27Aug 2019

Crypto is Based on Thin Air

by Tim Johnston

President Trump recently shared his thoughts on Bitcoin and other crypto assets. We were unsurprised to learn that he is not a crypto enthusiast. The President’s concern that crypto assets are “based on thin air” is not uncommon. Crypto assets are not backed by anything. But the premise that an asset cannot be valuable if it is not backed by something is short-sighted. Gold, fiat currencies and paintings are all valuable assets not backed by anything. The true determinant of whether something is valuable is the tension between supply and demand for that particular asset.

First, let’s start with valuing assets. How do we value assets? The simple answer to this age old question is the value of anything comes down to what someone is willing to pay for it. The financial services industry has developed models and techniques to determine the value of a variety of assets. While these models might help determine a range of potential values, the inputs to the models inevitably involve a great deal of subjectivity. (Let’s consider the alternative. If the models didn’t involve subjectivity, everyone would use the same inputs, the models would provide the same answers and asset prices wouldn’t fluctuate). Valuation is art as much as it is science and while these models may help, the true value of an asset comes down to what someone is willing to pay for it. Any other definition can only be theoretical.

How do we work out what someone is willing to pay for an asset? The answer: markets and the forces of supply and demand. Markets exist to facilitate the trade of assets. Less liquid assets are traded infrequently and price discovery is more difficult. Supply and demand are the forces that drive markets. Supply comes from issuing new assets and from sellers of existing assets. Demand comes from buyers looking to purchase at an attractive price. The value of any asset comes from the ever-present tension between supply and demand.

Markets tell us that crypto assets are valuable. Crypto markets are currently worth around USD$250bn. That’s a lot of value based on thin air! As is the case with every other asset class, supply and demand determines the value of crypto assets. Supply comes from new assets, increasing supply of existing assets and sellers. Demand comes from the increasingly large number of people who are realising the value of crypto assets. The question is not “how are crypto assets worth anything if they’re not backed by anything?” Rather, the pertinent question is “what is it about crypto assets that makes them valuable”? The answer: crypto assets have unique characteristics that are unlike anything else known to mankind.

Crypto assets often have the following unique characteristics:

  • Scarcity – using Bitcoin as an example, there will only ever be 21 million bitcoin in existence. If we think of Bitcoin as money, this is ‘hard’ money. Unlike fiat currencies governed by central banks, it is impossible to print more bitcoin, thereby devaluing all the other bitcoin

  • Digital – crypto assets are digital. The concept of assets in the digital ether is often difficult for people to grasp, they cannot touch or feel it and nor do they receive a share certificate. Native digital assets can be traded digitally with less friction than alternatives. As the world becomes more and more digital, digital assets make sense

  • Utility – crypto assets can be used for a variety of purposes, with different assets suited to different means. People can use Bitcoin as a personal, unseizable bank account, and all they need is a smartphone and internet connection. Crypto assets are often programmable, leading to a number of novel use cases, often disrupting and disintermediating incumbents. The unique economic model of crypto assets means they can capture enormous amounts of value in the process.



Let’s compare Bitcoin to gold. Why is gold valuable today? The short answer is because of supply and demand. There is demand for gold because it has always been valuable, because thousands of years ago, a group of people decided that gold has a number of unique properties which meant it would function well as a form of money. Gold is somewhat scarce, so it cannot be duplicated and printed (unlike today’s fiat currencies). Gold is durable, so people can store their wealth with some degree of assurance. It is malleable so it can be shaped into functional coins. Gold is fungible, meaning any piece of gold is replaceable with another piece of gold. Gold, particularly when shaped into a coin, is portable, meaning it can be carried around and exchanged with other people to facilitate trade. Gold became valuable because of these properties. The people of the day decided that gold is valuable and should be valued. This cycle developed further and further until gold was recognised as being valuable, by people all over the world.

It is important to note that this process did not happen overnight. Imagine presenting a group of people a new asset and proclaiming that it should be immediately valuable. It takes a long time for people to realise the value of a new asset class, as they become familiar with the asset and as network effects develop. Just as gold did not become valuable instantly, nor did crypto assets and nor will they realise their full value for some time.

If we compare Bitcoin to Gold, Bitcoin’s properties are superior. Bitcoin is more scarce than gold, easier to transfer, more divisible, equally fungible and easier and cheaper to store. On top of this, Bitcoin is programmable and is impossible to seize, unlike gold in the United States in the 1930s which was seized by President Roosevelt. The only advantage gold has over Bitcoin is it’s shiny. In time, more and more people will realise Bitcoin’s superiority to gold, demand will increase and the value of Bitcoin will increase. The estimated market capitalisation of gold is between US$8 and US$10 trillion dollars. Given Bitcoin’s current market capitalisation of around US$170bn, we believe there is a strong case that Bitcoin will capture some of the value from the gold market which is around 50 times larger.

Fiat Currency

When we talk about crypto assets as currencies, many compare to fiat currencies (US Dollar, Australian Dollar etc) which is “backed by governments.” I often smirk when I hear  people say the US Dollar is backed by the full faith and strength of the US government. The problem with this argument is this ‘backing’ exists until it doesn’t. Fiat currency is valuable, until it’s not. If macroeconomic problems creep in, people start to doubt the value of the currency. Once doubt creeps in, it can be a slippery slope until the currency is worthless.

Sadly, there is no clearer example of this than the current state in Venezuela. Hyperinflation has recently been reported at 10 million percent and the local Bolivar currency is worthless.

venezuela streets.png

Venezuela is not an isolated incident. Hyperinflation has plagued many countries over the course of history.

hyperinflation table.png

I’m not suggesting that the US or any other major economic force is soon to be affected by severe inflation. I am suggesting that because something is ‘backed’ by a government gives it no more value than a crypto asset that is based on thin air.


monet water lilies.jpeg

Let’s consider a painting by Claude Monet. A Monet painting is not backed by anything other than a canvas. The painting has no intrinsic value. Yet, it is undeniable Monet paintings are valuable. Different paintings by Monet will have different value, depending on the particular beauty of those paintings. And of course, paintings by Monet are scarce. Monet died in 1926, so we know that there will never be any more Monet paintings.

We can draw a comparison to crypto assets. Crypto assets and rare paintings are backed by nothing, they have no intrinsic value. Yet this does not stop them from being valuable. Investors often ask why crypto assets are valuable if we can simply create new crypto assets. We would say the same about paintings. I can paint a picture of some water lilies at my local pond, but this will likely be no more valuable than any crypto asset I produce. The crypto asset that I create needs to have unique characteristics that are deemed valuable by the broader crypto community, just as my painting needs to be deemed valuable by the art community.

The advantage that gold, fiat currencies and paintings have over crypto assets is they have been recognised as valuable for centuries, even thousands of years. Crypto assets are ten years old. It is highly unlikely that the value in the US Dollar will evaporate over a short period of time. While we think it is also unlikely this will happen in crypto assets, any unravelling of value in crypto assets is more likely than the same for assets which have long been recognised as valuable. In this regard, crypto assets are riskier than the traditional assets discussed, and this is well known and understood.

Crypto assets have unique properties that make them valuable. They are not backed by anything, they might be based on ‘thin air’, but this does not mean they are not valuable.

Tim Johnston

Tim is the Managing Director at Apollo Crypto. He has substantial expertise in both traditional financial services and technology investing. In financial investing, he worked at DMP Asset Management, a boutique Australian Equities Fund Manager, and was part of the investment team that managed a $33 billion super fund. On the technology side, Tim has worked as a venture capital Associate at Dominet Venture Partners and has been active in crypto markets for over four years. Tim is a CFA charterholder.