Germany experienced hyperinflation in the 1920s, which led to the election of Adolf Hitler.
Cryptocurrency Panic Sell

Why The Cryptocurrency Market Is Crashing (It’s That Old Stag Again!)

Bitcoin is deflationary, and combined with Ether's real hyper-inflation in the form of so much token creation in 2017, that pushed things up a little over the edge of rational.

Market sell-offs can be the scariest thing in the world when you are holding the bag. Just as the euphoria of the double-digit percentage gains every day seemed to have become a thing of the norm, so the reverse is a shock the likes of which ice cold water can’t compare.

They are much easier to handle if you know why they are selling off, however. I thought twice about writing this post, as I am not one for speculative drivel. But after the team at the Futereum Foundation encouraged – nay, insisted – that I write my thoughts on what is happening I find myself with few viable alternatives. (At least if I wish to keep things cordial with my foundation colleagues!)

Hyperinflation

What crypto markets have been undergoing as of late is an effect that any Argentinian or Zimbabwean will have no trouble identifying for you in a heartbeat. It’s called: hyperinflation. Hyperinflation of payment currency – which crypto qualifies as – happens when the mass-production of currency units exceeds the rate at which such units are used to make purchases (utility in crypto terms).

Hyperinflation? I hear you ask, incredulous. But I thought Bitcoin was deflationary!

Bitcoin is deflationary, and that is precisely why it went up so much once Ether began hyperinflating in the middle of last year. Because Ether is a token in itself, not dissimilar in substance to any standard ERC20 token, but at the same time because it is the very same payment mechanism by which all ERC20 tokens are created, every time a new token is listed on a crypto exchange you get, in effect, an inflation of Ether units.

This is what we might call embedded inflation, or real inflation. Ether may not be expanding in the total supply of all ETH, but it is in effect financially underwriting the largesse of the crypto market expansion. That is because by far the majority of Initial Coin Offerings (ICOs) use the Ethereum network as a platform upon which to create their tokens.

The creation of NEO, EOS, ICON and other similar rival platforms would be a tremendous advantage to Ether bag holders, for the real expansion of Ether units would sharply decrease in the process. Partly, that is what the Futereum Foundation identified with respect to the Ether price in 2018: once such platforms get underway being developed, Ether’s price will have much less organic implied dilution and thus, will begin to soar upwards.

Stagflation

The effect of hyperinflation in Ether supply in the form of so many new tokens being listed on crypto exchanges where they are traded against Bitcoin, combined with the deflationary effects of Bitcoin’s tight supply-side algorithm last year led in the end to what was tantamount to a collective freezing over of the altcoin market. There was no real price performance in tokens by the fourth quarter, but a measurable increase in Bitcoin’s price.

Why? Because in effect, Ether was being used to pump up the price of Bitcoin. This process is one we can liken to the economic equivalent effect of stagflation. Just think for a second about the process of participating in an ICO and this realization becomes much more apparent.

When you participate in an ICO, you (usually) send Ether first. The Ether gives you in return an ICO token; what in effect is an Ether substitute, or if you like, Ether derivative that is actively managed by a collective of entrepreneurial hopefuls. The management to whom you have given Ether will do one of three things once you have done this: they will either hold Ether, they will sell it to buy Bitcoin, or they will sell it to buy FIAT. I am no data scientist, but my bets are these events are distributed on roughly a 10%/20%/70% ratio, respectively (i.e. only 10% of management teams holding ICOs actually retain 100% of the Ether they receive, or rather, the average team saves just 10% of the Ether they receive, buys Bitcoin with 20% of it and cashes out about 70% of the loot).

Now, here is where it gets more interesting. You are holding the Ether derivative: the product that was created by Ether and which you paid for using Ether. This token is floated on an exchange and most commonly, it’s traded against bitcoin. After a while of lacklustre gains, you think for Christ sake man, sod these lacklustre returns, I’m selling! (or, I suppose, you may think to yourself Good Lord, 1000% in a week! I’m selling and buying the round of drinks tonight!)

Snap. At that point you have bought bitcoin and thus participated in the diffusion of hyperinflation in Ether into the deflation of bitcoin, the resultant effect of which is to have created a form of asset price hyperinflation in Bitcoin.

Bitcoin Price Hyperinflation

Of course, not everything can keep rising forever: as Newton taught us, what goes up must alas by the physical and geometric laws of mother nature, come down. And so it is with crypto prices, too. By this, I don’t mean that Bitcoin’s price cannot continue to soar indefinitely, but rather that the costs associated with such a dramatic increase of the BTC price must reduce the net demand for services for which such asset price hyperinflation is causing to becoming overvalued.

A great example of this is the cost of exchange listings. Exchanges typically charge about 5-10 BTC per listing. Back when Bitcoin was only $2,000 or so, that seemed like a tidy punt. Now however, that is more – far more, if I may add – than a full-fledged securities listing. What the hell is disruptive about that, man? Nothing! Is the simple answer. It is clunky and cost inefficient. Only an exponential increase in volumes could offset that sort of cost, and yet, because of Bitcoin’s hyperinflated asset price, volumes are on the decline in a real sense!

This is why the market is crashing today. Unfortunately, being a realist and not a fortune teller, I cannot tell you how low it will go, any less than I can forecast a sunny or a rainy day tomorrow without employing space satellite technologies to do so.

But, what I can tell you for certain is that, just like the rainy day clears the stuffy air, so will this sell-off make room for another round of crypto unit hyperinflation. Except this year, that hyperinflation will be much more distributed. As I pointed out at the start of this article, EOS, NEO, ICON and others such as Counterparty are gearing up to offer their own versions of the what the Ethereum platform is currently the only provider in the market for (effectively that is the case; I know, I know – there is Omni and others too. I may be getting old, but I am not disconnected from the real economy!) That will lead to a more distributed – and hence, elastic – process of market price appreciation in crypto.

And that is really something to look forward to, especially if you hold Ether. (Or by extension, a non-actively managed Ether-based derivative with quantitative underlying economic effects – that would be FUTR.)

Oh, yes.

About the author

Alexander Esmonde-White

Alexander Esmonde-White

Alexander Esmonde-White is Senior Chairman of the Futereum Foundation. He has over 25 years experience in proprietary trading, Prime Finance Solutions management and economic policy advisory. Esmonde-White trained at Barings Bank before going on to become one of the first pioneers of digital trading innovation while working on the London floor of Kidder Peabody & Co. as a core part of Joseph Jett’s European sales trading team. He occupied this place from the mid-1980s until 1992 when Esmonde-White left to form his own convertible arbitrage group within Bear Stearns. Following his official retirement in 2002, Esmonde-White remained an advisor to the bank until its demise in the subprime crisis of 2007/8. In 2005, Esmonde-White served as a senior economic advisor to Conservative leader Michael Howard in the ultimately unsuccessful conservative general election challenge against incumbent New Labour. Today, Esmonde-White sits on the board of 3 investment funds, which entails regular travel between time zones and not enough time for exercise!

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