the history of humankind, or at least a big new loop in the tangled story of cryptocurrency. We are told that, from now on, Ethereum (the second most popular crypto offering) will no longer be based on “Proof of Work” but rather on “Proof of Stake” (whatever that turns out to mean). The big selling point of the merge is that the cost of “mining” the stuff will be reduced. In fact, mining won’t even have to happen anymore (too bad for Nvidia, by the way, which has floated its market capitalization on sales of the mining hardware—its share price is 92.88% correlated with the price of bitcoin since November 2021).

In any case, “Merge parties” are said to have broken out world-wide, live-streaming from every time zone. Meanwhile, the hedge fund world has crowded into the options market to trade on the volatility that they expect.

  • “‘A lot of smart money [is] buy’… Outstanding option contracts rose from 1.2 million at the start of the year to over 4.6 million as of Wednesday. About 80 percent of those contracts are call options… This is a sign of ‘massive bullishness’.”

Of course, the existence of “massive bullish sentiment” would usually signal a fall in the market (investor sentiment is usually a contrarian indicator). The next few weeks will show how the merger will develop for speculators. But we already know that in practical terms it won’t make any difference to crypto’s long-term fundamental prospects.

The errors in the model

There are so many things wrong with cryptocurrency that it’s hard to know where to start. Hit this Piñata of Deception and False Hope and the slime will squirt out. The ugly stuff has to do with what might be termed “moral flaws” in the crypto model: facilitating illegal transactions, money laundering, ransomware extortion, drug trafficking, porn, and god-knows-what. Then there is the amazing waste of the mining process by which crypto tokens are “created”. Before the merger, it was said that Ethereum’s carbon footprint is “roughly the same as that of Finland.“The price tag for bitcoin’s climate damage is obviously a bit higher, equal to Sweden’s total energy budget. Add in dozens of hacking scandals and shed light on the pain endured by naïve investors who dabble in the totally unregulated crypto market. The overall Ponzi-esque nature of the phenomenon was clear from the start. (A typical Bitcoin boost was that of Bitcoin Savings and Trust — in 2011-2012 — which promised investors up to 7% weekly interest. It ended predictably and badly.) Today, even crypto advocates admit that the “value ‘ of their holdings is based on the bigger fool showing up when they need him. Last fall, the GF disappeared – and Bitcoin’s price fell by 70% (although not quite as badly as the Chinese stock market – another field of dreams – showing that centralized and decentralized economies can rival each other in value destruction).

Future historians will publish the What Were They Thinking narratives of the cryptocurrency bubble alongside Dutch Tulip Mania and Bernie Madoff in the Gallery of Scandal and Folly.

But aside from all that, there is a deeper problem. Crypto doesn’t work. It does not and cannot serve any valid commercial purpose. Obviously not as a store of value (see previous chart). Not as an inflation hedge. Nor can it compete with the dollar, either nominally or adjusted for inflation. Fiat money beats DeFi hands down.

But the most important failing of cryptocurrency, however, is its most practical failing: as a potential medium of exchange.

Can you buy stuff with it?

The short answer: you really can’t. For two reasons.

First of all, there is the question of “recording”. Where can you actually pay for a real product (not just another crypto object) with a bitcoin or something similar? There is a lot of fuss about this, and there are said to be workarounds for vendors like Amazon that don’t accept Bitcoin directly. But the fact is that after a dozen years, cryptocurrency promises Qua Currency is still not truly fungible. It is heavily discounted on the few transactions where it can supposedly be used.

A currency that cannot be traded, cannot be spent, meets the definition of a “bad coin” under Gresham’s Law. In the presence of “good coins” (e.g. the US dollar), crypto cannot circulate. Even in El Salvador, which has declared bitcoin its national currency, and even in “Bitcoin City” – El Salvador’s showcase for the crypto economy – the Barrons A reporter checking things out noted that “the money was almost useless; Only 3 out of 10 merchants we met in Bitcoin City would accept payments in Bitcoin.” Crypto remains a speculative vehicle with extremely limited convertibility into the real economy.

That’s not the worst either. One could imagine, or at least argue, that the adoption of crypto by traders in the real economy could somehow improve over time, perhaps with certain safeguards in place. That is the premise of the stablecoin concept, where crypto assets are said to be guaranteed by a peg to real money, i.e. US dollars. Similar to how the dollar to gold ratio used to be.

But there is a bug in the crypto framework that neither the merge nor the stablecoin Kluge can fix. It’s the extremely low transaction processing capacity of the underlying blockchains that support Bitcoin and Ethereum. For Bitcoin, the limit seems to be around 7 transactions per second – for the entire planet. For Ethereum, the limit should be around 15-20 transactions per second.

Apple sells about 10 iPhones every second. That would use up bitcoin’s capacity right there. At Amazon, the average number of transactions throughout the day is 18.5 per second — much higher during peak hours. Or maybe it’s 100 orders per second. During the holiday season, the volume reaches 300 orders per second. Walmart processes something on the order of 100-200 transactions per second. No cryptocurrency could even match the current level of business from Walmart or Amazon – let alone the transactions being received from tens of millions of other vendors around the world.

The extremely low limits of transaction processing capacity for crypto result in higher costs and long delays. Barron’s Reporters found that even a simple money transfer using Bitcoin took six hours carry out. (Think how long you could wait for a credit card transaction to be confirmed at the supermarket before you lose patience.) As for costs, Ethereum’s transaction fees have averaged around $2 lately — but early this one Year-to-date fees have been in the tens of dollars per transaction with odd spikes reaching as high as $200. (It’s not clear the merger will change that.)

Current reality-based payment systems such as Mastercard, Visa and American Express process around 1250 transactions per second on average. Peak volumes can be much higher and these real world systems are designed to handle that. Visa is said to be able to process up to 65,000 transactions per second. Alipay (Alibaba’s version) is said to have achieved an actual payment volume of 250,000 to 500,000 transactions per second during some of the most important shopping days in China.

Crypto promoters have their answers in the form of future plans. The next major Ethereum mod will introduce something called “sharding” – which will split the blockchain into many parts and reportedly increase the tps rate to 1000. The following modification may include another reconstruction of the ecosystem with “roll-ups” – and will bless the waiting world with volumes up to 100,000 tps. Then there’s Solana, which claims to have a “Proof of History” mechanism to validate its blockchain and says it can achieve much higher throughput:

  • “Solana has gained traction… Its blockchain processes 50,000 transactions per second and its average cost per transaction is $0.00025, according to its website. Ethereum can only process about 13 transactions per second and transaction fees are significantly more expensive than Solana. But the last year and a half has exposed it [Solana’s] Compromise as the blockchain network has suffered multiple outages. Most recently, on May 1st, Solana was suspended for several hours before being similarly brought back online after a restart of its validator network.”

The glitches have spread:

  • “On September 14, 2021, the Solana blockchain subsequently went offline a flood of transactions caused the network to fork and different auditors had different views on the state of the network. The Solana blockchain went offline on May 1, 2022 and again on May 31, 2022 [first] Outage lasted 7 hours and the [second] One lasted 4.5 hours. On August 3, 2022, the Solana ecosystem was attacked by hackers, affecting 9,231 Solana wallets [stealing] A total of $4.1 million from the victims. A class action lawsuit was filed against Solana on July 1, 2022.” (Wikipedia)

It would be interesting to know the extent of the disruptive “wave” that seems to have broken the Solana system.

The blockchain is not designed for this

No cryptocurrency comes close to serving as a medium of exchange in the modern retail economy. Blockchain is an interesting and useful technology suitable for small networks that are managed centrally and require high-quality transactions to be executed quickly and reliably. JP Morgan’s Onyx system for processing wholesale inter-bank repo transactions is an example that appears to be successful. But the blockchain currently cannot meet the capacity requirements of massive retail payment systems.

Neither Bitcoin nor Ethereum can serve as a medium of exchange as is. The merger doesn’t change that.

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