Crypto is a wood chipper

I'm sorry but it's true

Will Wilkinson is out with a post about whether crypto is bullshit. His conclusion: it’s not. Most of the post is about the epistemic problem of knowing what to believe when lots of people you respect disagree. Towards the end, however, he talks a bit about how crypto works, its uses, and why he believes crypto is actually the way of the future:

In my opinion, a technological/economic/institutional architecture that can coordinate economic activity in a way that makes the firm superfluous, deconcentrates ownership and control over vital networks, and broadly distributes economic surplus to network participants according to transparent, fair and relatively fixed rules, is the killer app. This can hard to see because the principal value of the underlying technical innovation is economic, organizational, and, ultimately, political. The consumer-facing technology that can be built on top of is genuinely exciting, but secondary.

There is a problem with this argument, however: there is no economic surplus to crypto. Because crypto is a wood chipper. A very, very energy-inefficient wood chipper, into which society regularly feeds valuable computer parts — an almost wholly wasteful endeavor that takes real resources and turns them into dust.

Why?

Mostly so that people can gamble.

I won’t go into the precise details about how crypto works, because Will covers that in his post. Suffice to say, it’s a way of using distributed computing power to verify that a transaction took place without us needing to place our faith in an authority figure (a bank, the Federal Reserve, whatever) to maintain a ledger on our behalf. One could imagine how that might be valuable.

But we all know that, by and large, crypto is not used as a revolutionary way of transferring money from one person to another, or keeping track of who owns a piece of digital art. For the most part, crypto is treated like a financial asset. People buy crypto like it’s a stock — they purchase it hoping for a return in the form of capital gains. And that’s a problem. Because while some people do indeed make capital gains, their capital gains are fully offset by someone else’s capital losses, and keeping the transaction machine running requires loads and loads of computer equipment and electricity.

To see why this is a problem, let’s think about how financial investments are supposed to work, starting with the simple case of a person making an investment with their own real resources. Suppose a farmer has some seeds that he can either eat or grow. Any seeds he eats today he gets to enjoy, but any seeds he plants will turn into more seeds in the future. In other words, he faces the choice between consumption (eating the seeds) and investment (planting the seeds). The latter requires giving up some consumption now (saving) in order to get a real return (the additional seeds he gets from growing).

At its core, this is really all there is to investment, even the sort of complex financial investment that typifies the modern economy. Say I buy a bicycle company’s newly issued bond. When I buy the bond, I give up currency that I can spend today in favor of an asset that cannot be exchanged for current goods and services. By giving up the currency, I am, in a very literal sense, freeing up real resources for the company to use. And the company, in order to pay back the interest on the bond, will have to turn those real resources into more real resources in the future, by (say) buying a bunch of steel, rubber, and other physical capital with which to make bicycles. Only by selling those bicycles can the company hope to return the financial investment.

Notice that, once you net out everyone’s contribution, this is no different from the simple farming example above: one person surrenders their claim to present resources (for consumption) in order to get some greater amount of future resources, and that claim to future resources is accommodated by the additional real goods and services that were produced by the real, physical investment of those forgone present resources. In other words, the financial investment had a corresponding real investment with a real return. That real investment made all of us richer, and the person who saved was compensated for their deferred consumption.

And this, ultimately, is the problem with crypto: an investment in crypto has no real return. It may have a financial return for some people — some people will successfully guess the market psychology and sell while the “asset” is priced high. But whatever capital gains on person makes will be fully offset by someone else’s capital losses. The game is zero sum. And once you net out all of these zero-sum capital gains and capital losses, all you have left are the resources you needed to keep the trading machine alive. That is, all that’s left is the computer equipment and electricity that is consumed to verify all of these transactions.

In other words, all you have is a massive, electricity-hogging wood chipper. One that keeps eating all of our goddamn graphics cards.¹

1. It’s worth noting that some more recent crypto systems use what’s called a “proof of stake” system, instead of the “proof of work” system of Bitcoin. Without going into detail, it dramatically reduces the cost of keeping the machine going. But while the costs are lower, they are still non-zero, and so the argument still holds. However low the costs are, once you net out the perfectly offsetting capital gains and capital losses, they are still nonzero.