Nobody Asked Me (About Cryptocurrencies) But…

This essay was originally published in Muhlenkamp Memorandum, Issue 139, July 2021 by Jeff Muhlenkamp, Portfolio Manager.

I thought I’d share my thoughts on them anyway.

At a high level, cryptocurrencies are built on a distributed database, called a blockchain. The “distributed” part means that the database is replicated on a number of computers, not just one or two, and so no one really “controls” it. Bitcoin, the original cryptocurrency, is a token awarded to people who use their computers to run the ledgers of the database and record new transactions—it is their payment for doing the work the system requires. Bitcoin also has a maximum number of tokens, or coins that can be created, so it takes increasing amounts of computer processing to earn the next Bitcoin. The limitation on the number of Bitcoins that can be created is for some an attractive feature but while the number of Bitcoins that can be created is limited, the number of cryptocurrencies that can be created is not. Bitcoin has split three times since its creation as the rules governing it have changed, so there is now Bitcoin, Bitcoin Cash, Bitcoin SV, and Bitcoin Gold. Further, not all cryptocurrencies limit the number of tokens or coins that can be created as they have different rules and try to solve different problems. Ethereum, for instance, allows developers to deploy immutable contracts on it—ones that execute without further human intervention and can’t be changed at a later date. The Ethereum blockchain also serves as the basis for other tokens using the ERC-20 protocol (ERC-20 stands for Ethereum Request for Comments 20). More on that a little later.

Cryptocurrencies have been suggested as replacements for other currencies ever since the original white paper published by Satoshi Nakamoto in 2008. The name itself is a marketing pitch for that idea. Cryptocurrency bulls, people who think the value of cryptocurrencies will continue to rise, justify their stance by asserting that as a given cryptocurrency is more widely adopted the value will inevitably increase. That is logical for cryptocurrencies with limits on coin or token creation, but not for cryptocurrencies without that limitation. Thirteen years after the original whitepaper and twelve years after the creation of the first Bitcoin how attractive are cryptocurrencies as currencies?