Thursday, September 21, 2017

Tether & two pals: the only currencies among cryptocurrencies

Over the recent weeks, I occasionally spent some time by thinking about new cryptocurrencies, how a central bank could buy them into reserves, guarantee a floor under each of them, issue its own, make some crypto-payments monitored, and so on. I've also analyzed the historical data of the Bitcoin price.

It's fun to think how $130 billion of the Czech National Bank may be spent or wasted, what can be done. The possibilities are limitless – "yes, we can" applies here. At some moment, however, a rational person also asks whether these computer games are good for anything – whether they have improved someone's life or the efficiency of the economy or something like that. And the result is much worse then. ;-)

The Bitcoin price in USD, \(P(t)\), as a function of time seems to be nicely described as\[

P(t) = \exp(R(t))

\] where \(R(t)\) is a random walk – Brownian motion. In fact, all the vanishing Markov-like correlations make this function \(W(t)\) one of the best random walks you can find in all of financial markets. When we talk about the random walk, we should also mention the typical time scale at which \(R(t)\) changes by \(1\). The time scale is several months in average. Moreover, by tracing some correlations, one can see that this time scale is a "somewhat slowly changing" function of time. When one enters a more volatile period in which \(R(t)\) and therefore \(P(t)\) changes more quickly, it typically lasts between half a year and one year.



Also, there is some slight positive correlation between \(R'(t)\) and \(|R'(t)|\). That means that the periods of higher volatility are generally tending to be good for the price of the Bitcoin, too. You're invited to make these analyses, it's fun. Nevertheless, the conclusion is that the bets for/against the Bitcoin are pure lottery.




I've made some analyses of all the 1,000+ cryptocurrencies, their capitalizations, volumes etc. To give you the basic data: the overall capitalization of all currencies is some $135 billion today. About 48% of it is Bitcoin's. That percentage is remarkably stable. In fact, almost all the cryptocoins' prices in the U.S. dollars are changing almost uniformly – in other words, the price ratios between the (top 50) cryptocurrencies change much less dramatically than their individual prices. When the Bitcoin goes up, most of the cryptocurrencies do the same, and vice versa. It is the case simply because the other cryptocurrencies, the altcoins, are mostly being traded relatively to the Bitcoin. People typically tend to buy Bitcoins as their tickets to the cryptoworld and then they buy other cryptocoins for that Bitcoin or vice versa. This activity inside the cryptoworld is much less intense than the imbalances between the cryptoworld and the real world which is why the relative altcoins' prices oscillate much less dramatically than the individual altcoin prices.




By the capitalization, the largest 10 cryptocurrencies are Bitcoin, Ethereum, Bitcoin Cash, Ripple, Litecoin, Dash, NEM, IOTA, Monero, and Ethereum Classic. However, if you look at the trading volumes in the last 24 hours, you will get the following top 5: Bitcoin (over $1 billion), Ethereum, Bitcoin Cash, Litecoin, and... Tether.

Quite a new currency jumped to the top 5, Tether (USDT). $143 million are traded in Tether every day (well, such high volumes only emerged this month) – which is about 1/3 of its market capitalization $442 million. Cool, so every 3 days, the whole capitalization of this cryptocurrency moves from place to place. This time scale is incredibly short relatively to the other currencies.

You will also find something else that is unusual: the current price of USDT is $1.00. It's been generally very close to $1.00 although you find some fluctuations towards $0.90 as well but they seem to have faded away again. I have also found two more dollar-like coins, DynamicCoin and NuBits, whose daily volumes are just $0.8 and $0.2 million, way smaller than Tether's, so I will only talk about Tether.

The word "tether" was probably picked because the currency is pegged – not to a horse or an iPhone but to the U.S. dollar. One should study how they achieve it and why the peg has broken a few times. Tether.to is the website where you can create your wallet. There is an explorer of Tether transactions. They're probably decentralized just like those for the Bitcoin except that the Tether may be used as a currency – it's backed by the good old dollars. If you create an account, you can fill it by the crypto-cousins of the U.S. dollars and Euros from your bank, and you can also send these crypto-cousins of the usual currencies to other Tether, Bitcoin-like addresses. For example, you're invited to try mine:
3EwZu96KsTu5K5okjyjYCoh9aoxBS4AVM2
Well, you may trade USDT at Bittrex, too – BTC-USDT is the highest-volume pair there.

Now, the Tether payments contain much of the Bitcoin-like technology except that they're stripped of all the nonsensical volatility that makes the Bitcoin and almost all of its clones unusable as currencies. With a currency like Tether, you may finally ask, within a controllable framework, whether there are advantages of having the Bitcoin-like cryptotechnology behind the wallets and payments.

You may sell iPhones and sleep well as your shop demands USDT 999 for one iPhone. It will almost certainly be equal to $999 rather accurately. How great it is when the payments may be confirmed within minutes and when the ledger underlying the payments is decentralized?

The blockchain is a creative idea – but from a practical viewpoint, it may make things better or worse relatively to the more conventional centralized systems, depending on the context. But the lack of volatility is a clear advantage of regular currencies or the Tether relatively to the Bitcoin. So if there will ever be a growing economy in which things are denominated in a cryptocurrency, the things will be denominated in a cryptocurrency like Tether, not like the Bitcoin, simply because one can actually rely on the value of the Tether.

Isn't it clear that the number of genuine products and services – such as cell phones – that are offered for Tethers will grow more quickly than those denominated in the Bitcoins? So isn't it obvious that the mostly Bitcoin-denominated economy will be getting further with time, not closer?

So in practice, even a complete switch to a Bitcoin-like ledger won't really create any completely new wealth or unit of wealth. It will still be just the U.S. dollar or the Euro – just represented differently within the Internet. The blockchain technology and the Bitcoin (or the remaining thousand or so minus three currencies) are completely independent things. The blockchain technology may be combined with the virtues of an actual monetary system that works – and Tether is a current example showing that it has a chance to succeed.

Once people start to think rationally, it's clear that the adoption of Tether by the businesses will unavoidably be greater – it arguably already is greater – than the Bitcoin's. So the story that the Bitcoin will actually be a unit in future shops will be identified as a fairy-tale, and once this self-evident point starts to be widely understood even by the irrational Bitcoin cultists, they will start to sell their Bitcoins and Ethereum and buy things like Tether – which basically means that they will start to buy ordinary dollars again.

The idea of a currency whose value is independent of everything that has existed before is just an utterly idiotic delusion of a communist type. The world has never switched to a "completely new way of quantifying the wealth" and the society will never agree to voluntarily undergo a massive wealth redistribution as imagined by the Bitcoin cultists – one that would turn the early (and even the "slightly less early") adopters into a new aristocracy for no good reason.

The tiny volatility of the Tether relatively to the Bitcoin is of course inseparable from the fact that the Tether is a currency while the Bitcoin isn't. In other words, a much bigger fraction of the Tether transactions – if not a majority – are actual compensations for some products or services, a genuine economy. After all, they're used just like the dollars and the Euros. On the contrary, almost all the Bitcoin payments are just speculative purchases. Whether you make a profit out of them is a matter of almost pure chance, as quantified by the random-walk-like profile of the logarithm of the Bitcoin price.

I don't know how much the holders of the Tether are guaranteed that they will be able to sell their Tether for a dollar in the future. And I don't know how much the Tether company is guarantee not to create a loss by guaranteeing it. The simplest recipe is for them to hold the physical dollars obtained for their sales of the Tether – so that the Tether is really backed up. They seem to promise it's the case. Note that the "money supply" is in no way constant or bounded, like for the Bitcoin – the money supply has to be elastic for the value of the coin to be constant! If they get some positive interest on the physical dollars (or higher interest than what they give to Tether users), they create profit. But it seems clear to me that if the offers denominated in the Tethers got more widespread, the exchange rate 1-to-1 relatively to the U.S. dollar would tend to survive more automatically at short time scales. Everyone knows that the Tether is about one dollar and everyone knows that everyone knows, and so on, so this strengthens the peg to the dollar. On the contrary, at long scales, you would need the same authority to issue the new Tether and change the interest rates etc. as the Federal Reserve has today. If the Tether payments underlied the U.S. economy, the company that issued them will hold about as many physical dollars as the Federal Reserve. Just like the U.S. dollar left the gold standard in the 1970s, Tether could abandon the backing by old dollars if the Tether became the true unit in which the people think about wealth.

But unlike the case of the transition to the Bitcoin, the switch to the Tether or a similar representation of the old currencies is possible. It will only include the change of the technology underlying the payments, not an actual giant wealth redistribution benefiting any early adopters. The adopters of the Bitcoin aren't pioneers of a new currency. They're participants in a stupid pyramid-scheme-like lottery where they could make some profits up to the approximate peak of the price and will make losses once the price of the Bitcoin begins to collapse as the people realize that the game doesn't lead anywhere.



Update: On September 22nd, I asked James Dimon, the CEO of JP Morgan, to review several recent cryptocurrency TRF blog posts on CNBC. He did well. Lots of other people said similar things. The vice-president of the European Central Bank said the Bitcoin is a tulip craze. Ray Dalio, John Hathaway, Nobel prize winner Schiller etc. said the same.

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