This is the third entry in my “Tech for CEOs” series. I’m analyzing topics that meet three criteria: 1) They’re in the news; 2) they’re frequently misunderstood; and 3) CEOs need to understand them.

My two previous posts are on AI and blockchain. Now, as promised, cryptocurrency …

What It Is And How It Works

Cryptocurrency is a digital coin that exists only in a computer program. That program is designed by, controlled by, and can be changed by human programmers. While the coin and its trading database (a blockchain) are protected with hard-to-hack cryptographic techniques (hence the “crypto” in cryptocurrency), the digital coin isn’t guaranteed or regulated by any official authority. If the humans who built the program want to change the rules to their advantage and to the disadvantage of market participants, they can.

While you can trade the digital coin, this isn’t money. Some merchants will allow customers to pay for goods using cryptocurrencies, but they’re not widely accepted, and the majority of merchants use service providers to convert the coins into fiat currency before they receive their payment. If you owned all the bitcoin in the world, you’d have nothing. In this sense, cryptocurrencies are speculative assets, more akin to tulips than to a productive commodity.

What Happened

On the cover of the August 2022 edition of Fortune, the visage of Sam Bankman-Fried beatifically beamed forth: “the next Warren Buffett.” That was the top of the cryptocurrency market, and it’s been an ugly slide through crashing prices and US Marshals since then.

Two questions stand out: “Why did the bubble get so big?” and “Is there a future for unregulated digital coins?”

The market was and is driven by three powerful forces: greed, youth, and technology. People were getting rich, and that drove interest and irrationality. A lot of those getting rich trading crypto were young and, in the eyes of many, undeserving, which drove more irrationality. Finally, the technology underlying digital coins is opaque and esoteric — meaning that most market participants had no inkling of the risks, limitations, and dynamics of the currency. When you have greedy, inexperienced, ignorant buyers in an unregulated environment, the stage is set for fast, unquestioning growth.

In addition, the market was propped up by an unlikely but passionate cabal. It consisted of techno-utopians, grifters, Redditors, paid celebrity sponsors, venture capitalists, libertarians, and “you don’t get it” billionaires. And of course, in their eternal quest to drive the dopamine of its readers, a mostly uncritical, cheerleading media (more on this in a future post).

Currently, there are three applications for cryptocurrency: 1) financial speculation; 2) extra-legal payment activity; and 3) substitution for unstable fiat currency. Unsurprisingly, the highest per capita ownership of cryptocurrency is in Thailand, Nigeria, the Philippines, and Turkey.

So, is there a general-purpose, productive future for crypto? No.

What It Means

  • Don’t confuse blockchain with cryptocurrency. There will be valuable, though limited, roles for blockchain in the future as a means of enabling untrusted parties to trade in trusted ways. Your company will implement blockchains in the near future for good purposes.
  • Crypto poses myriad accounting problems for banks and public companies. This is the reason why most companies use third parties for their non-fungible token (NFT) initiatives.
  • Don’t confuse unregulated, floating cryptocurrency (what this blog post analyzes) with regulated digital coins from trusted, certified institutions (e.g., governments, banks, or transparent public and private companies). There’s an important future for the latter.
  • Cryptocurrency increases risk to your company. If your company is associated with unregulated digital coins, it will take a brand hit when the next inevitable cryptocurrency crises arrive. And your financial risks will widen if you hold the asset or associate with other entities that hold the asset. You may not be Silicon Valley Bank, Silvergate, or Signature Bank, but an association with those and other crypto-exposed firms increases your risk profile.
  • Cryptocurrency is a threat to the traditional, boring, but necessary financial underpinnings of societies and nation states. Policymakers should aggressively firewall crypto off from the foundational banking and financial institutions that business and citizens depend on to transact, save, and invest.

One of my favorite business stories is from the 2008 financial crisis. In 2006, the young VPs of one of the large Canadian banks recommended to the CEO that the bank should move into the securitized subprime mortgage business. The bank invited Goldman Sachs, Morgan Stanley, and other investment banks to present to the CEO and his executive team. After a day of listening to the bankers extoll the advantages of making a market in the asset, the VPs asked the CEO if the bank would take a position. The CEO stood up and said, “No.” When his team asked him why, he replied, “Because I don’t understand it,” and he walked out of the room. That one decision kept the bank stable and solvent when the crisis hit two years later.

Lesson? There will be many digital financial products and instruments created over the next 10 years. As a CEO, don’t commit your company unless you understand how they work and what problem they solve. Which brings me to an aphorism from another crash — the dot-com meltdown of 2000: “If it doesn’t make sense, it doesn’t make sense.”