Chapter 2

The Economics of Value

One day, a man went to an auction. When an exotic parrot went on the auction block, the man decided he was going to buy the bird no matter what. The bird was unbelievably rare, and he had been looking for this particular bird for an extraordinarily long time.

The man wanted the parrot so badly, he didn’t think twice about the anonymous bidder who was consistently outbidding him. The man just kept bidding, getting outbid, and bidding higher and higher until he finally “won” the bird for a price of $23,000,000—a price the majority of auction investors would call “a definite bubble.”

Despite his disappointment about the price, the beautiful bird was his at last.

As he was paying for the parrot, he said to the auctioneer, “I sure hope this parrot can talk. I would hate to have paid so much for it, only to discover that he can’t speak!”

“Oh, don’t you worry,” said the auctioneer. “He’s a talker. Who do you think kept bidding against you?”

Price and Value

“Creating Value” is the corporate slogan of the twenty-first century. C-suite executives proudly parade around offering “value” at annual board meetings. Everyone seems to be obsessed with value, but no one seems to know precisely what it is. As with the man auctioning for the parrot, a disconnect seems to exist between price and value, and within this gray area, a great deal of confusion and risk arises.

Value is not price. At best, price is a hazy reflection of value—our best attempt to collectively come to a flawed universal agreement on what it means to trade any given service or thing for an equal representation of the subcomponents of value (such as labor) in the form of currency. Prices are actually the terms of exchange that two parties engage with; this concept can get lost as transacting becomes so ingrained in us that we don’t stop and think what price actually represents (a contract).

The whole system of valuation is shocking if you think about it. We have the ability to assign a price to an apple in relation to that of a multibillion-dollar behemoth such as Amazon. Society has the power to reflect the difference in how much we value one object/entity versus another. That is not an arbitrary accomplishment at all. Currency is one of the most compelling human agreements and inventions. Currency is the parameters we all agree to in order to make an exchange of value convenient for many.

Founder of the Austrian School of Economics Carl Menger was one of the greatest economists to tackle the ambiguity in “The Subjective Theory of value,” written in the late 1800s. He wrote, “When anything . . . whether of the material sort or not . . . has both desiredness and scarcity, it then has value for any person who concerns himself with it from this binary perspective.” Menger’s theory follows that valuation for one person can look radically different from another. This isn’t negative—a prevailing minority can believe in the desirableness of the underlying properties of an object, and that is all that truly matters for that object to be considered valuable. How much I value a paintbrush is going to look extremely different in relation to Picasso’s valuation.

Menger’s definition contrasts with other hazier, modern definitions, such as Huffington Post writer Caroline Banton’s 2019 description of economic value as “ . . . a measure of the benefit from a good or service to an economic agent. It is typically measured in units of currency. . . .” Menger’s definition isn’t concerned about the benefit derived. Instead, his definition is purely focused on the individual’s desire for what will be derived and how scarce the object of attention is. Banton’s definition, which is widely visible on Investopedia for millions of eager students to read, is an example of how the definition of “value” has been watered down; the potency and specificity have drained away over time.

Where does the idea of intrinsic value fit into Menger’s puzzle?

A house has “intrinsic value” for billions of people. Ask a group of intentional nomads how they value a house. What is the intrinsic value of a house for these nomads compared to you and me? Truthfully, a more accurate approach may be to view intrinsic value as a large number of people desiring underlying characteristics or function of an object such that the general consensus is that of readily agreed-upon value.

Intrinsic value is defined by the masses, creating generally agreed-upon prices. The masses can create uptrends in price and the masses also create downtrends as a result of the consensus of how desired the object is. As Menger stated, what the object is does not matter. The unprecedented truth that has altered the art of valuation is that in the twenty-first century, the rate and speed of information dispersal has increased drastically. The internet has quite literally made instant information a reality and as a result has allowed the masses’ demand to shape-shift and form quicker than ever before.

If checks and balances weren’t placed on the speed of this shape-shifting, we would begin to encounter ridiculous prices. For example, during the COVID-19 pandemic, toilet paper was sold out in stores across the United States. Hand sanitizer became a luxury. Clorox wipes were considered cleaning gold. If price gouging laws were not in place, you could have seen toilet paper worth ten to fifty dollars in some areas. Enough people valued toilet paper during the crisis such that they prioritized it as a purchase before other items, and the speed at which this desirability valuation evolved (“hysteria,” as the media would call it) happened exponentially faster than it would have happened half a century ago.

While the experts can calmly enter the marketplace and call the rest of the people sprinting to get toilet paper “irrational” because of their desire for what was perceived to be scarce toilet paper, at the end of the day, the masses and small sets of hoarders determined the shortage, not the armchair experts.

The Currency Proposition

How does this circle back to cryptocurrency?

It all boils down to identifying the value of cryptocurrency.

Ameer Rosic, cofounder of BlockGeeks, defines cryptocurrency as “an internet-based medium of exchange which uses cryptographic functions to conduct financial transactions.” Any given cryptocurrency’s worth is tied up in the trade of value between a buyer receiving a certain amount of cryptocurrency in exchange for a specified amount of currency the seller is demanding. While the US dollar is purely a medium of exchange, cryptocurrency (of which I will frequently interchange with “crypto” from now on) is special because not only is it a digital currency with a unique set of properties enabled by blockchain, but crypto is also the means by which the underlying decentralized ledger is secured, maintained, and incentivized. Cryptocurrency unlocks certain types of digital financial transactions that a US greenback cannot achieve on its own. Simply put, cryptocurrency has underlying utility that US greenbacks do not have.

“There are three eras of currency: commodity-based, politically-based, and now, math-based.”

—Chris Dixon

Every blockchain enables different types of special financial transactions—the more valuable the transaction possibilities on any given blockchain, the greater the cryptocurrency will be priced because of the increase in desirability for that crypto’s utility. This increased valuation happens because the cryptocurrency is both the facilitator and medium of exchange for these transactions on the blockchain ledger.

“Virtual currencies, perhaps most notably Bitcoin, have captured the imagination of some, struck fear among others, and confused the heck out of the rest of us.”

—Thomas Carper, US Senator

While blockchain’s reception has been overwhelmingly positive as a potentially valuable technology, the hegemony of sovereign currencies is uneasily facing the unprecedented competition presented by digital cryptocurrencies. The global hegemony understands digital cryptocurrencies have fundamental properties that are potentially more desirable than their paper currency alternatives. To return to where we began, the value proposition of cryptocurrency may be stronger than traditional fiat; the consensus is still out. A small tribe of individuals (compared to the stock market) have fiercely “speculated” and valued cryptocurrencies as being worth a significantly higher price than the majority of people in the world. Despite this, the intense desire for crypto by this small tribe of investors, against the better judgement of “experts,” does not take away from the validity of what they are valuating. It merely increases the risk entailed by investing. The powerful investing institutions, miners, and retail investors will decide the degree to which these digital assets will be priced.

What is the value proposition of the dollar? To the left of the portrait of George Washington, the dollar proclaims: “This note is legal tender for all debts, public and private.”

Hal R. Varian, a University of California Berkeley economist and New York Times columnist wrote, “A more profound, and perhaps slightly unsettling, reason that a dollar has value is simply that lots of people are willing to accept it as payment. In this view, the value of a dollar comes not so much from government mandate as from social convention.” This disturbing revelation reveals to us an unnerving truth: when a currency is purely a medium of exchange without utility, such as a piece of paper with ink on it, then the value of the dollar is purely built upon trust in the United States’ ability to guarantee those dollars’ transactional value. In addition, the purchasing power of any given dollar is based on the scarcity of the dollar—directly impacting the value as per Menger’s model.

The scarcity of the dollar is wrapped up in the total amount of supply in circulation. Envision with me for a moment the following picture: you are staring at a swimming pool—the surface area of the water represents the supply of the dollar. The less surface area, or amount of dollars in circulation, for swimmers to swim around in, the more valuable every part of the pool is worth. You can fit more people in a pool than a hot tub, which is typically why the hot tub is going to be full more often than not; the small amount of room available in the hot tub makes it valuable compared to a spacious pool. Yet this smaller surface area, corresponding to a smaller supply of dollars, is difficult to move around in, causing us to frequently bump into other people.

A mysterious entity called the Federal Reserve controls the size of the pool we all play in when it comes to the US dollar. As Roger Ver, a famous Bitcoin entrepreneur, put it: “At any time for any reason, the central banks can print as much money as they want. They call it things like quantitative easing . . . it makes the dollars you and I have worth less.” The Federal Reserve are the pool designers, constantly increasing or decreasing the size of the pool at will. This is where inflation created by the Federal Reserve deeply impacts the average person.

A simple thought experiment: how much is a dollar worth today compared to 1917?

Pause for a moment and genuinely make a guess.

The general belief is that the dollar is worth more now than it was back then. One dollar in 1913 had the same buying power as twenty-six dollars has in 2020. This is a deceptive portrayal, so let me reframe.

Your one dollar today is only worth three cents in comparison to the dollar from 1913. The dollar has lost approximately 97 percent of its value because of inflation since 1913. Not only is that ugly, it is downright terrifying.

Figure 6: Money Supply

The Federal Reserve has increased the size of the pool over time, and you can’t blame them. More swimmers have entered the pool that need to trade and transact. But when the excess reserves grow faster than exponential growth (the dotted line), we have significant cause for concern. Furthermore, this growth does not appear to be slowing down anytime soon. The Federal Reserve can choose to reduce the size of the pool, but it has refused to do so historically.

Why does the Federal Reserve refuse to reduce the size?

The Federal Reserve rents out the new pool space it creates to banks that then turn around and rent it out to swimmers, or everyday people and businesses, at a profit. Here is the catch: the Federal Reserve can increase the size of the pool infinitely for free—simultaneously forcing a portion of everyone’s dollar into the new pool space. Printing money is free. Clever manipulation can move the value of your dollars into the hands of those in cahoots with the banks and Federal Reserve, all without you doing anything.

And you can’t stop it. Even members of the Federal Reserve understand this truth.

“Printing money doesn’t produce goods and services. It doesn’t hire people. It may seem like the right short-term medicine, but can the cure be worse than the disease?”

—Charles Plosser, president of the Federal Reserve Bank of Philadelphia

The Zimbabwe Story

Inflation is an ever-lurking danger. Zimbabwe has “trillion-dollar bills” worth pennies. Enter hyperinflation: the bane of a stable society.

“The Impact of Cryptocurrencies in Zimbabwe. An Analysis of Bitcoins,” written by Anthony Tapiwa Mazikana in 2017, concluded that the Reserve Bank of Zimbabwe is hostile toward cryptocurrencies. This is no surprise—no one wants to give up their control of the pool when it’s a moneymaking machine and political tool. Yet the citizens of Zimbabwe appear to want to exit the murky monetary pool they swim in and move to the greener pastures of cryptocurrency.

Anita Posch, a podcaster and correspondent with CoinDesk, spent three weeks in Africa in February 2020 interviewing a variety of individuals about Bitcoin in Zimbabwe: “I wanted to see myself if this is true and how far Bitcoin is known and used there,” she said in her podcast, “Bitcoin in Africa.” What motivated Anita to go on this unique trip? “Bitcoin is in my eyes first and foremost not a speculative, trading object, where everything is about price. For me it’s a tool of liberation that enables individuals and communities to free themselves of tight restrictions by authoritarian or totalitarian nation states that harm people’s human rights.” Anita has pointed out that while first world countries go after cryptocurrency because of crime and lack of regulation, countries such as Zimbabwe must wage an all-out war against cryptocurrency because it would result in greater monetary freedom of citizens and a loss of power from the hands of the elite.

“Corruption is everywhere. And it seems that there are different rules for different people. Yes, I think one can say that for every country, but the differences are so big here. If you have USD, if you are in a high position, if you are in the right network, you can have a great life in Zimbabwe. I have seen private houses with swimming pools blue as the sky.”

—Anita Posch

Unfortunately for the majority of people in Zimbabwe, they are utterly tied down by the Zimbabwean dollar and monetary policy that cripple so many into abject poverty. When Anita asked an anonymous Zimbabwe online entrepreneur, “What do you think the use cases for Bitcoin are in Africa, or in Zimbabwe?” the anonymous entrepreneur was rather enthusiastic:

“If I can walk into the future . . . I see a lot of people actually taking the Bitcoin method . . . it’s because of number one, our inflation rate . . . some people can actually use Bitcoin as a method to save money.”

The value of cryptocurrency is tied to guaranteed scarcity, lack of inflation, and the underlying desire for crypto’s attributes.

But even amid the inflation and poverty in a country far away, the United States dollar reigns supreme as the determinant of wealth.

The Dollar versus Crypto

The primary factor that props up the dollar is the global agreement that the dollar is the de facto medium of exchange for the most valuable global transactions such as oil and other commodities. The dollar will continue to be so, enforced by the full might of the US government. And so we continue to trust it’s plashing around in the pool without knowing where the edges of the pool are. We are not privy to that information.

This is where the value proposition of cryptocurrency becomes immediately apparent purely from a scarcity perspective. Using Bitcoin as our cryptocurrency example, there is a fixed number of Bitcoin: twenty-one million that will always exist.

Not one more, not one less. No Central Reserve Bank. Cryptography and programming have been etched into the rules of the currency and the supplies. With Bitcoin, you know the size of the pool, and you never have to worry about your portion of the pool becoming less valuable because of inflation.

When we examine the desiredness of any currency, it always comes back to transparency and trust. The reason I will take cryptocurrency over a US dollar is because I trust mathematics and publicly visible monetary policies of a decentralized ledger more than the Federal Reserve. That isn’t to say the Federal Reserve hasn’t done a great job managing the US monetary policy and by extension the economy. It just means that people like you and me don’t get to understand how many dollars are in circulation nor the justification for the strategies of the Federal Reserve. Instead, we are just along for the ride, hoping that the decision-makers behind closed doors won’t take actions that damage the value of your dollar.

At the end of the day, I trust transparency more than anything, and I think most people do too. Because cryptocurrency is transparent in its design with monetary policy and circulation, I believe this will one day make cryptocurrency increasingly more desired as a more trusted option versus traditional fiat currencies.

Not all cryptocurrencies have zero inflation. Some have planned inflation rates that are typically fixed, predictable, and notoriously difficult to change, which is usually a good thing. The monetary policy is voted for in a decentralized fashion and is entirely transparent. This is in stark contrast to a single centralized player determining the fate of everyone in the pool (looking at you, Federal Reserve).

Yet again, welcome to a decentralized future. And because Bitcoin is digital, it can split into much smaller denominators than one-one hundredth (good luck doing this to a greenback dollar beyond a hundred pennies).

If the value of Bitcoin skyrockets, Bitcoin has the ability to be split into denominators as small as one hundred-millionth of a Bitcoin (also known as a “Sat,” short for the creator of Bitcoin, Satoshi) to handle the full range of economic transactions. This denomination splitting makes Bitcoin an extremely fluid currency. Note that the “splitting into smaller denominations” is not inflation; the boundaries of the pool remain firmly fixed. The pool is instead split up into smaller subplots to make it easier to have smaller transactions.

Value Speculation

What does it mean to speculate? As I think back to the COVID-19 pandemic, I begin to wonder who the speculators were. Are they the people who walked around without masks hugging other people until the last second before quarantine was declared? Are they the people who purchased apocalypse supplies long in advance? Or are they armchair analysts who read the daily news and believed they had their finger on the pulse of society and reality?

Carter Thomas, a longtime investor in many different markets, has a quote that comes to mind for speculation: “Reality is largely negotiable.” People will always have their theories and their stories—their triumphs and disasters. Interwoven between the present and the future are our speculations. Here is mine.

One day, we will live in a world where currency is decentralized, out of the control of any single entity. We will globally transact with people from all seven continents without needing multiple banks and intermediaries to conduct the transaction. Our exchanging of value will be peer to peer, person to person. Cryptocurrency will continue to be adopted because of its properties mentioned earlier in the book—it’s simply a better form of currency, even when you account for the trade-offs. Blockchain technology will enable use cases that will shake centralized organizations to their core; entire businesses will be run in a decentralized fashion, with participants rewarded with cryptocurrency using an automated design. We will not use “banks” in the traditional sense—the blockchain and its universal ledger will be our futuristic bank. Some people, organizations, and countries will adapt. Some won’t.

That is my reality, my negotiation with the future. Maybe I am an apocalyptic COVID-19 hoarder in a tribe of high-octane risk-takers investing in a speculative digital asset. I wouldn’t say “maybe so”—it is definitely the truth. I don’t deny it.

I want to be early to the game because great money has been made and is yet to be made by those willing to pull a chair up and believe collectively that we are onto something here, that this whole blockchain and cryptocurrency “thing” has potential to be seen as something with real intrinsic value.

Cryptocurrency is the very first instance of a currency capable of being decentralized, scarce, easily transportable, and digital. It is more reliably scarce than gold and more private and transactionally efficient than “modern” digital banking. This is why people are excited about cryptocurrency: it has the potential to completely and utterly revolutionize money, transactions, and contracts.

The game has changed drastically, and many are not aware of this new paradigm. Because of twenty-first century information transfer, cryptocurrency is the first time a new form of currency can be this easily poured into and speculated in the long term outside of an individual’s sovereign currency. It is why those tied down in tough economic landscapes such as Zimbabwe are opening their arms to crypto. It is financial freedom guaranteed by mathematics and designed to resist the heaviest hitters in the world from shutting it down.

China has banned, unbanned, rebanned, and finally reopened the door for cryptocurrency effective January 1, 2020, with the passing of the Cryptography Law. US regulators have uneasily begun outlining how to proceed with crypto regulation. Warren Buffet has made comments concerning his thoughts on blockchain as an investment. Clearly, the value of cryptocurrency and blockchain (which enables crypto) cannot be denied nor shut down any longer.

And yet painting a picture of an opportunity for easy money is far too easy. An abundance of writers, bloggers, and tweeters are peddling crypto investing as a walk through the park—an easy path to money. They encourage impulsiveness in the wrong way and push people to make atrocious financial decisions.

I am not here to do that. Do not mistake my enthusiasm for cryptocurrency and blockchain as a blind committal to throwing out logical investing principles to the wayside. In reality, principles are all you have as an investor. Principles are the only thing you can truly control.

You now know what the cryptocurrency value thesis hinges upon and what it aims to solve. We explored value in tandem with price and how cryptocurrency is viewed under a traditional Austrian economics lens using scarcity and desiredness. In addition, we went after the US dollar and peeked behind the Federal Reserve vale of trust and inflation.

This chapter is an open invitation to temporarily explore a different pool other than the US currency pool you currently swim in. Instead, we will now dive into the stories of blockchain and cryptocurrency. How did this emerging technology come together?

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