OT Nicholas Weaver on Cryptocurrency

Why This Computer Scientist Says All Cryptocurrency Should “Die in a Fire”.

UC-Berkeley’s Nicholas Weaver has been studying cryptocurrency for years. He thinks it’s a terrible idea that will end in disaster.

Warning: If you are a big cryptocurrency investor, you will need a strong stomach to read this.

In comparison to Weaver, Munger is polite and circumspect when opining about cryptocurrencies.

https://www.currentaffairs.org/2022/05/why-this-computer-sci…

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I wonder if a giant crypto meltdown will be the catalyst that takes the entire market down to 2008-9 levels. Hopefully it’s not so fully intertwined into the financial system where an across the board crypto meltdown could cause a systemic market failure, but I suppose it’s possible.

I agree with the article (and Charlie) and think it all needs to go away, or at least get seriously regulated like everything else, before it becomes “too big to fail”.

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John Oliver:

“Cryptocurrency: Everything you don’t understand about money, combined with everything you don’t understand about computers.”

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I was struck by Weaver’s comment:

You hear about people making money in Bitcoin or cryptocurrency. They only make money because some other sucker lost more. This is very different from the stock market.

I’m a savvy investor, and by “savvy investor,” I mean I put my money into index funds and ignore it for several years. During that time, there are dividends and share buybacks where the companies put their profits into me. I then eventually sell it to somebody else. And my gain is not just the difference between what I bought it for and what somebody else bought it for, but that plus the benefit of all the dividends and interest.

I guess we’re just not savvy enough as BRK owners.

And my gain is not just the difference between what I bought it for and what somebody else bought it for, but that plus the benefit of all the dividends and interest.

I guess we’re just not savvy enough as BRK owners.

To make that comparison, you have to add a small clarification:
the value of something is a direct function of the coupons and distributions it could pay in future, not the coupons it does actually pay.
It would be silly to follow the reverse reasoning to its conclusion that Berkshire has no value because it pays no current coupon.
Berkshire’s value isn’t really altered much by the decision whether or not to pay a dividend this year or next.
They certainly could, which is the bigger observation.

So, if you take his words to include that broader definition, it’s pretty good reasoning.

Some stuff produces nothing. Purely capital goods have no value beyond what the market thinks at the time,
determined entirely by supply and demand for that static asset. Paintings, gold, whatever.
They aren’t worthless, but the worth is only the market value worth. They’re zero sum games, as far as making a profit is concerned.
Absent a rise in demand (which is always bounded and generally transient), they offer no prospect of making money for the holder.
Every dollar made by one person is a dollar lost by another.

Other stuff produces income. Businesses, bonds (usually!), stocks, farms, and so forth.
Their value is a real thing, not a function of supply and demand for the financial asset used to hold them.
A machine that spits out a genuine dollar bill every hour forever has a value quite separate from
the current market price of that machine, and does not even depend on there being a market value.
Somebody holding that asset over time will make a profit, with or without a greater optimist to whom to sell it later.
Even if the machine sometimes stacks up the bills internally for a while.

Jim

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A machine that spits out a genuine dollar bill every hour forever has a value quite separate from
the current market price of that machine, and does not even depend on there being a market value.

I’m intrigued by this thought exercise, but I’m getting hung up mentally by it.

In this scenario, wouldn’t we expect the market price for the dollar printing machine to reflect the net present value of all future dollars-to-be-printed over the life of the machine (which collective market participants would be attempting to estimate)?

So in this sense, wouldn’t this machine’s dollar printing ability already be factored into the current price, such that a person buying the machine today would earn little in excess since the collective market participants had already run up the market price to a level representing its income producing potential?

And If so, wouldn’t outsized/excess returns only be available to the person who can better forecast the machine’s lifespan?

But then, isn’t that what someone buying an asset like gold is also trying to do - forecasting, just in this case, instead of the machine’s lifespan, the future price movement of gold as an asset?

This then leads me to question why investing in the dollar printing machine is better than investing in gold, which defies all preconceived notions I have about income producing assets being better…

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I had read this article before and think it is great. Love how he takes down Elon Musk. Also, some pithy quotes…
Cryptocurrency: teaching libertarians about market failure since 2009

Great stuff,

Smufty

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A machine that spits out a genuine dollar bill every hour forever has a value quite separate from
the current market price of that machine, and does not even depend on there being a market value.

I know that he does not consider my following questions to be germane, but to me this thought experiment is incomplete without more information:

  1. How much does it cost to build this machine and can anyone build one in their garage?
  2. How much does it cost to operate and maintain this machine – there must be some friction so wear would require repairs or replacement – can any machine run forever without maintenance – does it cost more than $24 a day to operate it?
  3. How many of these machines are there and how many people have one of them?
  4. Are there also machines that print out fives, tens, twenties, fifties or hundreds at a much faster rate, say, one per minute – bigger and better printing presses in every home?
  5. Even if these are genuine dollar bills, can congress, if it so choses, still refuse to define them as legal tender?

Without answers to my above questions, and probably a few more as well, I would say that the machine has a value of zero (just like the eventual value of the cryptocurrencies).

But, how do I square all this with what Buffett has taught: that the value of any asset is the net present value of all future free cash flows? It seems as if he is claiming that the value of the free cash flows of an asset has no relation to the market value of the business that produces those free cash flows. I don’t get it.

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It seems as if he is claiming that the value of the free cash flows of an asset has no relation to the market value of the business that produces those free cash flows.

Absolutely. You got it.
Price and value are different things.

OK, I guess “no relation” is a bit strong.
Market value is very weakly attracted to, and generally passes through, fair value at least once every few years for most assets.
Though every investment asset has a true fair value, it’s often not known precisely in advance…
I find that the things with the most vague evidence for their ultimate actual values tend to be the things that trade strange prices the longest.

That’s not to say there aren’t good opportunities among the things that are wildly hard to value.
But the bigger the uncertainty, the bigger the margin of safety you ought to ask for.

I don’t get it.

Seems you did! : )

Jim

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adding a bit of levity to this topic,
this from John Oliver over 4 years ago…

https://www.oohlo.com/2018/03/12/everything-you-dont-underst…

ciao

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I was reading the comment with an understanding (clearly a misunderstanding) that he meant some kind of rational price, not just some random day’s price (even though he said current market price). If all that is being said is that the value of an asset and its market price are two different things, why does that even need to be said – that is what the whole world of value investing is all about, whether on the Berkshire board or Saul’s board. I thought he was trying to say something profound (which escaped me) when all he was attempting was to state the obvious. My bad.

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I thought he was trying to say something profound (which escaped me) when all he was attempting was to state the obvious.

I think it is quite profound. And I think there are plenty of people out there who don’t understand it, so it is not so obvious (or perhaps we have to ask, “obvious to whom?”)

One insight I think has a lot more power than I have extracted from it: consumer surplus. When I buys something from B, generally the thing has two values that are important because the value of something is not the same to everybody. In an efficient investment market this is way less obvious because there is a sort of consensus on how to value investments. But still, on the day you sell me a share of BRK.B, that share is worth less to you than it is to me, and its price that day is between our two valuations.

Even in the case of investments, DCF is the value, right? But at what discount rate? And who’s prediction of future cash flows are we using? And how do we deal with the FACT that the future is always uncertain (at least until it becomes the past)? Buffett uses relatively low discount rates but demands a margin of safety, which means compared to people who use higher discount rates, Buffett is likely to be a buyer of things with greater future payouts and lesser near term payouts. This is just math, lower discount rates value future earnings much more highly than higher discount rates.

So every trade, investment or not, reflects a different value of the traded asset to the seller and the buyer. I guess it could be that the biggest cause of difference in valuation is error on the part of at least one of the parties to the transaction, but there is also an input to using different discount rates and margins of safety in valuing assets that can produce a difference. Presumably as a Saul investor I am using a higher discount rate and a lower margin of safety in my trading than those selling me Saul stocks so they can buy value stocks.

Another consideration, if I buy a Saul Stock tuesday and sell it 3 weeks later for 20% more than I bought it for, then the cash flows turned out to be an outflow of Price on tuesday and in inflow of 1.2Price 3 weeks later. At most reasonable discount rates, selling it for 1.2Price so soon discounts to pretty close to 1.2*Price on the day I bought it for Price. DCF doesn’t tell you the cash flows have to arise from the business operation or decisions by the company to pay dividends. All it says is cash has to flow. I think it is fair-ish to define the Business Value as the DCF value to someone who holds the stock forever, and that this is a very relevant consideration in attempting to predict what even stock trades might yield in terms of cash flows.

I don’t even know how we are supposed to determine our discount rate. Do we rank order the IRRs we are offered in the market, and then our discount rate is the lowest IRR we buy before we run out of cash?

Anyway, none of this seems obvious to me, and certainly not obvious to many participants in the market. A ton of casual participants don’t even seem to think it is relevant that stocks represent ownership of a business, their entire consideration is are people saying it is going to make you money or not?

R:

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