It’s all anyone can talk about these days so I guess it’s all I can think about….crypto, crypto, crypto.¹
1) El Salvador and Bitcoin. El Salvador officially adopted Bitcoin as a form of legal tender yesterday. We’ve discussed this before, and it is very, very, very strange, but maybe not so strange in the specific case of El Salvador (ES). So, long story short – ES is a small country that has an unusually high amount of dollar imports mainly because they’re an export based economy that has many foreign nationals sending USD back to ES every year. So they import this strong currency, it swamps the usage of the domestic currency and the federal government has a hard time maintaining price stability in the national currency because the better currency is in higher demand. So ES is in this really unique situation where they’re basically forced to adopt the USD as a domestic currency.
Now, this would usually be unadvisable because the ES government can’t create USD and that’s just a silly way to operate a government. As I’ve explained before, fixed money supply systems do not work in the long-run because they constrain domestic financial needs unnecessarily. I mean, imagine you get involved in a war and you have to tell your citizens “well, we can’t pay the tank company to build more tanks because we didn’t import enough USD this month. Sorry, looks like we’re gonna lose this one.” It’s just silly. Of course, it’s a double edged sword because, as I’ve written in the past, wars are often the primary cause of hyperinflation – for the loser. But you catch my drift – it would be silly to “run out of money” when you’re in distress just because you literally chose not to be able to create money.
Anyhow, Bitcoin people think this is a big big deal. And I guess it kind of is. But it’s also a really unique situation and one that really doesn’t apply to many countries. So no reason to go too crazy over this.
2) Are DeFi interest accounts “securities”? The CEO of Coinbase went on Twitter to complain about the SEC and how they threatened to sue Coinbase if they issued an interest bearing account. Coinbase argued that the account might not be a security mainly because other people do it and the SEC hasn’t crushed them yet. YET. What was weird about this whole thing was that Coinbase seemed to know it was a security. They proactively reached out to the SEC to let them know about this product. But then they were shocked when the SEC came back and said “if you issue this without a registration statement we will sue you”.
The short story here is that the Supreme Court issued a simple test called the Howey Test to see if something is a security. Basically:
- It is an investment of money
- There is an expectation of profits from the investment
- The investment of money is in a common enterprise
- Any profit comes from the efforts of a promoter or third party
An interest bearing deposit account clearly passes all four tests. So this Coinbase interest account would be a security. The exception to this would be FDIC insured accounts, which bear no principal risk and therefore aren’t considered securities. But you need a banking licensing to do that and Coinbase doesn’t want to be a bank because those regulations are too onerous for Coinbase (mind you, many of these firms will slowly become banks over time thereby becoming exactly what they claim to despise). But it seems like Coinbase already knew all of this, but was basically like “well, other people are breaking the law so why can’t we?”
The whole thing is very strange. It’s like that time in kindergarten when little Johnny threw a rock through the window and then I justified throwing a rock through a window by saying “but Johnny did it first”. Maybe this works for a Kindergartener. But not so much with the SEC. Anyhow, the whole thing is weird.
3) NFTs and what gives things value? Here’s a thought provoking piece by Dave Nadig at ETF Trends about NFTs. To someone who’s becoming kinda old I find NFTs to be some of the weirdest things imaginable. They’re basically just digital art. But some of these things are worth millions and millions of dollars. So it raises all sorts of weird questions. I mean, the Mona Lisa is valuable for obvious reasons – it is a physical painting by one of the most famous people who ever lived hundreds of years ago. The fact that this thing even exists, given its rarity, makes it valuable. You know, supply and demand. Now, the demand part of that equation of harder to put your finger on.
As a related tangent, here’s a fun story – when I was 7 years old I visited the Louvre with my family and I barfed two feet away from the Mona Lisa. Security guards kicked us out and they roped up the painting. Now there’s a full on wood divider. The point is, you can thank me for not being allowed to get too close to the Mona Lisa. But I obviously wasn’t very impressed by it either. So there’s this weird sort of demand element based on the subjective nature of why we like certain things. And that concept gets really messy. Why we like certain things and when is a very subjective and adaptive concept. I didn’t like the Mona Lisa back then. I still wouldn’t buy it even if I could afford it. But that’s just one person’s subjective personal view and given the value of this painting, it’s probably not a very good view.
That’s the weirdest part about all of this. What if we just like things because other people all agree to like them? Think about the Mona Lisa objectively – it’s an okay painting of a pretty average looking person (see what I did there?). It’s old, falling apart and was painted by a person that doesn’t live any longer and doesn’t have much (any) impact on modern life. You could make a decent argument that this painting is not that cool. But we’ve all agreed that this painting is amazing even though any modern day professional artist can probably paint something much more impressive. Now, I am not saying that the Mona Lisa isn’t great. What I am saying is that most of its value is derived from the fact that we’ve all just agreed that this painting is great. And that concept can be applied to almost anything whether it’s a picture of a pet rock, a beanie baby, the Mona Lisa, the US Dollar or almost anything that we value that doesn’t have physical utility.
Anyhow, I am sure I’ve infuriated a bunch of art professionals so I’ll let it go. Read Dave’s piece. It’s good.
¹ – I actually spend most of my time thinking about stocks, bonds and the boring traditional finance space, which, as we’ll see with time, is exactly what the crypto space is quickly morphing into. So, what looks “new” right now will slowly morph into something that really isn’t very new at all.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.