Crypto's dirty little secret

Think of the space as if it were Hotel California

There is plenty of data on the market “value” of all cryptocurrency tokens (about $2 trillion according to some sources) but little data on how much actual currency investors actually paid cryptocurrency exchanges to buy tokens and how much money came out from in hard currencies through sales and or withdrawals. And for good reason, the actual money that the 20,000 odd cryptocurrency exchanges solicited from mostly retail investors is a small fraction of the so-called value of the tokens in existence. The eventual collapse of the whole Ponzi scheme will occur when the amount of new money going into the system falls well below the amounts investors attempt to withdraw - a classic “run on the bank”.

Basically, it is easy to put real money into crypto tokens but quite difficult to get real money out. A bit like Hotel California. SEC approval of a Bitcoin ETF will require its sponsors to identify an broker-dealer responsible for buying and redeeming units of the ETF. Buying is easy, redemption is another matter.

Crytocurrency investors are eagerly awaiting SEC approval of a Bitcoin ETF even to the extent of hacking the SEC Twitter page to post a false Tweet saying the SEC had approved the proposal. Approval seems hung up on the insistence by regulators that if a Bitcoin ETF (or any other crypto ETF) gains approval, it must have a hard and fast method for investors to get their money out - in effect, to redeem their units. That creates an untenable situation for the crypto world where the trading value of tokens is inflated by “wash trades” between exchanges and within exhanges and no real audit trail or enforcement mechanism to confirm actual trades took place between arms length investors. Such trades played a key role in the failures of Celsius and FTX for example. Sam Bankman-Fried sold people “tokens” for real money and used the money to speculate on stocks like Robin Hood or buy real estate and art, and the investors had little ability to prevent it, and likely had agreed that FTX could do so in the murky “user agreements” they likely signed without reading.

Real money goes in, nothing is created, and real money is consumed by the owners of the exchange and their employees. Investors get nothing but some code that people keep telling them has value and will keep rising in price because it is digital and supply is limited so as long as demand exists, the price will rise. Any money taken out must come from new money going in since the tokens create nothing and the crypto miners consume computer and energy to “mine” the next Bitcoin. Any scheme where you invest money but your return depends on someone else investing at a greater price to provide the money you want to receive is a classic Ponzi scheme.

The scam works like this. I buy a Bitcoin (say) for $40,000 from an exchange. The exchanged has my money and I have some digital code either held by the same exchange or somehow held directly by me in a so-called “digital wallet”. The exchange charges fees for transactions, custodial fees, etc. and real money leaves the exchange leaving less than what was invested. If I want to sell my Bitcoin (say for $50,000) the exchange need only find another greater fool willing to buy it. But if I want to withdraw the money by “cashing in” my Bitcoin, where will the cash come from?

If the SEC does approve a Bitcoin ETF it will be immediately popular and raise a lot of new money going into the crypto space. Bitcoin prices will likely rise as a result. But at some point, maybe to buy a house or a new car, investors might want to realize some the benefit of their “digital” gains in hard currency like the U.S. dollar, and unless the ETF can entice new investors to buy in, the whole charade comes crashing down. A hard legislated “right of redemption” is an Irish curse for the crypto cult - “may you get your wish”. As the “rake” of expenses and fees of crypto exchanges and their owners and employees depletes the cash on hand, and no profit is created by anything that Bitcoin or exchange owners do with the money they take in, a “run on the bank" is not just likely but inevitable. At that point, the dream of a deregulated peer reviewed ledger replacing fiat currencies back by the full faith and credit of the U.S. government turns into a nightmare of bankrupties, business failures and years of litigation to clean up the remains.

Bernie Madoff would be proud.

People who think Bitcoin or other tokens have value should invest in Ben McKenzie’s book “Easy Money” and get the low down on the scam in detail. It is a great read and for those people a cold shower. The amount of actual money in the cryptocurrency “ecosystem” [I hate that word] is somewhere around 10% of the claimed “market value” of the tokens. Major players like Blackrock and JP Morgan can cover the cash shortfalls if there is a large number of withdrawals up to a point, but where the $2 trillion claimed value of issued tokens is backed by about $200 billion of actual hard cash which will be depleted daily by fees and commissions and ETF MER’s, it is not hard to imagine a crisis emerging where the whole charade collapses and the sponsors take a bath.