Crypto Fundamentals

Our good friend Chris Burniske was on Squawk Box this morning. I got up and watched it.  You can see the video here.

Of course there is interest in the crypto market right now, as it is falling hard. I suspect there are many out there who are enjoying the drop, waiting for the bubble to finish popping and for this whole idea to go away.

One takeaway from watching the segment is how much of a learning curve there still is around this whole space.  If you look at the questions Chris fielded this morning, you’ll see a looming gap in understanding of the fundamentals.  The questions range from “why do we even need this” to “what is the rational basis for these prices”

It’s a complicated topic, with complicated mechanics, and to make matters worse, the narrative itself has shifted a bunch over time (digital cash, digital gold, decentralized computing, the new internet, etc).

Here is one way to think about it, that feels native to CNBC and the financial markets industry:

Crypto is a market-based system for providing computing services.  The “miners” and other participants are just like the participants in other commodities markets.  It really is a shift from providing computing services via a corporate/securities/centralized model to an ecosystem/commodities/decentralized model.

If you just hold that idea for a moment, then where Chris was trying to take the conversation (but didn’t exactly manage to — talk TV is tough!) is around the rational pricing of commodities.  A simple way to start is by looking at the marginal cost of production, which is one way of looking at commodities pricing.  While this does not make sense in a highly speculative bull market, it makes a lot of sense in a flat or bear market, as we seek a basis for understanding where the bottom might be.

Another challenge here is that the utility of cryptoassets like bitcoin ethereum is still being understood, so we do not yet have solid anchors for pricing.  In the case of oil, for example, we have industries upon industries using it, establishing consumer value which lets price flow back to the original production.  This is still nascent in the crypto space, but is getting clearer every day.

Thank you Chris for working to advance the dialogue.

   

  • jason wright

    Nick, would you please characterise what Squawk Box is for those not familiar with it, its tone, its target audience, et.c., et.c.,… thanks.

    • it is mainstream financial markets — the pre-game show for the daily markets

      wall street audience — very familiar with markets but very skeptical of new technoloyg

    • Nick is being polite, but basically like how CNN and BBC are fake political news, squawk box is fake financial news

  • Paul Nichols

    The fundamental value of gold/bitcoin seems largely driven by the amount of surplus cash available. Sort of like a sink for capital without a productive use.

    • jason wright

      safe haven.

  • JLM

    .
    Commodity pricing is driven by a measure of demand which is driven by actual usage.

    If construction is booming and there is demand for copper wire, then the price of copper will arguably rise if supply stays static.

    If the price of copper rises, then the cost of wire will also rise as it uses copper to make the wire.

    If copper suppliers expand supply of raw copper in response to increased demand, then they will satisfy this heightened demand, perhaps blow past it, and copper may, in fact, decline in price.

    If copper declines in price, then the cost of wire will also decline because the price of copper incorporated into wire has also declined.

    There is a very real connection between the commodity, the conversion of the commodity by manufacturing into a saleable product, and the demand for the saleable, manufactured product.

    No crypto currency has a similar mining, manufacturing, demand driven cycle.

    in fact, crypto is an “outcry” market in which a continuous auction is held in which sellers and buyers cry out the price upon which they will act. When those prices coincide, a trade occurs. This may be totally disconnected from the actual usage of the product or the creation of a manufactured product.

    In this manner, crypto is a “thing” with no demonstrable demand for a manufactured product which indicts the commodity analogy. Crypto is a classic outcry auction market in which emotion and feelings drive trading.

    We are all waiting for the killer app.

    JLM
    http://www.themusingsofthebigredcar.com

    • LE

      All true but I will add that commodity prices (and stock prices) are also driven in a large part by what people will think will happen based on news. In other words events that they feel will impact the price but have not happened yet. Future events which are uncertain.

      In this way crypto is not the same. There does not appear to be future news that moves the price at all. There have been cases where this has happened but nothing I think like what happens with stocks or commodities. Where is the information edge with bitcoin? Is there one?

      One thing about crypto, bitcoin, blockchain is this. It doesn’t pass the simpleton test. What it does is actually show a pattern to many types of investing (or schemes) that turn out bad. Maybe this is not intentional simply because computer types are running the show (and are poor communicators). Or maybe not.

      You know even in the day when Henry Ford said “people would have said ‘faster horses'” it would be simple to explain why an automobile would be better in a sentence or two that made sense to every person out there. (Ditto for airplanes).

  • burrrata

    I agree with everything you’re saying, except that the commodity isn’t computing: it’s trust. Before when you wanted to perform a transaction (with money or data), you’d need a neutral trusted 3rd party to help get it done. Blockchains don’t remove that trusted 3rd party, but they become the trusted third party. When you execute transactions on the network you trust the protocol rather than any one specific player or institution. This means that trusted 3rd parties (and trust itself) become a commodity because the network can perform that function.

    If blockchain networks were providing the commodity of computation, they wouldn’t be wasting all the compute power on PoW puzzles and it would actually be used to perform computations (like with Golem). The reason the compute is being spend on PoW puzzles instead is that trustful execution is the primary feature or product of the network. Then anyone can use this to build applications that dis-intermediate trusted 3rd parties and provide “direct” transactions between parties where the only intermediary is a (mostly except for a few bugs here and there) verifiable contract that performs operations at a fixed cost.

    Of course this only solves trust at the protocol level, but doesn’t solve Trust with a big T in the larger game of life, but that’s another discussion… lol