The missing link: the supply side of cryptocurrency
Clay Wilkes, Galileo Processing: make no mistake, crypto is here to stay
Supply and demand are the bedrock of market-based economics. To achieve economic equilibrium, supply and demand must be in balance. If one is too high or too low, the system is in a state of disequilibrium, associated with inefficient allocation of goods – not a healthy state.
It’s easy to think about supply and demand in terms of what our microeconomics textbooks used to call “widgets”. But, the law of supply and demand applies to intangibles, too. Everyone knows the example of the stock market. The value of stock is what someone is willing to pay for it, so when demand is high and supply is low, stock prices rise; when the situation is reversed, stock prices fall.
A more topical example is Uber. Uber fares rise and fall with rider demand and driver capacity. When ride demand outpaces supply, Uber’s “surge” pricing corrects the imbalance. Other digital age companies – like Airbnb, Task Rabbit, Craigslist and more – also use dynamic, supply and demand-based pricing to create what economists call “efficient” markets for their services.
The law of supply and demand also should apply to the cryptocurrency market. But today, it doesn’t. We see this disequilibrium in the radical swings in cryptocurrency value, which – while benefitting those who bought Bitcoin, for example, in the $800s earlier in the year and have ridden the rollercoaster to its current $10,000+ value – make it a poor currency replacement.
Cryptocurrencies’ state of disequilibrium: it’s all about demand
Think what you like about cryptocurrencies, but the genie is out of the bottle. There has been too much investment and growth for cryptocurrencies not to be a part of the future of payments. One estimate puts VC investment alone in cryptocurrency start-ups at about $2 billion, and that doesn’t include funds raised through initial coin offerings (ICOs). Last quarter, the cryptocurrency exchange Coinbase achieved unicorn status by closing another funding round, giving it a $1.6 billion valuation.
Moving forward is inevitable, but there are three key factors keeping cryptocurrencies in a state of disequilibrium and, therefore, not benefiting from an efficient allocation market.
- Scale
According to Coinschedule, token sales in about 140 initial coin offerings have topped $2 billion this year. With “at least a few ICOs typically beginning every day”, some predict the yearend number could be as much as $4 billion.
However, despite tremendous growth, cryptocurrencies haven’t yet scaled to achieve price efficiency; i.e., the marketplace has yet to mature. Referencing an example above, Airbnb, in its startup days, experienced significant housing mispricing until there was sufficient supply to make its pricing efficient.
The immature market also introduces confusion and adds to the speculative environment of cryptocurrencies.
And, ironically, there’s a flip side to the coin involving too much scale; that is, the ability for the underlying blockchain technology to efficiently handle even relatively small number of transactions is well known.
- Rational investors
Efficiency assumes rational investors, but we can’t, in my opinion, assume the bulk of today’s cryptocurrency investors meet that criterion. Reasons for investing in (or buying) cryptocurrencies are varied. Some are lured by get-rich-quick possibilities, some by the cool factor and some by the opportunity to transact virtually anonymously.
I don’t believe we can yet say that the bulk of cryptocurrency investors are acting on their belief in the need for a universal currency without regulation or oversight by a sovereign nation or central bank, or on their need for a faster, more cost-efficient way to transact – in other words “rational investors.”
- Absence of “sellers”.
Without a critical mass of merchants and other payments recipients that accept cryptocurrencies and convert those cryptocurrencies to fiat currencies (i.e., “sell” the cryptocurrency to run their businesses), the cryptocurrency market remains a one-sided demand market. Again, this fuels a speculative marketplace characterized by big run-ups and drops in valuation. This is not a stable way to sustain a currency in which value can be exchanged for goods and services in a predictable way.
In sum, in its current state, today’s cryptocurrency market is asymmetrical. It’s all about demand. And, that asymmetry means the cryptocurrency market is, for the average person, illiquid – cryptocurrency exchanges, which are slow and expensive, notwithstanding.
Unlocking liquidity through a more efficient cryptocurrency market
The clearest path I see to greater cryptocurrency liquidity is unlocking the available supply to promote scale and, over time, attracting more rational investors – leading to a cryptocurrency market that approaches equilibrium and is, therefore, more efficient. By unlocking available supply, I don’t mean creating more coins. I mean actually using cryptocurrency as currency; thereby increasing its velocity or the rate at which value is exchanged from one transaction to another.
The key to this approach is encouraging and supporting major retailers and other high-volume acceptors of payments, like utilities, to accept cryptocurrencies. If these types of businesses are paid in cryptocurrencies, they will convert these payments to dollars so they can then pay their suppliers. (In time, they may make these payments in cryptocurrencies.) This unlocks the supply side, with the added benefit of a multiplier effect throughout the supply chain.
This is easier said than done, of course, but it’s clear that retailers and other high-volume payments acceptors are the key because of the current disequilibrium between cryptocurrency supply and demand, and the consequent lack of liquidity. Those of us in payments are in a unique position to support these payments acceptors – along with the current and yet-to-be-created cryptocurrency exchanges – to create a gateway between the existing financial world and the financial world that is evolving inexorably to virtual money.
Creating gateway products
A product that enables consumers to deposit in USD; buy, sell and hold cryptocurrencies; and transact in USD or cryptocurrencies is a powerful product for the current state of the market.
Make no mistake, barring massive political or regulatory interference, crypto is here to stay and is the next great frontier for payments.
By Clay Wilkes, founder and CEO, Galileo Processing
