April Fools: A Taxonomy of Shitcoins
By: John Lakness
Tags: ICO, Blockchain, Economics, Bitcoin

In the long run, crypto will win. It will overtake fiat, and it will be massively valuable. But not all crypto…. Here are some clues that a crypto token is probably worthless in the long run from an economic system perspective. This is not about speculation in the short run. It is also not about specific tokens, and I will not mention any.

Poor distribution

Why would anybody want to transact in a currency that only a few people have? One of the main problems with fiat is that a small group controls and holds almost all of it in their virtual vaults. Regardless, I don’t know of a single popular crypto that is even remotely as well-distributed as fiat. People are rioting all over the world over inequality, and you want to make it worse? That is not a recipe for the success of an economic system. Unfortunately, this seems like every creator and investor’s goal in crypto, to corner the asset for themselves and some small group of plutocrats. Sorry guys, it’s not going to work. You need the rest of the world to agree to your evil plan. They are your customers. Amazon didn’t go into business with a plan to screw over the world with high prices. Amazon went into business with the plan to screw over the plutocratic distributors with low prices to the people. More distribution of benefit = more participation = win. Less distribution of benefit = shit. Why? Because capitalism. Read Clayton Christensen’s books.

Pre-Mining

That which can be created overnight, is destroyed in the morning. It doesn’t take anything to start a pre-mined currency and make yourself into a shitcoin-denominated billionaire. But why would anybody want to join your stupid game where you win by default? Probably because they don’t know any better. A little pre-mine is maybe excusable, maybe necessary for the team, but seriously, look at a lot of the popular coins. It’s most or all of the entire lifetime supply in most cases. Shit.

ICOs

The ICO is a special kind of pre-mine with a very deceptive quality. It makes the creators and investors insanely wealthy, wealthy enough to manipulate the hell out of the market and still have plenty left over for their crypto lambo. Most of the time, there is some kind of ‘utility’ promised that doesn’t exist, and there’s really no good reason to think that it will exist with that particular coin. Usually the token promises some share of a crowdsourced utility that nobody has provided. Granted, if all goes perfectly, and the money is managed to extremely high ethical standards, they could use the money to ensure a strong market for that utility. Ha! Show me one ICO that guarantees this. No VC or angel investor in their right mind would ever hand a founder money with no guarantees that it is is used for the business they are investing in. That’s what you just did. Sorry bro, they don’t have one bit of fiduciary responsibility to you. Lambos all around, and you get nothing but promises. Is it possible to do a responsible ICO? Absolutely; financial disclosure and fiduciary responsibility is key here.

Overselling

If the token is for the next big killer app and it’s going to be worth a huge amount of money later, then why would the coin creator sell more than they need to? We’re now seeing ICOs in the billions. Nobody is going to use that much money to develop software. And if they do plan on making something that awesome, wouldn’t it be worth more later? Overselling is a sure sign of a shitcoin. If an ICO is oversold, it’s nearly impossible for the creator to develop a product that meets expectations. The smart thing to do at that point is to just sell all the coins that they hold, take the money, and buy a tropical island. It creates a massive moral hazard for the creator because there really is no incentive to act in good faith. Most importantly, there is absolutely no reason to raise that much money if they are committed to acting in good faith. In fact, they would be doing so against their best interests. A good faith actor will raise only what they need and tell everybody, prior to investment, exactly how the money will be spent.

Proof-of-Stake

As a fairly strong environmentalist, I’m as concerned about PoW as anybody. Proof-of-stake, however, is dangerously plutocratic, especially with a pre-mine. The person who has the most coins gets all the new coins, and determines the state of the network, including who gets to run transactions, and possibly even how many coins everybody else has. Go ahead and hardfork, Ha ha Ha ha Ha! Sure, it’s less wasteful, and I’m not 100% against this, as I could see it work with an exceptionally-wide distribution, given that proof-of-stake with a uniform distribution is democracy, which is often considered to be better than feudalism. Unfortunately, I don’t know any popular cryptos with even remotely wide distributions. Add a pre-mine and you have something approaching a self-ordained theocracy, where coin creators give themselves god-like powers that we all must obey. Sorry, but I don’t worship the living.

Monopolism

One of the strongest early signs of success for a coin is developer adoption. This is only sustainable, however if the coin is attractive to new developers that don’t have any coins. They have to be convinced that they can succeed on the platform, but some currencies are set up so that app studios with large holdings can easily crush a new developer. This is likely in the case of massive ICO, and especially if it is a proof-of-stake coin. Consider the worst-case scenario of a proof-of-stake coin where one studio pre-mined a large share of the total supply. Firstly, this gives them control of the transactions that run on the network. If anybody wants to develop an app on the network, they risk their transactions not being processed. Or, they can just copy the app. Everybody likes to shit on Facebook now, so I’ll safely say that they do this all the time, and there is no antitrust in crypto. But let’s say, best case scenario, that you are an amazing entrepreneur that can raise a huge amount of money for your project, and there is no proof-of-stake for the pre-miners to stop you. You have to convert that money to their coin anyway, which buys up all the float, and raises the price. Since they have so much of it, you’re actually raising more money for them than yourself. Smart developers know this, and will migrate to a different platform.

Trusted Third Parties

Some cryptos that represent assets require humans in the loop to provide it on demand. This is not by itself a problem. It becomes a problem when there is no aspect of the crypto itself that ties it to the provenance of such asset. Trusted third parties is one of the fundamental things that crypto set out to disintermediate. Further, there is another question about the chain of custody down to the original asset. In a crypto demand token for fiat, there shouldn’t be another layer of control placed on the crypto by nature of it being itself a demand deposit in some bank account. The entire point of crypto is that fiat will eventually fail. Now we have to trust two intermediates which the entire crypto ethos is in direct opposition to. Fiat-linked crypto should be through full-reserve banking with open records and the ability for anybody to audit the coin through publicly-available information recorded for immutability on the blockchain. None of this is hard.

Vaporware

The vast majority of ICOs present their status of development as much further along than reality. This is common practice in startups for public relations, but would be considered a crime in investor relations. Most of these networks have no intrinsic user-facing products or way to show that it works, so ICO ‘investors’ really have no idea what they are giving their money to. There is no investor-only confidential disclosure for an ICO. Every time I hear ICO fundraisers on a podcast, it’s like pulling teeth to get them to admit that their network isn’t live and working. Most of these ICOs will never have a product.

Ignorance

If somebody doesn’t know they are being deceptive, are they? I don’t think Elizabeth Holmes lied; I think she honestly didn’t know anything about the science that she was selling, although perhaps willfully so. There are a huge number of crypto creators that have zero clue what they are doing, and have no idea how hard it really is to figure it out as they go along, or worse, realize much later in the game that what they are doing is way harder than they thought. I’m going to call this one forgivable and even possibly necessary to doing great things if and only if they are open about what they know, open about what they learn, and have impeccable stewardship of the money raised.

Lambos

Invest in smart people. Invest in big thinkers. Invest in friends. Heck, invest even in dumb people that you trust. But whatever you do, do not invest in somebody else’s crypto lambo. If you see people screaming on stage about how rich they are getting on their crypto, before it’s actually doing whatever it’s supposed to be doing, it’s not a good sign. Why? Firstly, see ‘Overselling’, and secondly, because the people that they attract to their crypto are going to expect the lambo too. And they will sell out for the next scam as soon as they don’t get it.

Hacks

I can’t blame creators for hacks. They had good intentions, and then some nefarious actor took over. To whatever degree you might be concerned that a coin creator is in control of your network and has the ability to do bad things, you should be a lot more concerned that a bad actor will do those bad things. What if the hack is ‘fixed’? Well, look at how that was done. I have to be very careful here, but essentially, the forked solution that fixes the hacks can really screw over certain groups of coin buyers. For instance, let’s say that coins were all bought at different prices, and then refunded at the same price. The people who bought earlier at the low price were essentially endorsing the value for the later investors and then made huge returns on a failed product while the later investors who trusted them got totally screwed and lost money. This is all to deny the possibility of an insider hack, and although I doubt it for most of what I’ve seen so far, if you know anything about the infosec business, this possibility can’t be denied.

Taxes and Fees

This might be one of the most forgivable sins, and to some degree, at some level, it actually makes sense. A mining tax is when the coin creators take a percentage of the coins created using their software. It’s not a lot different than the 1.5% that VISA takes for every transaction on their network, which took considerable effort to build, allowed consumers to buy things without carrying cash for the first time, and is still in use today. Nobody screamed foul at the time, although 1.5% does seem outrageously high today, which is one of the reasons the crypto revolution started 10 years ago. On the other hand, some crypto mining taxes are way higher than that, and I have reason to believe that they’d be doing a lot better with lower fees. If VISA had charged 10%, they wouldn’t be around today. Granted, that fee is not equivalent, but If a crypto charges too much, neither will it.

Scalability

If an economy can’t be built on it, and it has no intrinsic value, it’s basically worthless. If the blockchain can’t support the necessary number of exchanges, or the characteristics of the exchanges that are demanded by the economy that supports it, it won’t work. Right now, the economy that supports these coins is the exchange of potentially-valuable hype for eventually-worthless fiat. This market is extremely sparse compared to everyday commerce. I’m not saying that it has to record every financial transaction in the world, but it has to support whatever set of exchanges that will give it value.

Inflation or Scarcity

This is harder to judge because I don’t think anybody really knows the right level of supply for a currency. One theory is that supply should meet demand at the point at which prices remain stable. Price stability, however, is affected also by technological deflation via productivity increases, and demand growth from population growth and increased consumer expectation. Nobody has the answer here. Some people want maximum economic participation, and some people want maximum hodling potential. But regardless of what your objectives are, the rest of the world has to somewhat agree with you because none of this crypto has any value at all if you can’t exchange it for goods and services. Go too far in either direction and the productive people that you have to buy from will abandon it.

Pump and Dump

I don’t want to say much about this, and I don’t know much about it except that it exists, and there are people everywhere trying to take advantage of you. A common scam is when the scammer invites you into their inner circle to pump and dump on others but you are the real mark. You lose your money and your reputation and your friends. Even if it’s not a full-on scam, you have to realize that this market is full of people that don’t care about you or your reputation, or any ideals of crypto at all. Take care of your integrity; it’s worth more than money.

A future you believe in

Think about what kind of world you want to live in. Some of the hope of crypto is that you really can live in that world, so long as it is economically sustainable and desirable to the people that you need to participate in it. In fact, one of the big hopes is that we can all operate within the economic system of our choosing without anybody forcing it upon another. So think about the economic system that you will live in, and consider whether the currency has a place in that world. If it has no place, the value to you will be zero. If everybody chooses to invest in, support, and transact in the coin that represents the economic system that they would want from the perspective of the people that they would share it with, then there’s a good chance we’ll get it. No guarantee that will happen, but a currency that everybody wants less than fiat is probably worth nothing.