A couple of weeks ago, I tracked the performance of the Venezuelan stock market (under hyperinflation) against the performance of Bitcoin. At the time, I thought it was just a weird anomaly. But since then, I’ve been doing some thinking. And I’d like to throw something out there, into this unregulated world of cryptocurrencies. And please just bear with me until the end – there are a few things that I need to cover first.
First, here’s a reminder of that graph:
Secondly, here’s a chart that is doing the rounds on Twitter:
Whatever your beliefs are about Bitcoin, I think that these kinds of graphs should give you pause.
Yes, the technology is great. Yes, Bitcoin has become quite mainstream. But we can’t say with certainty that the price rise is caused by Bitcoin going mainstream. I mean, perhaps it’s going mainstream because the price is suddenly rising?
And we should be talking about this: for the sake of cryptocurrency everywhere. Because the Bitcoin price looks a lot like it’s undergoing hyperinflation.
And here’s the thing: I’m pretty sure that there is a way to print cryptocurrency – and then use it. Which is the kind of thing that cryptocurrency is meant to be avoiding. It also highlights a key risk in the cryptocurrency ecosystem.
It involves creating your own altcoin, and then listing it on an unregulated exchange. Helpfully, almost all cryptocurrency exchanges are unregulated.
So to kick us off:
How To Create A Cryptocurrency With A $100 Million Market Capitalisation
This might be easier than you’d think. After all, Dogecoin was created as a joke (it was named after a popular internet meme dog).
Fun fact: today, Dogecoin has a market capitalisation of $232 million.
How to replicate this?
Well, here’s how I could create a massively-capitalised altcoin:
Step 1: partner with a programmer, and get him to write the code that would get Ralphacoin going. Let’s put in place a 250 million coin cap.
Step 2: get my friends to connect their computers to my Ralphacoin mining network.
Step 3: initiate the network, and begin with an initial flush of 2 million coins for early adopters.
Step 4: get Ralphacoin registered on an exchange.
Step 5: buy my first Ralphacoin from my friend with a bid order for $50.
Ta dah! My new market capitalisation is $100 million.
It’s the weakness of “market capitalisation” as a measurement. It takes the last traded price, and multiplies it by the total number of coins in circulation. And suddenly, that’s the ‘value’ of my altcoins.
Obviously, the exchange registration is a hurdle to overcome.
But the potential rewards of Ralphacoin (coming up shortly) may well make it worth the trouble.
Because wait – there’s more!
Folks, assuming that I get Ralphacoin onto an exchange, I don’t even need to spend $50 to get my Ralphacoin market capitalisation up to $100 million.
Because I can buy fractions of a Ralphacoin.
You see, when we buy shares, the smallest denomination you can buy on your own is 1 share. But with altcoins, you can buy decimal points of an altcoin. No problem.
So if I allocate $10 to my Ralphacoin purchase, I can basically decide what I want my market cap to be:
- If I buy Rα 0.20 for $10, my market capitalisation is $100 million.
- If I buy Rα 0.10 for $10, my market capitalisation is $200 million.
- If I buy Rα 0.01 for $10, my market capitalisation is $1 billion.
So what should be stopping me from doing this?
There are two hurdles:
- The exchange: Ralphacoin needs to make it onto one.
- The market: I may have a small little altcoin network, with these fantastical values – but if very few people will trade with me for them, then I’m nowhere.
But is the market really a ‘hurdle’?
Who really gets to decide whether my Ralphacoin is worth $100 million?
There are two ways to spend a Ralphacoin:
- I can try to buy things with it (for this, I need the market); or
- I can put it up as collateral for my margin-trades (for this, I only need the exchange).
I guess what I’m saying is: if I can get my altcoin onto an exchange, and persuade the exchange to accept it as collateral for margin trading, then I can print cryptocurrency.
How to print cryptocurrency
Assuming that Ralphacoin is listed on the exchange, and is accepted as collateral, here’s how it could work:
- I set up some bots to trade fractions of Ralphacoins between themselves. My only cost is the trading commissions payable to the exchange. This sets the value of my market capitalisation.
- I take my bag of Ralphacoins, and put them on the margin-trading table at the exchange as collateral. Let’s say that I deposit 100,000 Ralphacoins (which, assuming my $50 trade from up top, gives me $5 million worth of ‘collateral’ to play with).
- The exchange allows me to borrow up to three times my collateral.
- So it allows me to purchase up to $15 million worth of cryptocurrency on margin.
- And I don’t buy Ralphacoins. Oh no.
- Instead, I buy Bitcoin. Or Ethereum. Or something that is ‘real’.
Essentially, the exchanges have become the gate-keepers to crypto-credit.
Helpfully, I also wouldn’t need to persuade the market to accept my altcoin.
As long as I could persuade the exchange-owner to list my altcoin, and to accept it as collateral for margin-trading, then I’d be free to print my altcoins and exchange (and leverage) them for those altcoins that the market already accepts (ie. Bitcoin).
I just want to emphasize this: you don’t need to print Bitcoin to inflate its price – if you capture an exchange, then the exchange can hand you all the leverage that you need.
And you can have yourself a crypto-credit crisis.
COUNTERPARTY RISK, PEOPLE
The cryptocurrency exchanges are not just thoroughfares for trading.
They are providing leverage. They are determining collateral. And they are unregulated.
They are the real risk here.
Because if an exchange fails after over-lending on the back of baseless collateral, and they’re holding your crypto-wallet, yikes.
“But isn’t it in the interests of the exchange to limit this kind of thing?”
Sure, it’s in their long-term interest. But in the short-term, there’s a lot of profit to be made. And that tends to make people…corruptible.
We keep learning this history lesson. In order to stop this kind of thing happening on exchanges that have been around for some time, we rely on legislation, filing deadlines, audits and market regulators. Much of that has built up over time. Whenever some small corruptible part of the system would find a loophole to exploit, leading to some kind of market crash (or failure), new regulations would be introduced to prevent it happening again.
But the crypto-exchanges have none of those safeguards.
Which makes them riddled with loopholes.
PS: also this:
Rolling Alpha posts opinions on finance, economics, and sometimes things that are only loosely related. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha. Also, check out the RA podcast on iTunes: The Story of Money.