This is an impromptu commentary arising from my reading of the interesting Seeking Alpha article titled “The Next Bitcoin? Take A Hard Look At IOTA” by Quad 7 Capital. I posted a comment to the article with questions about what exactly is IOTA’s value proposition. Some of the reader comments on the article helped me but I still wanted more so I did some more digging and thinking. My commentary below is driven by trying to understand the cryptocurrency phenomenon and the macro-economic implications of the distributed ledger, and “block-chain” or “tangle” type technology as it relates to money.
Background: Bitcoin observations
Bitcoin is the first cryptocurrency that uses block-chain technology and a distributed ledger system to allow individuals to collect and use digital tokens to conduct transactions, and that has obtained extreme notoriety. The hype around Bitcoin and increasingly popular alt-coins and me-to-coins does not appear to match up with actual foreseeable durable practical utility as money. Sound money (currency) should be a stable store of value and efficient unit of account for transactions. So far, the promise of “naked” cryptocurrencies  such as Bitcoin do not appear to fit the bill for a new sound money system. Note, those that subscribe to the conventional economic orthodoxy probably are going to have trouble seeing the value of any cryptocurrency system that is adopting sound money principles. Some folks simply are not able yet to acknowledge that current centrally planned monetary policies may be damaging and a significant reason for the cryptocurrency phenomenon.
What I find important about the Bitcoin phenomenon is that it is based on the fundamental human desire of some to innovate and to be free; to be free of financial repression; to be free of financial repression by a sovereign authority . However, the Bitcoin phenomenon appears to have morphed into a speculative mania divorced from economic and practical reality.
My sense is that the current Bitcoin phenomenon is now driven mostly by a speculative greed-based “greater fool” theory and “fear-of-missing-out” (FOMO). It currently is not about more efficient resource allocation or productivity, but rather is essentially an open Ponzi-like scheme where players all believe they are smarter than most of the others; and/or where the players believe they will just get lucky regarding timing for bailing out when there is a loss of confidence. The price of Bitcoin right now does not appear to be linked to a durable commensurate inherent utility of Bitcoin as a unit of account for conducting most transactions or as a long-term store of value. The Bitcoin speculation mania is driven by a positive feed-back loop reflexivity meme. Despite the flawed, unrealistic, fictional aspects of the narrative around Bitcoin there is enough of a resonating message that is reflexively driving the Bitcoin price up. The danger is that many speculators that get into Bitcoin will become addicted to or trapped in this “asset” via powerful psychological confirmation bias when price goes up and/or incapacitated by cognitive dissonance when price goes down.
What is an IOTA token?
The IOTA token is supposedly a layer of crypto technology (naked cryptocurrency) that sits on top of a base technology platform involving the IOTA tangle distributed ledger. The value proposition of the IOTA token is that it allows a user to conduct transactions on the IOTA tangle distributed ledger that assertedly has benefits over other block-chain distributed ledger systems (see above reference SA article). The IOTA user can be a human but for now is mainly autonomous IOTs (“internet-of-things” machines) transacting peer-to-peer transactions. The IOTA platform is designed to allow users to trade IOTA tokens or create their own non-naked tokens and trade the same. The concept of non-naked cryptos trading on a distributed ledger system is very interesting but beyond the scope of this article.
The IOTA token (cryptocurrency) is not a block-chain token and therefore is not created by mining a block-chain. All of the IOTA tokens have been created at inception with the “genesis” transaction site in the tangle ledger. The IOTA platform is based on a distributed “tangle” ledger that is different from a block-chain ledger system. The IOTA tangle ledger was created (started) with a genesis transaction site, that distributed all the tokens at inception to a number of founder site addresses, that then have been expanded upon by users to create the IOTA tangle ledger. Therefore, the activity of users of the system propagates the tangle distributed ledger without fees or miners, or creation of new tokens.
To propagate the Bitcoin ledger miners need to be induced to do computational work, by payment of fees paid in Bitcoin units. One of the problems with the Bitcoin system is that as more people use the system the slower it gets (the scalability problem) and the higher the fees become to process a transaction. In theory the IOTA distributed tangle ledger gets faster (and more secure) as more people use it. The cost of using the IOTA ledger to process a transaction is the cost of the user’s computational effort to verify two randomly selected existing prior tangle ledger sites (transactions). IOTA can be thought of as a flexible cooperative work-to-play platform that enhances the overall value of the system, via second order type network effect, that is the tangle ledger becomes more valuable because it is more secure.
IOTA may have superior utility to a Bitcoin (or other “naked” block-chain) cryptocurrency system because of its proposed costless scalability, among other proposed benefits. IOTA arguably could eclipse Bitcoin as a cryptocurrency because of IOTA’s superior utility for more efficiently processing transactions. My guess is that there are many value propositions that can be (will be) proposed that are based on a network effect, but it does not mean that the system will ever get adopted or displace an existing system/network effect. In any case, as we have seen from Bitcoin price action, there are crypto speculators that do not really care about fundamental practical utility of any specific cryptocurrency.
Right now, the cost of Bitcoin goes up because it becomes more costly to mine Bitcoins as more people mine Bitcoin (because of price escalation reflexivity in connection with the hashing algorithm), and not because more users use Bitcoin to conduct routine transactions. For IOTA tokens there is no cost of production because all the tokens already exist. The cost of IOTA is front loaded and deferred until dilution occurs presumably when the IOTA system founders cash out their stash of undistributed tokens. Bitcoin also has the problem of future dilution from dissemination of a large hoarded stash of tokens that were mined early on at very low costs when the crypto was created. Value of IOTA tokens are linked to the increased utility and become more valuable from first and second order network effects.
It seems to be a stretch to assert that currently Bitcoin value is associated with a true “network effect”. Bitcoin price goes up not because of enhanced use of the system for transactions, but rather because the price trend is steeply up at the moment and FOMO creates speculative demand. The concern for investors is that Bitcoin demand will vanish when speculators are tapped-out and/or lose confidence. There does not seem to be a sufficient base level of competitive practical utility for Bitcoin that will support any value proposition for Bitcoin when speculative price appreciation disappears, and users migrate to the numerous more utilitarian alternative cryptos or other tangible stores of value.
Unanswered questions about IOTA
What still is not clear to me is how the original finite pool of IOTA tokens is distributed and marketed to the public; or what prevents expansion of the pool in the future. And who stands to gain from the selling/distributing undistributed tokens. Also, there does not seem to be a reasonable simple direct trusted system for obtaining and holding IOTA tokens yet.
The above referenced Quad 7 Capital SA article does not explain how token distribution works beyond the genesis transaction, and does not explain how distribution will (or will not) benefit early or new adopters versus providing windfall gains to originators of IOTA. I reviewed the Popov/IOTA white paper and could not find relevant answers to my questions. Here is an excerpt of what I did find (at page 2):
For those readers who are interested I found what appears to be an IOTA video presentation that provides some additional interesting information but also it did not answer my questions.
After writing this article I found a good SA article titled “IOTA – IoT Capable Technology And The Alternative To Blockchain” by Keyanoush Razavidinanithat provides a more technical comprehensive explanation of the block-chain in comparison to the IOTA tangle ledger. Also, the following excerpt from Razavidinani provides interesting comments on how the founder-pool of IOTA tokens may be distributed in the future.
As soon as official partnerships are announced and new investments into IOTA will be declared, a redistribution of IOTA tokens will begin, having major influence on the price. As stated before, all tokens have been mined and at the beginning only a few addresses contained the majority of tokens. It is interesting to follow the distribution of tokens, because one of the main conflict points of anyone reading this may be that the developers of IOTA make a big profit on their IOTA tokens selling them on the market. The market is trading with a fraction of available tokens and distributing all tokens once may seem illogical adding high amount of liquidity and devaluing the token.
Until there is clarification and dissemination of information by IOTA there will be uncertainty about the enterprise, investment risk and the taint perhaps of a Ponzi-like scheme.
The cryptocurrency revolution
The cryptocurrency phenomenon seems crucially linked to the recognition of the power and utility of block-chain and other distributed ledger systems that solve the double-spending problem. Another important driving force is the desire by many to be free – to be free of something – what that is specifically I will leave up to the reader to ponder. The cryptocurrency revolution is giving hope to the idea that via innovation there might be a way to secure a better more equitable, efficient and durable currency system based on sound money principles.
From time immemorial sovereign authorities have resorted to debasing the existing money supply – as a way of expropriating and redistributing wealth from the public . The 2008 financial crisis was a very notable benchmark in exposing what some view to be extant whole sale massive combined governmental and institutional fraud in furtherance of the status quo. The rule of law and legal liability was effectively suspended as it relates to the “too-big-to-fail” financial players. The cryptocurrency revolution appears to be driven in large part by the sentiment that the powers at-be “saved the system” by simply papering over the problem with more printed easy-money.
If IOTA is to attract investors, it probably needs to articulate a clearer value proposition and a logical mechanism for action and adoption, that taps the human desire for freedom, liberty, sound money, and free-markets, and eschews the Ponzi-like modus operandi. An IOTA narrative needs to be compelling, simple and inexorably resonate both cognitively and viscerally with a broad spectrum of stakeholders, and goes beyond simply extolling how great it will be to have autonomous internet-of-things (IOTs) all seamlessly exchanging cryptos while babysitting humans. Just to be clear I think IOTA presents some very interesting concepts and I hope to learn more about how it might work as a practical investment opportunity.
1 A “naked” cryptocurrency as used in this article denotes a crypto that is not linked to tangible property rights or other exogenous bundle of legal rights.
2 The point of this article is not to debate whether there is or is not “financial repression” or debate the mechanism of action for such repression or explain the cause of the same. The intent is to identify that there is a public sentiment about “financial repression” and that it is a perceived reason for the cryptocurrency phenomenon. Obviously, the term “financial repression” might be viewed as unduly pejorative by some who believe in the conventional current economic theories and/or want to maintain the status quo monetary policies – that the organic cryptocurrency revolution might disrupt someday. Identifying and understanding the potential fundamental driving forces behind the cryptocurrency phenomenon is critical to assessing specific value propositions proposed by Bitcoin, IOTA or any other disruptive technology, and the investment potential therein for an investor.
3 I believe the extant debasement of currency is a problem (this is not a novel concern or concept). My concern is that debasement of the currency can result in inefficient resource allocation, unproductive consumption, an inequitable wealth gap, price inflation/stagflation, and/or currency collapse and a financial system reset, but this is beyond the scope of this article.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.