Thought Experiment: From Roman Gold to Modern Money Supply
Let's embark on a thought experiment, traveling back to the zenith of the Roman Empire, a time devoid of banks and dominated by gold aureus coins. In this era, the circulating money supply was quantifiable by the total number of minted denarius aureus, minus those gold coins held as wealth reserves, such as those in the imperial treasury.
Fast forward to today, and the M2 money supply of the US dollar serves a function akin to that of ancient Rome's monetary system. It represents the number of dollar units readily available for spending — essentially, the circulating money supply. However, unlike the tangible coins of Rome, today's money supply primarily exists as digital ledger entries maintained by banks, like JP Morgan. In this sense, the US dollar, much like Bitcoin, functions as a digital unit of measure for purchasing power. It is stored and transferred within a distributed ledger system, moving between various accounts and wallets.
In the digital age, the concept of money has evolved. While the US dollar still acts as a crucial unit of account and a medium for correlating wages with prices, it is now just one of many assets convertible into purchasing power. This shift highlights the transition from physical currency to a more fluid, digital representation of value, paralleling the rise of digital currencies like Bitcoin, which further exemplify this transformation in how we perceive and utilize money in the modern world.
While the US dollar is consistently used as a medium of exchange, its role extends beyond just facilitating transactions. Considering the recent surge in inflation, one might question whether it is truly inconvenient to sell assets like IBM shares, convert them into US dollars, and then use these dollars to make purchases, such as buying a car. This process underscores a crucial point: storing wealth in assets other than US dollars can be a strategic response to the currency’s devaluation due to incessant government printing and inflation.
In this context, anything can serve as a store of wealth, and the use of US dollars could be limited to their function as a medium of exchange. This is exemplified by the practices in countries with unstable local fiat currencies, such as Venezuela and Argentina. Citizens in these countries often store their wealth in US dollars due to its relative stability, while restricting the use of their local currencies solely for making purchases. This behavior aligns with the principle, initially formulated by Copernicus and later known as Gresham's Law, that "bad money drives out good money." In such economies, people tend to hoard the more stable currency (good money) and spend the less stable currency (bad money) in daily transactions.
Thus, the most secure guarantee of purchasing power lies not in money but in owning the means of production. For example, to ensure consistent access to lumber, the most reliable method is to own timberland and a lumber mill. This approach significantly reduces the risk of future scarcity compared to relying solely on monetary wealth. While money offers no absolute guarantee of being able to purchase lumber, direct control over lumber resources assures its availability, illustrating a timeless economic principle: true security in resource access often lies in direct ownership.
Revisiting Risk and Investment in the Context of CAPM
From the perspective of safeguarding purchasing power, the S&P 500 index emerges as a lower-risk investment option. This index, encapsulating major companies crucial to real GDP production, offers a more secure means of retaining purchasing power in comparison to the goods and services these entities generate, much like owning a lumber mill ensures access to wood. This empirical finding challenges a foundational assumption of the Capital Asset Pricing Model (CAPM), which traditionally views government bonds as 'risk-free' assets. However, the notion of a completely risk-free asset is a misnomer, especially when risk is defined as the potential loss of purchasing power. In this context, bonds actually pose a higher risk compared to stocks.
Nevertheless, this observation does not negate a central principle of CAPM: the cost of capital depends on systemic, undiversifiable risk. You can't expect to be paid for taking chances in a casino, and operating a gambling enterprise, where diversifiable risk could theoretically 'print money', is illegal. This underscores why idiosyncratic risk, mitigable through diversification, doesn't attract a premium in investments. Thus, the methodology for calculating investment alpha (market outperformance) and beta (market risk adjusted for leverage) remains valid. Whether these are assessed through a traditional single-market alpha-beta CAPM model or through more advanced, sophisticated approaches like the APT-style model, such as USE4 by MSCI-Barra, the underlying concepts of CAPM hold, albeit with a nuanced understanding of risk and its implications in investment strategies.
The Paramount Importance of Counterparty Risk in Modern Finance
Counterparty risk, the risk associated with the other party in a financial transaction not meeting their obligations, stands as one of the least diversifiable and most critical risks in the financial world. A pivotal shift in the landscape of stock ownership has occurred over time. Direct ownership of stocks has become less common, with brokerage firms now holding stocks on behalf of investors. These firms act as intermediaries, liaising with the Depository Trust & Clearing Corporation (DTCC) or directly with corporations to record the shares owned by each investor.
This intermediary-based model introduces significant risks. In the event of a brokerage firm's failure, as seen in the case of MF Global's collapse, investors face the harrowing possibility of losing access to the liquidity of their portfolios, sometimes irretrievably. This risk is heightened for non-US investors who lack the protections afforded by the Securities Investor Protection Corporation (SIPC), and for US investors whose portfolios exceed SIPC’s margin requirements.
The practical consequences of this risk were starkly illustrated by the collapse of Lehman Brothers in 2008. This event served as a vivid reminder of the potentially devastating impact of counterparty risk. It highlighted the vulnerability of investors when their assets are tied up in the hands of intermediary firms during financial crises, underscoring the need for greater awareness and management of this critical risk factor in financial planning and investment strategies.
Cryptocurrencies and CAPM: A New Perspective on Systemic Risk
The rising popularity of Bitcoin and other cryptocurrencies can be insightfully analyzed through the lens of the Capital Asset Pricing Model (CAPM), particularly its emphasis on systemic, undiversifiable risk premiums. CAPM, traditionally used to evaluate investment risks in stocks and bonds, offers a framework to understand the appeal of cryptocurrencies in today's financial landscape.
In conventional financial systems, counterparty risk is a significant concern. Banks and government-issued fiat currencies are inherently susceptible to failure and devaluation, respectively. Cryptocurrencies, however, present a fundamentally different form of currency. Operating autonomously from traditional financial intermediaries and government control, they substantially reduce counterparty risk. This decentralized nature makes cryptocurrencies less vulnerable to the kinds of systemic failures and government interventions that have historically plagued conventional financial systems.
Recent events, such as the collapse of FTX and SoftBank, have further highlighted the weaknesses in traditional financial structures. These incidents demonstrate the kind of systemic failures that cryptocurrencies, by their design, are more resilient against. This resilience aligns with the principles of minimizing undiversifiable, systemic counterparty risk, as outlined in CAPM theory.
Thus, the growing interest in and adoption of cryptocurrencies can be partly attributed to their inherent design, which offers a unique hedge against the systemic counterparty risks now prevalent in traditional financial systems. Unlike traditional assets, cryptocurrencies inherently diversify away from these systemic risks, primarily due to their decentralized nature and lack of reliance on traditional financial intermediaries. This key feature not only extends the application of the Capital Asset Pricing Model (CAPM) into the realm of digital assets but also highlights significant shifts in global finance. As cryptocurrencies continue to gain traction, they challenge and reshape traditional financial paradigms, offering both investors and the broader economy new ways to mitigate and manage financial risks.
Innovative Approach of 'Green-Coin' in Cryptocurrency Market
However, the 'green-coin' stands out in the cryptocurrency market, offering even lower counterparty risk compared to other digital currencies like Bitcoin or Ethereum. Its dual distinguishing advantage is its backing by a tangible asset — timber land. This unique feature offers a dual benefit: independence from the traditional infrastructure of miners, validators, or payment processors, and the stability of real asset backing. Such a combination not only positions 'green-coin' uniquely in the market but also contributes to a reduction in the cost of capital, potentially yielding higher returns for investors.
This innovative approach in cryptocurrency design enhances both security and stability. It introduces an element of tangible asset value that sets 'green-coin' apart in the digital currency landscape. Additionally, the strategy of using multiple custodian banks, akin to the diversification approach of multiple prime brokers in a hedge fund, allows TNT-bank clients to effectively diversify country and fiat currency risks. This not only underscores the forward-thinking design of 'green-coin' but also highlights its potential in reshaping the framework of digital assets investment.