Cryptocurrencies are an experiment to determine if making money can create wealth.
Contrary to popular belief, money is not wealth. Money is just a way to transfer wealth between people. Wealth is the thing you want — it’s the result of human ingenuity to create value for others.
Here’s an example: an artist buys $10 worth of paint and canvas to make a painting. If the painting sells for $100, they’ve created $90 of wealth. Money is how the buyer transfers wealth to the artist. This isn’t zero-sum; the buyer now has something worth at least $100 to them, and the artist has $90 that they can use to buy more paint and start the process all over again.
Poof! Wealth has been created out of thin air.
Companies create wealth by making something people want. It just so happens that people want to transact with each other. That’s why some of the most valuable companies in the world are banks; banks allow people to store and exchange wealth easily. The main service that banks offer is reducing transaction friction.
Cryptocurrencies are in the same business as banks. Cryptocurrencies, like banks, make it easy to transact with other people. Instead of providing this value as a service offered by a private company, cryptocurrencies embed the value into the money itself. You don’t need a bank to hold your money in escrow if you can just program your money to do the same thing.
The question is whether the market capitalization of cryptocurrencies is justified by the value they provide. We’ve already established that (1) it’s possible to create wealth and (2) reducing transaction friction is an effective way to do that. If this is true, then why all the fuss about crypto?
I think cryptocurrencies are controversial because they get the idea of money and wealth all tangled up. We don’t normally think about money as technology, but it had to be invented, just like every other technology we’ve developed throughout history. Wealth is created whenever a new invention is better than the previous solution. If we invent a new, better form of money, then we will also have created wealth.
Now, here’s the problem: many cryptocurrencies are not a better form of money than what we already have. But since we tend to associate money with wealth, it’s easy to mistake the creation of new money for the creation of wealth.
Unlike a bad painting, which can’t be sold for money because no one will buy it, cryptocurrencies can seem valuable even if no one is using them. Once again, we get the relationship between money and wealth mixed up. Money is a way to transfer wealth, but it can’t create new wealth unless it adds value in some way. Simply printing money does not automatically create wealth.
In the 1980s, at the height of the financial boom in Manhattan, there was a saying amongst bankers: it was better to be “close to the money”. This implied that the opportunity for value capture was higher if you worked directly with money, as opposed to working downstream of it as say, a doctor or a lawyer.
Cryptocurrencies are about as close to the money as you can get. Since they are money, there are plenty of ways to siphon off value directly from the source. This leads to the crypto industry having lots of seedy individuals with less than reputable projects.
However, some cryptocurrencies represent genuine improvements over existing money technology. Bitcoin is an improvement in international remittances and gold. Ethereum has created a new, global model for crowdfunding that is unlike anything available in the public markets. Other cryptocurrencies offer improvements in transaction speed and privacy that represent legitimate wealth creation. Since cryptocurrency markets are open 24/7/365, they offer an improvement in information discovery over traditional equity markets.
Although cryptocurrencies have made it easy to make money, they still need to add value to create wealth.
Thanks to James Tamplin, Max Ladabaum, Geo, Jacob Blish, Madisen Bocenda, and Michael Santore for reading drafts of this.