How economic "tethers" help see beyond the hype and speculation

Day 2: 30 Days of Crypto-modeling

This is part of 30 consecutive series of posts related to understanding and modeling cryptocurrency-related economic activity. I will not cover hype and speculation. Rather, our goal will be to gain insight into the fundamentals and see where quantitative theories from economics and behavior economics can provide insight.


I am a cryptocurrency skeptic, at least relative to the crypto-bros. I love financial modeling, and I love programming, so the idea of programmable money gives me mini nerdgasms.

But I hate speculation. If I wanted to win at gambling, I figure the time would be better spent learning card counting or poker strategy. 

I was an early investor in Bitcoin. I made some money, but I sold too soon.

The early use case of Bitcoin was apparent to me. At the time, I frequently traveled between countries that tended to tie people's money in red tape, particularly when it crossed borders. A decentralized currency made sense.

I sold too early when I realized that Bitcoin worked poorly as an actual currency despite being the most established cryptocurrency. When you paid for a thing in Bitcoin, the transaction took many minutes to clear (it is worse now since the volume of transactions is higher). The value was so volatile that a vendor might lose money by the time the transaction cleared. I reasoned that if the value was not "tethered" to a fundamental economic activity, specifically the frictionless ability to buy goods and services, then the only thing driving the value of Bitcoin was speculation.

I was right about Bitcoin sucking as a currency, but I missed other key tethers.

The Carribean Bank tether

The first tether was the use of Bitcoin as a high-friction currency for illegal and grey market economic transactions or for people who were trying to stay under the radar because of red tape, regulations, and taxation. I call this the Carribean Bank tether.

Moral judgments aside, I consider this activity to be fundamental because as long as governments make laws, regulations and constraints on property, there will be financial incentives to get around them.

The “Twilight of the Elites” tether

The second tether is that people used (and still use) Bitcoin as a long-term store-of-value that can hedge against wayward central bank policy. There is an upper bound on the amount of Bitcoin that will ever exist. Neither gold nor any other traditional store-of-value that is similarly upper-bounded can be carried on a thumb drive.

I call this the “Twilight of the Elites” tether, after the book by Chris Hayes, because it aligns with our society’s declining confidence in the competence of the elites in powerful institutions like Central Banks.

Because of these tethers, I am back to having an automatic periodic buy order for Bitcoin (while strictly ignoring the cryptocurrency news and social media posts that fuel the speculation).


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What to ask when evaluating new blockchain applications.

I hold to this "tether" logic when I evaluate new blockchain applications. To assess whether some application of blockchain technology (the core tech beneath cryptocurrencies) is more than just hype and speculation, we need to find some fundamental economic activity that tethers that application’s usage to reality.

But that isn't enough. At its core, blockchain is simply a distributed digital ledger. Centralized digital ledgers require some third-party entity to record transactions in the ledger. Third parties usually charge fees, and nobody likes paying fees. However, they also add value beyond book-keeping, such as customer service and policing bad behaviors like fraud.

So when we think we've found a tether, the key question to ask is, "Why is simply having a third party provide this solution a bad idea?"

For example, your favorite social media platform's network of database servers is a centralized digital record book storing your account and its connections to your friends' accounts. The corporate entity that owns it is the third party.

Crypto-enthusiasts would argue that the benefit of a blockchain social network would be privacy and anonymity. Nonsense. Consumers have repeatedly demonstrated they will happily give up their privacy to a third party in exchange for a coupon to buy a designer handbag. They only want the third party to be a good steward of their data.

However, suppose the social media platform captures a large amount of the value of the economic transactions conducted between the platform's users. In that case, a distributed solution that cuts the middleman starts to seem like a good idea.


Stay tuned for more. But mind you, I am by not a crypto-economist, I only play one in this newsletter. If you have thoughts or feedback or know someone who might, please comment/share.

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