Investors in cryptocurrencies exhibit breathtaking leaps of faith that make stock buyers look like they never take risks.
This isn’t to say that leaps of faith aren’t required to trust that companies won’t cheat shareholders. Enron and Worldcom, for example, are strong reminders that trust in publicly traded corporations must be verified.
Nor should we forget the level of trust required to believe that the Federal Reserve won’t debase the U.S. dollar DXY, -0.12%. The dollar’s fundamental value has suffered over the past 15 years at the hands of the Fed’s multiple rounds of quantitative easing and efforts to keep interest rates low. In the process, the Fed’s balance sheet has ballooned from $ 800 billion in 2006 to more than $ 8 trillion.
Cryptocurrencies were supposed to be better than this. Bitcoin BTCUSD, +0.28%, ethereum ETHUSD, +0.53% and other cryptos were born out of resistance to blind faith in corporate and monetary authorities, built instead on a foundation of anonymous and decentralized trust. How ironic that the crypto world has, in the process, developed in ways that require an even greater amount of blind faith.
This doesn’t mean you should automatically avoid cryptocurrencies. But don’t think you’re not hugely dependent on others’ honesty. You should also remember that, unlike publicly traded stocks and the Fed, cryptos aren’t regulated — though there has been widespread speculation that the SEC would impose such regulations.
Tether’s reserves
An example of this need for faith is the enduring mystery over whether Tether USDTUSD, coins are all their creators claim them to be. Tether coins are a particular type of cryptocurrency known as a stablecoin, which are designed to be redeemable at any time for U.S. $ 1 per coin. Tether says it backs the coins fully with reserves, which the company defines as currencies, cash equivalents and other assets, that cover every stablecoin it issues.
But outsiders are finding this difficult to verify. I by no means am the first to point this out, and I have no new information one way or the other. My point instead is to marvel at how much faith that crypto enthusiasts have in Tether’s claim.
How is this claim in essence any different, or more believable, than the legal mandate codified in the Federal Reserve Act that the Fed is to maintain stable prices? I don’t want to take sides in the debate over cryptos, which has become as polarized and passionate as have our current politics. My point instead is to disabuse you of the myth that it doesn’t take blind faith to hold cryptocurrencies.
Bitcoin and other cryptos
Are you sure you understand how bitcoin and other cryptocurrencies operate, as well as their protections against the vulnerabilities and risks from both known and unknown sources? Most likely, very few of those who have bought cryptos have such an accurate and comprehensive understanding.
There’s no shame in admitting that you don’t. If there is something to be ashamed of, it’s insisting that you’re sidestepping blind faith by avoiding Federal Reserve notes (i.e. dollars) and holding crypto. You’re not.
Listen to Joachim Klement, a trustee of the CFA Institute Research Foundation and former head of equity strategy for UBS Wealth Management. In an email, Klement conceded that, despite having degrees in theoretical and particle physics, mathematics, economics and finance, “whenever I try to understand cryptocurrencies I am at a loss. Either, I manage to translate the jargon into something in plain English at which point I often end up with trivial conclusions, or I am unable to translate the jargon and technical terms into something that makes sense.”
Yet there seems to be no shortage of investors with seemingly unlimited reserves of blind faith. Dogecoin DOGEUSD, +0.59%, originally created as a joke, now has a market cap of $ 32 billion. The market cap of Shiba Inu , another crypto coin, jumped to $ 14 billion after Tesla CEO Elon Musk tweeted a picture of his Shiba Inu dog.
Claude Erb, a former commodities portfolio manager at TCW Group, characterizes the crypto world’s reliance on blind faith in religious terms: In an interview, he pointed out that no one has actually seen the bitcoin blockchain, and yet we have faith that it is all-knowing and benevolent. “Is that all that different from a belief in a crypto–God?,” he asks. “There are many leaps of faith required.”
Why does this matter?
You might dismiss all this as little more than much ado about nothing, involving the gambling activities of investors whose investment motto seems to boil down to “You only live once.” But in fact just Tether alone has grown so big that its collapse would have huge repercussions for the rest of the financial system — not to mention your own net worth. There would be ripple effects that could lead to the collapse of major parts of the global credit and equity markets.
Many of the discussions I’ve had with crypto enthusiasts bring to mind the “greater fool theory.” According to it, it doesn’t matter whether Tether is truthful about its reserves, whether anyone has ever seen a blockchain, or whether you truly understand how cryptos operate. The only thing that matters is whether there is someone who will buy from you at a higher price — a greater fool.
To illustrate the greater fool theory, Warren Buffett has told the following joke, which he says was told to him by his mentor Benjamin Graham:
“An oil prospector, moving to his heavenly reward, was met by St. Peter with bad news. ‘You’re qualified for residence,’ said St. Peter, ‘but, as you can see, the compound reserved for oil men is packed. There’s no way to squeeze you in.’ After thinking a moment, the prospector asked if he might say just four words to the present occupants. That seemed harmless to St. Peter, so the prospector cupped his hands and yelled, ‘Oil discovered in hell.’
“Immediately, the gate to the compound opened and all of the oil men marched out to head for the nether regions. Impressed, St. Peter invited the prospector to move in and make himself comfortable. The prospector paused. ‘No,’ he said, ‘I think I’ll go along with the rest of the boys. There might be some truth to that rumor after all’.”
Before investing in cryptos, don’t you want to be confident that you’re not the butt of a similar joke?
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
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