The Battle of the Quants came to New York City on Wednesday, June 20, and the CAIA Association was one of its media sponsors. Much of the event involved cryptocurrencies, including an exchange between John D’Agostino (the global head of investor engagement at DMS Governance) and Nouriel Roubini, Chairman of Roubini Macro Associates. Over the weekend, in advance of the ‘battle,’ our Christopher Faille discussed cryptos with Mr. D’Agostino, who had much of compelling interest to say. AAA: Bitcoins have fallen in value considerably in recent weeks and months. Just in the last two months (mid-April to mid-June) they have fallen $2,000, to around $6,500 now, and that was only part of a longer decline from a peak of $20,000 late last year. So, first, what might be the cause of this trend and, second, does this support the view of the skeptics who regard it as a bubble? JD: Predicting, or assigning causality to short-, medium-, or even long-term price movements on any illiquid asset, outside of a clear idiosyncratic event, is a very silly thing. Technical analysis is tough enough even when there is a robust data set. With bitcoin, despite the fact that the pubic blockchain shows most transaction data, there is not yet a robust data set, and prediction, or assigning causality to price movement, is at best guesswork. An optimistic view is that the market was simply overbought, and is now trying to find a stabilization price. A more cynical view is that the reason it was overbought was price manipulation. While recent academic evidence has emerged indicating manipulation may have played a major role in the price run-up of BTC (and this certainly deserves investigation), I’d be cautious of making the claim prematurely. There is a very very thin line between legitimate buying activity and manipulation in illiquid markets, and that line is ‘intent’. Regardless of reason, does the price decline and significant volatility reinforce the skeptics? Obviously, yes. Whether you believe that the ultimate use-case for bitcoin is a stable store of value, or that it is a new currency, extreme volatility weakens its utility in either case. However, I think if you believe (like I do) that a reasonable potential use case for BTC (or an alternative digital asset with similar characteristics) is a store of value whose primary function is not to protect value from market volatility but to protect from government seizure, then the position that volatility lessens its effectiveness is not as compelling. We are somewhat spoiled in the West. Despite how you feel about the government, it’s unusual for government to arbitrarily seize assets. In many parts of the world, that is a real risk. In those circumstances, even if the asset loses half its value while you are making your escape, you have saved that half where otherwise you would have lost everything. So if you’re using bitcoin to protect some of your wealth from government seizure, a store of value that is: (a) easy to transport; (b) somewhat anonymous; (c) irrevocable; and (d) largely outside the global banking system and is truly unique and therefore has some value. Whether that value is $1 or $1,000,000 I can’t say. It depends on the amount of demand for this protection and the interest in others to speculate on the future demand for that protection. Also, there may be a use-case that sees bitcoin as a temporary stopgap currency in failed nation-states where the official currency has become worthless and momentary infrastructure is broken, then a digital asset could potentially serve as currency until a new government can be installed and a fiat currency be adopted. In those conditions, stability is more important, but again, one has to consider the alternative which is using a hyper-inflating or black-market currency with no local infrastructure. AAA: Pop culture has certainly latched on to cryptos. I saw an episode of Ellen recently in which a celebrity guest made an on-air donation to a charity in her name, and used Ripple to make the donation. Is this sort of big cultural footprint good news or bad news? I remember in the 1990s when pop culture was full of dotcom references, just before the crash of all things dotcom. JD: I don’t think it’s a good sign. There’s a reason we have securities laws, a reason we have the concepts of suitability and fiduciary responsibility – namely because for certain disciplines like finance and medicine, the impact on people’s lives is so profound and the knowledge gap is so wide that we have decided as a society to create extra protections to avoid predatory behavior. If you allow celebrity to supplant expertise, it becomes easy for the unscrupulous to persuade the uninformed to do something against their best interests. That is what a high pop culture profile most likely leads to. What’s best for people is usually very boring. We know that most people would be fit by eating a diet of vegetables/lean protein and exercising an hour a day. We know this. Yet a massive industry exists to serve a populace that knows the answer but doesn’t want to follow it because it’s boring. We know that the best use of most people’s savings is to invest the majority into fixed income and passively managed equities (and of course have some fun and take some risk with a reasonable amount). But that’s boring. Cryptocurrencies are exciting, and excitement in investment should be looked at skeptically. If you want excitement, the pass line in Craps generally pays the House a mere 1.41% edge. It’s a lot more fun and social than buying a toke and you have a much higher chance of making money and enjoying yourself Investing shouldn’t be a leisure activity. AAA: One impulse for the growth of cryptocurrencies was the libertarian politics of it all. Libertarians say to each other, “We don’t trust the government, so let’s not use government money, money pushed on us by politicians and central bankers. Let’s create our own money.” How much of it does that sentiment explain? JD: That depends on what metric you are looking at, number of transactions or percentage of assets? The larger digital assets are highly concentrated. A lot of the market cap is in the hands of a relatively few large players, the ‘whales’ who were there in the very beginning. The “OGs” of digital assets. How many of these whales believe in the politics of it, believe that cryptos will help displace the current system of government, banking, and corporate law? I won’t guess a percentage but it is higher than one might expect. At the time they bought it, it was difficult to predict the speculative frenzy we have today, so a primary reason for believe in it was buying into the core crypto-anarchist philosophy. Then you have the next weave of market participant. More recently, many people who don’t necessarily buy into the philosophy entered the market, and these pure speculators account for a large share of the transactions. Not so large a share of the assets involved, though, since they are usually coming in (relatively) small. AAA: The agenda of the upcoming Battle of the Quants tells me there will be a presentation by Ryan Robinson on cryptocurrencies and quantum computing. I know nothing about quantum computing and so I have no idea how these two circles intersect. Can you give me a head’s up? JD: I’m not an expert on quantum computing, but I know enough technologists to have an opinion. The challenge QC poses to digital assets seems pretty straightforward. The core technical foundation digital assets were built on (ie the tech that makes them secure) was developed in a computing paradigm that may be turned on its head by QC. The absolute faith that most technologists have in digital asset security (the impossibility of altering the block, the computational cost of mining, etc.) is ALL based on the current paradigm of what computers can reasonably do now, and in the future, based on everything we know about physics and computational evolution. Quantum computing throws all that out the window. So anything built on the old model of computing is thrown into doubt. It’s as if a security system was developed that relied on all of us keeping a simple number in our minds. Never writing it down or sharing it with anyone. Then we wake up one morning to find that we, or some of us, had become telepaths. We could read minds. The foundations of our security would be invalidated. Based on what much smarter people than me have explained, QC could do something like that to the current crop of digital assets. AAA: Finally, the Securities and Exchange Commission has decided that neither bitcoin nor ether is a ‘security.’ That’s good news if you own either. But are the regulators likely to scrutinize other cryptos and find that some of them ARE securities? JD: No one who has been closely following the SEC’s comments should have been surprised by this. Declaring Ether a security would destroy the ecosystem. The SEC has been extremely thoughtful in their regulatory approach toward digital assets. There was never an indication they were looking to destroy the ecosystem, in fact I think it’s the opposite. However, they also don’t want to, and haven’t, said anything that would prevent them from aggressively going after ICOs, finding many of them to be scams and pretty much all of them to be securities, and this within the scope of the regulatory system. I’ve been advising people for some time that when the SEC moved, this is the direction in which it would move.
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