Jim Chanos Is Out of His Depth Trashing Crypto Assets
Formerly a developer and director of software engineering, Andrew Rodwin is a crypto assets and blockchain trainer in the Boston area.
Add Jim Chanos to the list of venerable experts who consider cryptocurrencies to be a scam.
In a recent interview, Chanos says, among other things, “Cryptocurrency is a security speculation game masquerading as a technological breakthrough.”
Jim Chanos is an expert on financial fraud. He even teaches a course on it at Yale. But he is not an expert on cryptos. Neither is Buffett. Their cluelessness about the topic shows. In positing an argument, they subscribe to Huey Long’s rhetoric dictum “weak point: holler louder.”
At a high level, the flaw in their positions is: “I know finance, crypto is finance, so I know crypto.” Finance is one of many aspects of crypto. Treating crypto as “just another financial instrument” is naive. It’s not an equity. It’s not a commodity. While Chanos is not the only one guilty of misusing the term “cryptocurrency,” it’s still seriously misleading.
Not every crypto is a currency. Ethereum arguably isn’t. Cardano isn’t. Hundreds more aren’t. If he took the time to learn more about crypto before issuing sweeping statements, Chanos would use the generic term “crypto asset.”
Throughout the interview, Chanos makes a series of vague, misleading, unsupported contentions.
Chanos opens with a high-level description of financial fraud patterns. As he is an expert on that, and I’m not, I assume that what he writes on this topic is airtight. Once he veers into crypto, I no longer give him the benefit of the doubt.
After covering fraud patterns, Chanos makes the following logical jump:
“So today we’ve got bitcoin and ICOs [initial coin offerings], which went ballistic in 2017. I suspect going forward we’re going to see more and more evidence of questionable companies as this bull market keeps advancing and aging. We’re now nine years into this bull market, same as the ’90s, so I suspect that now things are starting to percolate. I think bitcoin and the ICOs are just one manifestation of that.”
Chanos is saying that 1) bitcoin and 2) ICOs fit the pattern of questionable investments typified by the tail end of a bull market. He doesn’t provide any detail of why they fit the pattern. They just do.
By the same logic, the world was flat because people declared it was flat. And by this argument, any new venture in the tail end of a bull market can be lumped into this category, shy of any analysis of why or why not it might fit the pattern. It’s a round hole, so it must be a round peg. In reality, it’s a square peg, but no matter. Hammer it into place!
Apples and oranges
Additionally, lumping in bitcoin with ICOs is sloppy at best. Bitcoin has been around since 2008. ICOs were not. And 2008 was … not a bull market, to say the least. The phrase “bitcoin and the ICOs” is an apple-and-orange fruit salad of meaninglessness.
And “the ICOs” is a hugely diverse set of projects. Chanos is correct that some, perhaps most, are questionable, as a recent Wall Street Journal article demonstrated. That doesn’t mean they all are.
When the internet took off, “the dotcoms” included Pets.com and Amazon.com. Lots of losers and some really big winners. If you wrote off the entire class, you failed to understand what was happening. Distinctions matter. Precision matters.
Separating wheat and chaff is a natural development in a paradigm shift. As Chris Burniske and Jack Tatar observed in their book “Cryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond“:
“[C]ryptoassets are not going through bizarre growing pains unique to them. Instead, they are experiencing the same evolutionary process that new asset classes over hundreds of years have had to go through as they matured.”
In writing about the interplay between financial and capital markets, Venezuelan economist Carlota Perez posited a similar dynamic.
Chanos then says, “At one blockchain gathering there were a set of rented Lamborghinis parked outside to entice the traders and day traders and retail investors: this, too, can be yours if you hop aboard the blockchain and bitcoin bonanza!”
Ah, the Lambo argument! (Thank you, Consensus 2018.) Yes. The rented Lambos were an epic fail. When a handful of spoiled traders choose to embarrass themselves flaunting symbols of conspicuous consumption, they’re easily lampooned. But it’s not relevant to whether cryptos are innovative or fraudulent, any more than Nikola Tesla dying a pauper reflects on the value of his inventions.
The idiots with the Lambos are not bitcoin. They’re just idiots with Lambos.
After a brief exposition on the relationship between government and fiat currency (which struck me as right on target), Chanos adds: “In the new bitcoin and crypto-craze, the whole idea is that we need to get away from fiat currencies by creating our own fiat currency for which there is no lender of last resort, no third party adjudicator.”
Well yes. And no. The whole idea with bitcoin (but not all cryptos) is to create a currency which governments and banks cannot screw up. As in Weimar Germany. As in 2018 Venezuela.
As far as third-party adjudication goes, that can be used for good or ill. China, for instance, uses financial control to punish dissidents. And look at Venezuela. And Argentina. Chanos only cites the good, not the ill. That really weakens his point.
But here is where Chanos really goes off the rails:
“For those who believe it’s a store of value in the coming apocalypse, the idea is that you’re going to have to safeguard your key under a mountain with fingerprint and eye scan security while the hordes are outside your bunker trying to get in to use it – for what, I have no idea. Because for those who believe that you need to own digital currency as a store of value in the worst-case scenario, that’s exactly the case in which a digital currency will work the least. Food would work the best! … And if you say, well, fiat currency is going to bring the world down, which could, of course, happen, then I say the last thing I’d want to own is bitcoin if the grid goes down.”
I’ve spent about 2,000 hours reading up on cryptos and never once saw that apocalyptic use case. Chanos apparently has crypto asset enthusiasts conflated with survivalists.
He also singles out one of the three aspects of money for which cryptocurrencies (a subset of crypto assets) are used: a store of value. They are also a means of exchange. For rhetorical purposes, the end-times store-of-value rant is catchier, but it’s not grounded in reality. Gold is widely accepted as a store of value that is outside government control, but its use is not de-legitimized if a tiny fringe hoards it in anticipation of Armageddon.
The other distinction Chanos conveniently ignores is that while an apocalypse may be a binary event, economic misery produced by failed governments is not. Witness, Venezuela. The people of Venezuela are not sitting in bunkers hoarding private keys, but they are using crypto assets to work around real, in-your-face, economic woes brought on by an inept government that badly mismanaged its economy and its fiat currency. Cryptos make their lives better, because the government cannot screw them up, other than by making a bogus national crypto that no one wants.
In this environment, yes, cryptos are valuable as both a store of value and a means of exchange. Even Jamie Dimon, not exactly a crypto fanboy, saw the value of bitcoin in a disaster like Venezuela. Just because we in the United States have not experienced this sort of catastrophe doesn’t make it less real.
Next, Chanos makes the common error of confusing pseudonymous with anonymous: “Bitcoin is still the area for people who are trying to avoid taxation or other examinations of their transactions. That’s one thing where I think it probably still has utility, but the governments have figured that out.”
Yes, the governments have figured it out, using tools like Chainalysis, and no, it is not the ideal area for people who are trying to avoid taxation. There are anonymous, not pseudonymous, cryptos for that, and the privacy they provide is not merely to avoid taxation: there are a host of reasons why people would want to keep their transactions private.
Cynics assume the only possible motivations for wanting transactional privacy are to avoid taxes, buy drugs, or launder money. Those are reasons. They’re not the only reasons. Anyone who knows anything about bitcoin is not going to use it (in the U.S. anyway) to dodge taxes.
Next, Chanos regales us with a story about the hassle an investor went through when trying to cash out his bitcoin. This is yet another blunder by Chanos, of the crypto-ecosystem-is-not-crypto variety. The aforementioned hassle, no doubt, had to do with exchanges trying to comply with government know-your-customer and anti-money-laundering laws.
Using that story to indict bitcoin is a huge reach, and reflects a fundamental misunderstanding of the boundaries of cryptos relative to their surrounding ecosystems. If your Facebook iOS app repeatedly crashes, you don’t replace your iPhone.
Right on the heels of that story, as if it justifies his conclusion, Chanos closes his crypto rant with “So this is simply a security speculation game masquerading as a technological breakthrough in monetary policy.”
There is no detail or analysis in the interview that justifies the conclusion Chanos reaches. And crypto assets are not a technological breakthrough in monetary policy. They are a technological breakthrough in building secure and private markets, relying on mathematics rather than counterparty trust, with transparent, immutable records not subject to a single point of failure.
But to Chanos, an expert on financial fraud, because some investors treat bitcoin like a speculative asset, and we are late in a bull market, and some morons choose to flaunt their Lambos, then bitcoin must be a fraud. That is not rigorous logic.
And this is the problem with the rants by these experts.
Buffett, Chanos, Shiller … all brilliant people, experts in their domain. But crypto is not their domain. They haven’t taken the time to understand it, but they weigh in as if they do.
Warren Buffett called bitcoin “rat poison squared.” Though late to the party, Berkshire Hathaway is now a big Apple investor. If someone stood up at a Berkshire Hathaway meeting and complained that Apple stock was rat poison squared, how seriously would Buffett take that position?
No one knows how all of this will turn out, of course. It’s entirely possible that Chanos and Buffett, et. al. are right about cryptos. They may turn out to be an utter failure.
But if so, Chanos got lucky. He could have reached the same conclusion by flipping a coin.
Chanos was lazy. He did no rigorous logical analysis, which requires an understanding of what you are analyzing, because while he understands fraud, he knows almost nothing about cryptos.
He’s famous, he has been right about many things, and he teaches at Yale, so in the eyes of journalists, he’s an expert. Maybe so on financial fraud.
But when it comes to cryptos, despite trying to sound smart, he’s willfully ignorant and lacking in humility.
Image via Investors Archive