Reality needs to intrude on valuation of cryptocurrencies

Reality needs to intrude on valuation of cryptocurrencies
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The cryptocurrency phenomenon rolls on, despite the fact that the most valuable cryptocurrency, bitcoin, has yet to recover from a breathtaking plunge when its price dropped 41 percent from a peak of $20,089 on Dec. 17 to a low of $11,833 five days later

It has since had a jagged recovery, to $15,069 at 4 p.m., Eastern Time, Thursday, according to www.CoinMarketCap.com. It is still 25-percent below its peak price.

Many other cryptocurrencies have performed similarly in recent weeks — a swoon in late December and then a bumpy price recovery since then, none more so than Ripple XRP. 

XRP clearly is the new darling of the cryptocurrency speculators, in part because it is so cheap — just $3.31 per XRP at 4 p.m., Eastern Time Thursday. XRP is now the second-most valuable cryptocurrency, with a current market valuation of $128 billion, compared to bitcoin’s $253 billion valuation and a total valuation of all cryptocurrencies of approximately $745 billion.

Clearly, cryptocurrencies exist in a world of their own, with at best a tenuous link to the real economy and the investor-owned companies that produce the goods and services consumed by real people. 

Even Ripple’s XRP has no ownership link to Ripple’s real-world attempt “to send cross-border payments more quickly, transparently and cheaply,” according to an article in the American Banker. Instead, Ripple periodically issues XRP to fund its development activities and for other purposes, such as charitable contributions.

Like bitcoin and most other cryptocurrencies, XRP has no claim on any real assets or business activity. As I said in an earlier Hill op-ed, there is no “there” there for any cryptocurrency and possibly for some of the initial coin offerings (ICOs) that fund the start-up of real businesses.

I also noted in subsequent op-eds that cryptocurrencies essentially are Ponzi schemes. It is only a matter of time until they collapse, leaving the so-called investors in these schemes with hundreds of billions of dollars of losses. 

It is no surprise, then, that Merrill Lynch has blocked clients and financial advisors who trade on their behalf from buying bitcoin-related investments because of concerns over the cryptocurrency’s investment suitability. Other brokerage firms have adopted similar policies.

Thursday, the SEC reinforced the Merrill Lynch policy by urging investors to "exercise caution" with cryptocurrencies like bitcoin, warning that while the SEC and state regulators are pursuing violations of the securities laws, "there is a substantial risk that our efforts will not result in a recovery of your investment."

The folly of cryptocurrency valuations is immediately evident when those valuations are compared with the stock-market valuations of real companies that produce goods and services and employ human beings. 

Those companies own real assets, such as buildings, computers and production machinery, as well as financial assets, including loans and investment securities that represent claims on real assets. 

Most importantly, these companies generate cash profits, something no cryptocurrency can claim; any increase in a cryptocurrency’s market valuation most certainly does not reflect any underlying profitability.

A few examples will illustrate this contrast. Since cryptocurrencies can reasonably be classified by their investors as a financial asset — they certainly do not represent or have a claim on tangible assets, such as buildings or machinery — it is appropriate to contrast cryptocurrency valuations with real-world financial firms.

JPMorgan Chase provides an excellent contrast. As an aside, its CEO, Jamie Dimon, has been very critical of cryptocurrencies, stating at a conference that bitcoin is a “fraud” that “won’t end well.”

As of 4 p.m. Thursday, JPMorgan Chase had a stock-market valuation of $378 billion, only slightly less than the combined valuation of bitcoin and XRP — $381 billion. JPMorgan Chase has total assets of $2.6 trillion, including loans of $900 billion, and over 240,000 employees. Does anyone really believe that bitcoin and XRP are the equivalent of that megabank? If so, I have a planet or two I would like to sell to them.

For those who are not enamored with financial firms, a few non-financial comparisons are worth noting. The market value of the 1,385 cryptocurrencies tracked by CoinMarketCap was $745 billion at 4 p.m. Thursday, falling between the current stock-market value of Apple ($880 billion) and Microsoft ($672 billion). 

Does anyone really believe that the sum of the market value of all cryptocurrencies even begins to approach the economic value of either of those technology companies and their contribution to the global economy?

At some point in time — and the sooner the better — reality needs to intrude on the valuation of the cryptocurrencies. Those valuations must reflect the real-world value they create, or rather destroy, through the consumption of enormous amounts of electricity, computer chips and human effort.

This assessment of cryptocurrencies is not a negative reflection on blockchain technology, per se, but rather a recognition that this technology is not suitable for storing monetary value.

Once real-world valuations are applied to cryptocurrencies, these Ponzi schemes will collapse, wiping out hundreds of billions of dollars of fictional value “investors” in them thought they had. Smart investors, though, will bail out before that inevitable collapse, and be thankful that they did.

Bert Ely is the principal of Ely & Company, Inc., where he monitors conditions in the banking industry, monetary policy, the payments system and the growing federalization of credit risk.