What is the use of cryptocurrencies?

9 months ago
(edited)
10 Min Read
2066 Words

Forewords:
This is a post in response to SteemLeo's writing contest. I get to know about this a little late and I think I might have missed the deadline. In any case, I had planned to write about this topic and here goes.



Adapted from voytek pavlik [CC0]

The most common complain about cryptocurrencies is that they cannot be used as a effective mode of payment. This is a valid observation but it is missing the point of owning cryptocurrencies now. Cryptocurrencies, as they are now, are not suitable as a payment method, however, they do have their use cases. But first, let's see why cryptocurrencies are an ineffective mode of payment right now.

Why we do not use cryptos for payments now?

Volatility

Cryptocurrencies cannot be used for payment at this point for 2 key reasons. First, cryptocurrencies are volatile. The volatility of cryptocurrencies, such as Bitcoin and Ethereum, makes it difficult for merchants to accept them as payment. Taking the recent Bitcoin dump from $8.5k to $6.5k for example, this price action took place within one week (between 16-23 Nov).

Bitcoin chart courtesy of @coingecko

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For a merchant who accepted Bitcoin payment on the 16th Nov but did not manage to convert to fiat fast enough, the merchant had effectively lost a quarter of the value in a week. Most merchants do not operate at high enough profit margins to absorb such losses. Hence, it is absolutely understandable for merchants to be reluctant to accept cryptocurrencies. And since merchants are reluctant to accept, naturally consumers will not be able to spend cryptos.

Note that for simplicity, I will omit stablecoins from the discussion in this article. Stablecoins are designed to mitigate the problem of volatility, however, they have problems on their own, which I will explore in future articles.

Usability

The usability problem consists of several parts. First, payment speed. Fiat currencies benefited from decades of development and along the way, multiple layers of solutions were built on top of them to make it a speedy payment method. However, even though cryptocurrencies are pure digital currencies, transaction speed is still pretty slow right now. Bitcoin is doing 7 TPS and Ethereum around 25 TPS. Works are still underway to improve cryptocurrencies' transaction speed. While there are other cryptocurrencies that boast a high transaction speed, the lack of network effect is still a problem.

Next, ease of use and acquisition. To start off, it is difficult and/or costly to acquire cryptocurrencies. Today, in many countries, there isn't a cheap way to convert fiat to cryptocurrencies. I live in a place where I can acquire cryptocurrencies in a relatively cheap way. Unfortunately, that is not true for many other countries.

In addition, using cryptocurrencies isn't that easy. Once you manage to get your cryptocurrencies from an exchange, you then have to transfer them to your personal wallet. There are dozens of wallets to choose from, you have to hold your own keys and be responsible of your own funds. All these are very different from the system we are used to.

We are very used to the current system of custodian service, where a bank/credit card/remittance company hold your money for you. We are very used to not be responsible for our own money and if anything goes wrong, we can find someone to complain to 😅. We are very used to relying on third parties. This is a problem on its own and it requires a mindset shift before cryptos will be widely adopted in payment. It is perhaps too late for the earlier generations, such as the baby boomers and Gen X, to change their mindset but we are seeing the millennials shifting our mindset and I am pretty sure this change is going to be much easier for future generations.

Overall, a certain level of technical knowledge is required to start using cryptocurrencies. Such knowledge may not even be present in millennials so it will be even more difficult for earlier generations to use cryptocurrencies. Furthermore, a mindset shift is required. People have to start to doubt centralized custodians and start to take more responsibilities of their own money. All these, in my opinion, make it difficult to cryptos to be used for payments, at this point.


What is the use of cryptos if they cannot be used for payment?

So you might start to question the purpose of cryptocurrencies as it cannot be used for payments now. Humans are very much hardwired for instant gratifications and I can understand why many will feel that cryptos are useless if they cannot be used payment now.

But hear me out, cryptos can still be used in several important ways as we speak.

As a Store of Value - The Lindy Effect

Bitcoin Passage or Time/Lindy Effect from Murad Mahmudov

Source

Remember the chart above from Murad Mahmudov? He is a popular crypto social influencer and analyst on Twitter. When this chart first came out, it was circulated quite often and many YouTubers were also talking about it. Over one year has past and I think many have probably forgotten about this chart.

This chart depicts the possible path for Bitcoin to become a global currency. The Lindy effect basically states that the longer a technology survives, the harder it will become obsolete. In the chart above, Murad believes that Bitcoin having survived for a decade will likely continue to live on. As more people starts to own Bitcoin, it gradually moves up the chart. At this stage, Bitcoin is gradually becoming a store of value without many people noticing.

BTC Logarithmic chart courtesy of @coingecko

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If you zoom into specific time frames of a Bitcoin chart, you will see that it is choppy and volatile. However, if you observe from a macro perspective, Bitcoin has proven to be a good store of value. The above logarithmic chart shows quite clearly the trajectory of Bitcoin and how its value has gradually increase over time. At least for now, Bitcoin is continuing to show promise that it can be a reliable store of value in the long-term. Hence, the first use case of cryptocurrencies, is that they can be a store of value.

Cryptocurrencies as a Hedge

People often seek the "Holy Grail" of investing but it is elusive. However, the world-renowned investor, Ray Dalio, has an answer for that. Ray Dalio believes that to achieve the investment "Holy Grail" is to reduce your portfolio risk level to one which is below your consistent returns. This can be achieved by owning multiple asset classes of low to no correlation.

Risk diversification through owning uncorrelated assets

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As illustrated in the chart above, if you own 6 uncorrelated asset classes, your risk will be reduced by up to 60%. The more uncorrelated assets you have in your portfolio, the lesser risk is your portfolio. If you can achieve a return on the portfolio which is higher than the risk you take, you basically found the "Holy Grail" because in theory, your portfolio should make you money regardless of the market cycle.

The key thing here is to find uncorrelated assets. In this hyper-connected world of ours, that is extremely difficult. However, in a recent study by Binance, Bitcoin is found to be largely uncorrelated with traditional assets.

Three-year weekly return correlations among asset classes

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As you can see from the table above, Bitcoin is one of those rare assets which exhibits near-zero correlation with other asset classes. This means that if you add Bitcoin into your portfolio, you improve the diversification of your portfolio which thereby reduces risk. This is one step towards the "Holy Grail" which Ray Dalio mentioned.

Aggregated results for monthly rebalanced portfolios

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In the same Binance study, they back-tested and simulated the "BlackRock Multi-Asset Income" and "Vanguard Managed Payout Fund" by adding Bitcoin into those portfolios. True enough, portfolios with Bitcoin did better than portfolios without Bitcoin as seen in the table above. In particular, if Bitcoin forms 1% of those portfolio, the maximum draw-down and volatility is similar while the overall returns improved significantly. Hence, the other important use case of cryptocurrencies is to use them as a hedge and portfolio diversification tool.

Participate in a New Kind of Economy

Finally, owning cryptos allows you to participate in the new kind of economy. The traditional economy is centralized and filled with middlemen/custodians. We are at a juncture where a new kind of decentralized economy is emerging. As more people own cryptocurrencies, more people have the opportunity to participate in this new economy and naturally, more people will participate in this new economy. Based on Metcalfe's law on network effect, this new economy will therefore be growing stronger and spreading faster over time.

So what is this new economy I am talking about? First off, we have DeFi, or Decentralized Finance. I have talked about this before in one of my earlier posts. DeFi is a rising movement and as of today almost $665m worth of value is locked into this new kind of financial system.

Total value locked in DeFi

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To participate in DeFi, you need cryptocurrencies like Ethereum. There is no other way for you to do that. DeFi, as it is now, is a permissionless system with prudent risk management. It is basically the opposite of the traditional financial system. Naturally, this gives DeFi a strong selling point and I am pretty confident that this movement will continue to progress.

On top of DeFi, there are other decentralized economical phenomena that are on the rise. One is the decentralized attention economy. Our attention is worth something, each time we read an article, write a comment/post and view an advertisement, value is created somewhere. The idea of the decentralized attention economy is to capture this value and return it to the person who created this value. Social media is an example of attention economy.

Traditional social media like Facebook captures the value of what the users have created but the value is not returned to the users. Instead, value created by users are turned into revenue and profits for centralized companies. Sound unfair? Fret not, platforms like Steem and Basic Attention Token are here to overturn this by starting a decentralized attention economy.

Gods Unchained - An example of digital collectibles trading card game
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Another rising phenomenon is digital collectibles. Collectibles like arts and antiques worth a lot in the physical world. Before we have open and decentralized blockchains, the idea of digital collectibles are not possible. This is because no one can make sure that digital items cannot be duplicated. Now, with blockchains like Ethereum, it is possible to own digital collectibles as non-fungible tokens. These collectibles are provably rare and cannot be duplicated, enabling the digital collectibles economy to be possible. An example is Gods Unchained, which is a trading card game which allows you to own digital collectibles and trade them.


Conclusion

By focusing on using cryptocurrencies of payment, people are mostly missing the point. At this stage, cryptocurrencies cannot and should not be used for payments. We should view them as a store of value, a hedge against traditional financial system and a ticket to participate in the new decentralized economy.

We are still early in adoption. If you happen to be reading this post but not owning any cryptocurrencies, consider buying some for the reasons I mentioned. And if you already owned some cryptocurrencies, congratulations to you! You are one of the early adopters driving a much needed movement 😎.


10% of post rewards goes to @ph-fund and 5% goes to @leo.voter to support these amazing projects.


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