Stand and deliver: Your crypto or your life!
Implications of the rising trend of physical cryptocurrency theft
Welcome to my new, free Substack: Seriously, Marvin?! If you already read my paid Substack, Thematic Markets, you know that I’m often contrarian and have an unusually good record of being right when I swim against the stream. But I have far more counter-consensus ideas than I have time to research. Rather than let those unresearched ideas perish in the recesses of my mind, Seriously, Marvin?! will be an outlet for my unfiltered random thoughts. While I may not have time to pursue them all, maybe some of you will. And if you would like me to pursue any of them further in Thematic Markets, please be sure to let me know in the comments!
A new form of portfolio risk
Portfolio risk is usually associated with significant, perhaps catastrophic loss of wealth. At the extreme – when positions are levered or one is short options – portfolio risk can even encompass negative net worth. But what if your life or the lives of loved ones were at risk from your portfolio choice? More to the point, what if that risk increased as the value of your investment rose?
In the rapidly evolving world of crypto currencies, with its many unforeseen twists, that appears to be a growing reality. A recent article in The Wall Street Journal described a disturbing rise in personal attacks and kidnappings to extort crypto currency from large holders. Increased crime against significant owners likely reinforces crypto’s trend toward institutionalization and use as a state-sanctioned payments method – surely to the chagrin of its evangelists –rather than a truly independent money.
Realism and sovereign powers
While the idealized vision of crypto as a stateless money free from sovereign control is attractive to any freedom-loving person, as a realist I’ve always seen it was just that, a utopian dream. Unavoidable sovereign rule of our physical domain grants governments a great degree of control (likely total) over our digital lives. States will always be able to control the on-and off-ramps to the digital realm and have the resources necessary to pursue your digital twin across the internet.
The rise of criminals targeting digital wealth reinforces the underpinnings of sovereign power and invites them into our digital lives. Just as our forebears traded some of their freedom to governments in exchange for protection from highway bandits, the rise of crypto crime incentivizes the same exchange in the digital world. That is even more true when it crosses from the online world to our physical reality in the form of life-threatening personal extortion.
One reason violent theft is rare in modern economies is because states control our payment systems, the electronic pathways – often referred to as “payment rails”1 – we use to transfer money to one another. For the criminal, the most dangerous aspect of extortion is receiving payment. A physical transfer exposes the criminal to immediate arrest. But transfer over payment rails leaves a trail of breadcrumbs to their location. The same low traceability (not untraceability, mind you) that makes crypto currencies ideal for libertarians also attracts extortionists by creating enough latency or anonymity to allow them to vanish before authorities can apprehend them.
Implications of Bitcoin banditry
There are several implications from the trend rise in physical threat to crypto currency holders:
Increasing institutionalization: If large crypto holdings outside of regulated institutions expose owners to personal harm, investors in crypto currencies and related assets will increasingly prefer to invest through institutions, i.e. via registered institutional accounts at regulated financial institutions or through passthrough products like exchange traded funds.
Reinforced value of secure crypto payment systems...: Because personal security is enhanced by traceability, physical crime against crypto holders reinforces demand for secure, transparent crypto payment rails, the systems over which crypto currencies and digital finance products are transferred between users. Indeed, the above WSJ piece recounts how a group of kidnappers, ironically of a founder of Ledger, a secure offline digital wallet for crypto currencies, were caught because they demanded payment over Tether’s traceable blockchain.2 As volume grows on these secure, effective and transparent blockchain-based payment systems, so too will trust in them as a means for non-crypto currency payments, as illustrated by Tether’s rapid growth in US dollar transactions.
...With increasing state involvement: But traceability is only a deterrent to criminal activity if sovereigns are invited to do the tracing. Sovereigns are only going to grant that privilege in exchange for open monitoring and, likely, regulation. In what amounts to a payments version of Gresham’s Law – the idea that “bad” money drives out “good” money as the latter is hoarded – crypto payment systems that gain sufficient scale to thrive will be those that accept sovereign participation.3 As I’ve written at Thematic Markets, the US government is likely to see a geopolitical advantage in an independent, blockchain-based payment system (that it can monitor) as an alternative to state-sponsored Chinese (or European) payment systems.
These trends are self-reinforcing and likely not correctable: Anyone who remains outside of the institutionalized, state-sanctioned sector will face increasing pressure to join as criminals will concentrate predation upon the holdouts. (One should not discount states encouraging that trend as an enforcement mechanism.) Nor are improvements in crypto-based anonymity likely to change those realities. In most of the cases listed in the WSJ article, criminals identified and located their victims through conventional hacking of customer databases. It matters little that you are using an untraceable cryptocurrency and payments protocol if your physical address and ownership details are available in some exchange or wallet provider’s database.
Long-run cap on demand for crypto currencies: This creates a paradox for crypto currencies and related digital assets that limits their uptake. Crypto currencies were created to enable anonymous peer-to-peer transactions free from state interference. But if that exposes holders to personal threat that can be alleviated only by transacting through a state-monitored payments system, it evicerates crypto currencies’ raison d’être. Especially in a geopolitical order increasingly characterized by gangsterism, that implies the existence of a cap on demand for crypto currencies/assets: why hold a non-interest bearing, volatile asset that is as vulnerable to state seizure as any other asset?
A lower long-run value: Once demand reaches its natural upper bound, crypto currencies will be (mostly) robbed of their two primary drivers of value: (1) as a haven from sovereign seizure; and (2) capital gains from increased adoption amid fixed supply. The first source of value will be maintained at some level by the minority of holders that remain outside the state-sanctioned system, trading security for freedom, implying a non-zero long-run value for surviving crypto currencies. But the “total addressable market” for crypto currency demand, i.e. the maximum level of desired holdings, likely is lower than evangelists expect due to personal security risk. That implies a lower long-run value than many assume.
Ironically, reinforced demand for reserve currencies like the US dollar: The growth of state-sanctioned crypto payment systems, ironically, likely reinforces demand for traditional reserve assets. Imagine two people, one from a large country and one from a small country. Both distrust their own governments and hold money abroad on a traceable blockchain payments network. For the small country resident, holding wealth in a crypto currency is largely uncorrelated with the threat of seizure: if Argentina seized all its citizens’ Bitcoin it would have little effect on the price. But that is not true of large-country residents. If the US, European Union, or China seized residents’ Bitcoin, the negative price effect would be large. Hence, a rise in perceptions that a major economy may devalue its own currency should negatively affect the values of crypto currencies, reducing its value as a hedge. As a result, there is little incentive to diversify away from the perceived strongest reserve currency that provides superior transaction properties. That holds true for both large country residents and small country residents and explains the dollar’s continued dominance in remittance payments over digital systems like El Dorado.
Payment rails refer to the systems that move money between parties. In traditional finance, these include banks, SWIFT, or card networks (like Visa or American Express). In crypto, they’re blockchain-based systems that carry digital assets securely.
Blockchains are the underlying technology behind cryptocurrencies and many digital payment systems. They function as decentralized, tamper-resistant ledgers that record every transaction in a secure and transparent way. This allows users to trust that the sender truly owns the digital asset being transferred, and that ownership is reliably passed to the recipient—without the need for a central authority to verify it.
Gresham’s Law is the economic principle that “bad money drives out good.” Applied here, it means users will abandon risky, untraceable systems in favor of safer, more regulated ones, even if it costs them the privacy that crypto currencies and payment systems were created to provide.
This is essentially an attempt to revive bearer assets under the guise of new technology. While registered assets replaced bearer assets for good reasons decades ago, some use cases still favor bearer assets. It’s striking that, rather than prioritizing these practical use cases, crypto proponents are fixated on reinventing the entire infrastructure of international finance. Shouldn't come as a surprise I guess: a VC-backed asset class is destined to chase the largest possible TAM!