HODLers Dilemma - The ethical and intellectual bankruptcy of bitcoin

A piece of the pie

The other day, I popped into local shop for a slice of pizza. It advertises itself as a boutique grocery store, but it's really more of a fancy liquor store with a pizza oven. I ordered my slices, and as I was paying at the cash register, I spotted a paper sign that read "Keep calm and HODL on"

I pondered to myself, "are they for real, or is somebody just being cute?"

As I had skipped lunch that day, I didn't have time or blood-sugar-level to grill the cashier about it. Perhaps this was for the best- their pizza is awesome, and I'd rather not have a stilted conversation about the finer points of cryptocurrency with a liquor store cashier.

This is the second physical "HODL" sign I've seen in recent weeks, and I've also had some (mercifully abbreviated) conversations with other folks on the subject recently. Frankly it's fascinating to observe the gyrations of bitcoin true-believers in the flesh - not just anonymous internet people, but real, honest-to-goodness humans out there who are vocal and fervent HODLers. Motivated mainly by its parabolic rise in value, they're optimistic about the prospects of the platform, and lord help you if you try to argue with them about it.

This spirit of camaraderie which has swept over the bitcoin community has a funny sort of egalitarian charm to it really– The Coming Together of The Community to Protect the Future of Cryptocurrency! My goodness, it almost warms the cockles.

Unfortunately it's also load of complete self-serving bullshit, or profound naivete at best. Of course there's nothing new under the sun – selling a misrepresented asset to an unsuspecting buyer is as old as commerce itself. Without a doubt, there are many in the bitcoin community who hold earnest beliefs about the power of a stateless, decentralized currency, and its ability to change the world for the better. It's hard to blame them for feeling this way – It's a brave new world with the emergence of cryptocurrency, and it's hard to know who or what to trust. What better environment could there be for such unbridled optimism? It has the potential to touch all aspects of life, commerce, politics, and it's undeniable that the stakes are high. I won't venture a guess as to the proportion of participants who are craven scoundrels, but for the sake of argument, lets assume its either nil, or nearly so. Lets dispense with the suspicion of malefactors for today and take it as a given that we've no wolves among our flock, only honorable folks, every one a pillar of virtue and discipline.

(Of course, there's a pretty robust argument to be made here that none of us is really beyond reproach when we have something to gain. The insidious power of cognitive bias toward one's incentives can be quite profound. Suffice to say, earnestness is neither objective nor obvious)

The HODLer's Dilemma

Markets are subject to game theory, and bitcoin (BTC) trading is no exception. What we have here would seem to me to be a fairly clear-cut case of the prisoner's dilemma, albeit at a rather larger scale. The dilemma in this case is that while working together could lead to a bigger reward in the form of a stabilized or increasing price, the fear of sellouts (justified or otherwise) drastically increases the risk of sellouts actually occurring, and ultimately becomes a self-fulfilling prophecy. If by some miracle of human cooperation, a sufficient fraction of BTC positions are held rather than being sold off, the strategy might actually work - Ask prices could stay high, the hype cycle could be maintained, and more market entrants could keep the bid price rising. Unfortunately, it seems equally likely this will lead to you nobly holding on to your BTC position while others use that support to sell at a good price. This will add negative pricing pressure. If enough holders become sellers, it could easily ignite a race to the bottom, and you get screwed for having held. My point here is that just because someone claims to be a "HODLer to the end" doesn't mean they're not actually selling like its going out of style.

Having seen the frothy marketplace, and observed the level of hype, you might be inclined to buy or hold BTC anyway under the Greater Fool theory. It doesn't need to be a good investment if it has enough upward momentum, the theory goes. You only need to have enough buyers to keep the price going up. This is speculation and it's a dangerous game, because at some point, you might run out of fools, and have to wear the “Greatest fool” hat yourself

Usually at this point, the conversation devolves. You're eating lunch with a colleague or friend who is rather of a BTC-bug, and they don't want to hear any more of your pesky jibber jabber, or better yet, you pull the cord before it even gets to that point. Despite having no evidence, they're quite sure that someone else has ironed out all the details, and it'll be fine. Cognitive bias can be a real bitch.

If you're particularly lucky, they'll try to justify their advocacy under some theory about how it indeed can grow forever, and that the inequities and instabilities in the system are either inconsequential, or will work themselves out in due time. I wish I could be that trusting of anything.

In my view, the only argument for long term support of BTC value which remotely approaches cogency is that the meteoric rise is justified because bitcoin will at some point become the store of value for some significant fraction of all earthy commerce. Under this argument, the rise in price and traffic is sustainable because all of the technical limitations which plague us today will somehow be patched though gradual evolution of the platform (SegWit, Lightning Network, etc are just the beginning.) Furthermore, it states that hype cycle will be enough to propel it to international dominance, and ultimately to saturation of its Total Addressable Market. Once the TAM is saturated, net inflows should in theory match outflows, and the system will finally achieve equilibrium sufficient to stabilize the exchange rate, at least roughly on par with the present day volatility of fiat currency exchange pairs.


This scenario is theoretically possible, but it really strains credulity. For starters, you're working without a net from a technical perspective, with billions or even trillions of dollar-equivalent value on the line. Any single technical error, vulnerability, or failure to adopt a necessary hard-fork quickly enough could end in disaster. Secondly, it assumes that the promise of this end-state is sufficient motivation, for a significant fraction of the global economy mind you, to defer actual utility as a currency. After all, its value would be dramatically increasing until it plateaued, having reached market saturation. Why on earth would you buy something priced in bitcoin, a phone, a car, a house or anything in-between, if the price was likely to be 2% cheaper tomorrow than it was today, and another 2% cheaper the day after that?

I hasten to ask: Assuming it can be stabilized at all, what are the ethical implications of an economic system which is as regressive as this? Bear in mind that there are fewer than 1,000 people who hold 40% of all bitcoin. Assuming that bitcoin expands to even 5-10% of the global currency marketcap, the disparity between these early adopters and the late adopters is so shockingly profound, that it should give you pause. Many of these people would become Multi-trillionaires in terms of today's USD-equivalent. They would also have the power to move markets in ways not even imagined by today's wealthiest multi-billionaires.

It is theoretically possible that the community could come together to change the money supply curve of bitcoin, such that it is responsive to demand, rather than the fixed curve that it has now. This would be similar to how a central bank operates, by expanding and contracting the money supply to ensure that it's sized correctly to main value stability as demand for the currency naturally ebbs and floes. There is a movement in the cryptocurrency community to design what's known as Stable coins, specifically for this purpose. Unfortunately they tend to be built on top of other deflationary coins like Etherium. I would therefore question its economic soundness on similar grounds to the above, subject to further study. While a nice idea in theory, I think the notion that the bitcoin community would perform a hard-fork to implement a responsive and elastic money-supply seems implausible. It could solve a tremendous part of the problem by creating a stable valuation prior to market saturation, thus saving the day. Unfortunately it would also kill the golden goose – That is to say, it would necessarily eliminate all further meaningful appreciation in value, and more or less pin BTC at is valuation as of the time of hard fork that enabled it. Maybe I'm missing something, but it seems inconceivable to me that the BTC community, at least as it stands, would even dream of doing this when they are so motivated by the prospect of great wealth. It would take a truly seismic shift in thinking on the part of the community to successfully execute such a change. Suffice to say, this seems fairly fantastical to imagine.

Utility Futility

In order to have a sustainable value, an asset must offer some direct utility. In addition to offering this value in the long term, the bitcoin phenomenon has to survive the journey to equilibrium by offering some direct utility in the short term.

What do I mean by Direct Utility?
Here are some examples:


Imagine RailCo makes railroad ties. It's not sexy, but they make something that's directly useful to railroads. For as long as railroads are around there will be some market demand for their product. The product has direct and stable utility, at least relative to the stability and viability of railroads. RailCo's market value is based heavily on the direct utility of their manufacturing, or the plausible prospects for same in the future.


Gold is directly useful for jewelry, industrial goods, adorning temples, etc. Buying gold is often highly speculative in nature, but it's hard to argue that it's value could ever go to zero– it is stable relative to the viability of jewelry, industrial goods, adornment, and the plausible prospects for same in the future. Gold's market value is based primarily on this direct utility, with market speculation being secondary, and ultimately based on the perception of its direct utility in some future context. The relevant question here being: How long can the perception of its value be misaligned with reality, and what are the implications on the stability of the market for gold?


In the same sense as the above, US dollars themselves are directly useful for... well, not much actually, at least not in quite the same way. You can patch a bicycle tire with a dollar bill, and make some cool origami, but the US dollar actually has little real, direct utility as a material, or as a commodity. Yes, you can use it to exchange and to store value, but all of that is predicated on the pre-existing stability of USD. The stability of USD is not created by its direct utility – the stability of its value IS its direct utility. The US Treasury tinkers with the money supply to artificially create and engineer this stability. The market has faith that they'll continue to do this reasonably effectively. That's the direct utility of the US dollar - manufactured stability! This is what "full faith and credit" means in the modern era.


It's off the chain

Ok, so assuming that everything goes well with off-chain transaction networks like Lightening Network, Jane and John Q. Public can finally use bitcoin to buy their morning latte, completing their payment within mere seconds, and with a trivial transaction fee - "Suck it Visa! The crypto-future is here!"

So what are the ways Jane and John might actually use bitcoin in the near term? There's only two that I can think of:

1. Instant currency exchange.

Jane uses a third party service to convert her USD into BTC in milliseconds, and then Starbucks does the reverse. USD->BTC->Lightning Network->BTC->USD in the blink of an eye. Setting aside the minor problem of having replaced one middleman (Visa) with two middlemen (Coinbase, Etc) let's consider the implications of this transaction on the value of the BTC currency as a whole:

This transaction requires that Jane purchase some BTC, which fortunately is extraordinary divisible, so the spot price doesn't really matter. It could be $1 USD per BTC or $10 million USD per BTC. Nobody cares, it'd work just fine. Of course there's always the issue of the bid/ask spread, and so you'd have to include that in your consideration of transaction fees, but in a sufficiently frothy market, that shouldn't be much of a problem in theory.

Rather than the impact of the market price on the transaction, the question instead becomes: what is the impact of this transaction on the market price?

Much like HFT on the stock market, even with millions of transactions per second, the only value this kind of fleeting long position adds to the market is increased liquidity and narrowed bid/ask spreads. It doesn't add any kind of value in the underlying asset itself, just the marketplace. Barring a perpetual motion machine, high frequency trading by itself cannot maintain any asset value for long.

2. Store of value

John buys and holds, but uses it to pay expenses. He might even have a deal arranged with his employer where they pay him in USD equivalents, essentially implementing the first half of the above scenario, but merely holding for longer. How awesome would it be to get paid by work with an asset that is exploding in value? Unfortunately it also means you accrue less and less in BTC value over time. Everybody else wants to be paid in dollar equivalents, so your prices don't actually get cheaper. Your holding risk is incredibly high, and the early entrants are also thousands or even millions of times richer than you are. Maybe you'll come out ahead  of the Joneses, but it's not a sure bet. Are you in it for the cryptocurrency future? Or are you in it to get rich? How does difference this affect your risk tolerance?

( As an aside, lets dispense with the whole "intrinsic value" conversation. Fiats or IOUs, or points, airline miles, or whatever– it doesn't matter what it represents. Even Dutch tulip bulbs were fine as a store of value, provided there was a sustainable demand for tulips. It doesn't even matter if that demand is rooted in rational thought, just that it lasts longer than your investment horizon. How long is your BTC horizon though? Does that horizon correspond with the story you've been telling yourself, or others about the long term viability of BTC? )

It could well be that the bitcoin community is able to thread the needle: getting the technology right by rebuilding the wings in flight, AND Carefully manipulating greedy folks hellbent on personal wealth into reshaping the system toward stability AND somehow contend with the gross inequity already in the system. Is this likely?

At the end of the day, we must contend with the system dynamics of a deflationary currency. The fact is, demand for bitcoin is generated almost entirely based on its meteoric rise in price. The whole utility-as-a-currency thing is a cover-story at least as it stands. Buying that latte with BTC sounds great, and it would be great; but people aren't mortgaging their houses and spending tens of thousands of dollars on credit card purchases of BTC because they're stoked on our disintermediated coffee-buying, deregulated cryptocurrency future. They're doing it because they want to get rich. They don't see or care about the value of a stable system, but because they want to get in at the top of the pyramid. This is speculation, not investment.

Is this sort of statement made in earnest, or is it cynical in nature?

Is this sort of statement made in earnest, or is it cynical in nature?

I would wager that just about any BTC buyer claiming otherwise is either lying to you, or to themselves. Few people would shirk the security, power, and prestige that comes with ridiculous wealth if given the opportunity. This is an intoxicating and powerful cocktail for deception of the self, and of others.

In this game, with incentives this misaligned, I believe the spirit of collaboration can only ever be skin deep. There is no honor among thieves, nor is there honor among those convinced they're about to get rich. We need to closely scrutinize our own incentives, and consider their powerful role in the shaping outcomes through cognitive bias.

I will say that I believe it's entirely possible for cryptocurrency to be our monetary future, but the incentives are dead wrong for the enablement of that future with bitcoin. Notwithstanding the tremendous potential for suffering which would be brought about by a collapse, it's actually pretty fascinating to watch the process unfold. It could be that instead of the bubble popping rapidly, or finding equilibrium with a significant fraction of world currency market adoption, it could end up being more of a slow burn – a gradually expanding cult of economic irrationality that's just potent enough, just strong enough to keep surfing the wave of continuous growth for a while, but without continuing in a parabolic fashion, and without having the bottom drop out. The outcome would ultimately be the same, but merely over a longer horizon, and with less drama.

For now at least, the community is not optimizing for utility, it's optimizing for continued appreciation. Until such time as that changes, or the bubble bursts, HODL on to your butts.

Daniel NormanComment