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When picking crypto winners, don't think long term

JPMORGAN Chase chief executive officer Jamie Dimon retreated last week from his contention that bitcoin is a fraud. Still, he told the Fox Business network that "bitcoin to me was always what the governments are going to feel about bitcoin as it gets really big".

Will governments smash cryptocurrencies, or will cryptocurrencies smash government monopolies on money? Neither extreme is likely. Thinking about intermediate outcomes helps choose which cryptocurrencies to back today.

The last major money innovation was paper money. Paper is cheaper to produce, transport and store than precious metals, and can incorporate security features  and contractual terms. Crucially, paper could sidestep usury prohibitions and cross-border restrictions. Initially, paper was a payment mechanism for gold-settled transactions. Over time the link to gold became more theoretical, often severed in stress times. In 1971, it was cut for good. Money was paper and gold was just another commodity.

Electronic money is to paper what paper is to gold - cheaper to produce, transport and store; more secure; able to embed smart contracts and to flow around regulatory obstacles. But an electronic payment mechanism could settle in dollars. The essential innovation of cryptocurrencies is not the specifics of the protocol, but making the exchange network the foundation of value.

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Dollars have value because people accept them. This is not just habit; it requires an expensive system of regulation, law, banking and processing. Although paper money was created in the private sector, in part to avoid regulations, today the system is largely controlled by the government.

There are many potential exchange networks that would have large value. PayPal, eBay and business-to-business intermediated exchanges would not have happened without the Internet. These and other companies raised money for development and operations, and grew networks by burning cash to attract and induce users.

Satoshi Nakamoto designed  a self-sufficient network. Developers and processors were paid in the network currency. Early adopters were not subsidised, but hoped for currency appreciation: the larger the network, the more currency value. The hope is this will evolve into a stable equilibrium with a valuable exchange network created out of nothing, owned by its users.

As with paper money, the first response of governments has been to try to fit crypto into existing regulatory categories and address problems it creates. Stage two with paper money began when governments realised they could use it to monetise debt,  raise money by taxing the network and selling permissions, and engage in more complex transactions than gold would support. Eventually, governments took over the system.

People who have only known government-monopoly money may assume nothing else is possible. In that world, they believe governments will either exterminate or take over crypto. While one of those may be the end state, I think stage two comes first. Cryptocurrencies such as Ripple, Cardano and Stellar are relatively easy for governments to exploit. But governments may decide to create their own cryptocurrencies rather than regulating and taxing existing ones.

At the other extreme are dark Web cryptocurrencies such as Zcash, Monero and Dash that governments will never embrace. These could thrive if governments screw up cooperation with more mainstream cryptocurrencies, especially if they mismanage their fiscal and monetary policies as well. These can also do well in weak government scenarios either due to political dysfunction or rising libertarianism. On the other hand, these could fail if authorised cryptocurrencies thrive, or if strong and competent governments smash them.

In the middle are cryptocurrencies such as bitcoin and ethereum that governments could tolerate but never love. (Full disclosure: I own bitcoins and other cryptocurrencies.) I think these have value in any likely government scenario. Governments may or may not encourage regulated cryptocurrencies, and they may or may not act aggressively to stamp out dark cryptocurrencies, but I can't see them being successful enough at either one to remove the need for independent cryptocurrencies or to extinguish all cryptocurrencies.

Mr Dimon is correct that crypto investors should think about "what the governments are going to feel". That's important for valuation of any asset, including cryptocurrencies. But there are lots of potential feelings and lots of governments. Specific resolutions favour some cryptocurrencies over others. But any plausible resolution leaves significant value for at least some cryptocurrencies.

Like crypto, paper is not a single concept. In early modern times there were goldsmith receipts, banker's acceptances, banknotes and many other types of money written on paper. Today we have government cash, personal checks, bills of exchange, credit card receipts and others.  Like serial numbers and signatures. Like payment only after a certain date or only in certain places or only after acceptance of goods. Some would streamline existing transactions, some would bring into formal exchange networks things that are now exchanged informally or not at all. Via ingenious application of game theory and cryptography. Mainly instability and unsanctioned transactions.

Rather than incur the expense of repaying it or the reputation hit of default. They can be used for transactions, regulation, law enforcement, revenue collection and debt absorption. The first will expand the exchange networks and confer legitimacy, the other four will increase costs to users. Except that I'm pretty confident they are already using them for covert purposes; secret police and cronies never met a black market they didn't like.

I see these as surviving on the margins of the regulated financial system like offshore banking havens, bearer bonds and physical gold. They will have only limited exchange for traditional cash, either via highly regulated exchanges and clearinghouses, or in surreptitious transactions. Their primary uses will be within their own networks and exchange for other cryptocurrencies and cryptoassets.

Moreover, even if some governments do one or the other of those things, as long as other governments have different policies, there will be demand for cross-border independent cryptocurrencies. And lots of competing actors in any one government.

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