Enron 2.0: How Cryptocurrency Could Lead to Another Meltdown

Posted in: ArchiveOp-ed
February 4, 2018 3:48 PM UTC

Cryptocurrencies have changed the way we view economics. Cryptocurrency entrepreneurs have found ways to tokenize everything from time to real estate. What struck my attention most, though is the tokenization of power. Commoditizing power is nothing new. The idea has been around as long as electricity itself and the liquidity of this market led to great infrastructure development in the United States and abroad.

What scares me about the tokenization of power is something that happened just about 17 years ago: long enough to be out of memory many of today’s prominent crypto investors and consequently a large portion of the total crypto holdings today. I’m referring to Enron, a commodities company which, at the time of its demise, was the largest corporate bankruptcy in history. The scandal led to at least one suicide, a congressional hearing, several executives being arrested and hundreds of billion dollars in lost market value.

Right off the bat, bulls will accuse me of making unfair comparisons, citing Enron’s fraudulent accounting practices, rampant insider trading, misrepresentation financial information to investors, and dozens of dissimilarities like Enron’s centralized corruption that blockchain is supposed to prevent. They would be right: but they’d also be missing my point. Regardless of Enron’s behavior, the company was still losing money. Why they were losing money is the important thing to note here, not what was done to cover this up.

An Enron Refresh

Former Enron CEO Jeff Skilling in front of Enron Towers with the second tower under construction on the right.

Considering the fact that many of our readers were in diapers when the Enron scandal broke, a quick recap is in order. Enron was the product of a merger between two energy conglomerates in the 1980’s which led to a massive reorganization of the newly formed company and the rise of Ken Lay who would remain chairman and CEO for the remainder of Enron’s existence (with the notable gap of a few months during the beginning of the end). At first, Enron was primarily a gas pipeline company. This was a low market cap, somewhat boring business until Jeff Skilling, a consultant at the time, suggested the facilitation of natural gas sales between consumers turning natural gas into a commodity. Enrons job, at first, was to facilitate the transfer of this gas between traders. This proved to be lucrative, but nowhere close to the ambitions of Skilling and Lay who were just getting started.

During the bull market of the 1990’s, Enron transitioned from merely from the production and transport of natural gas into a fully formed financial institution. Enron brought in Andrew Fastow, an early proponent of asset-backed securities which readers may recall were a factor in leading to the 2008 financial crisis. Fastow’s expertise in complex financial instruments is what allowed Enron to lose billions of dollars without being caught. For his role in the scandal, he would serve 6 years in prison.

California flag used as part of anti-Enron protests following the California Energy Crisis.

In 1994, Enron began to take advantage of increasing deregulation of the energy markets and moved into the retail energy market. This division became one of Enron’s most profitable and with its armies of traders, Enron was eventually able to quadruple revenue from $12 billion in Q1 of 2000 to over $48 billion the same time next year. This blatant manipulation of the market caused over 30 blackouts in California. This led to protests, elaborate lobbying efforts involving George W. Bush, and Arnold Schwarzenegger which is far outside of the scope of this article, but noteworthy to give a sense of scale.

Within a few years of it’s expansion to the energy market Enron was eager to trade anything and everything. It set up an online trading platform, EnronOnline. Here, anything and everything went. Billions of dollars of trading volume were processed every day on things like broadband, freight, water, multimedia, and even weather derivatives were traded.

The rise and fall of Enron.

Over the following years, the company fell apart. The unveiling of a cover-up of billions of dollars in losses by Enron executives and it’s accounting firm resulted in the stock price crashing from $90.56 to less than $1 in the course of about a year and a half. Ken Lay died before being convicted and Skilling was given the longest sentence in the history of white-collar crime, a record that would hold until Bernie Madoff‘s conviction just a few years ago.  Yet, even after the bottom fell out and the stock was trading at $0.45 the underlying business model was being hailed as a “New Economy”. The concept of Enron, now being revived in the offices of Crypto Companies around the world, was still alive.


The Crypto Connection

Enron’s first lesson to the cryptomarkets is the behavior of the trader’s effects on the underlying assets. Cryptocurrency traders are notoriously bullish. Members of communities (or cults, depending who you ask) around a specific coin will chant “HODL” and encourage each other with the pictures of Lamborghinis they’re all going ot buy. This works fine in a telegram group with thousands of other retail investors, but the real market with real people cannot handle rampant price fluctuations and estimating their electric bill on the whims of free-market sentiment. This is a continuing challenge facing coins like SolarCoin, WePower, and blockchain plays like peer-to-peer retail energy provider  Drift. Most similar in it’s challenges to Enron is PowerLedger.

PowerLedger is an especially interesting case. It has taken the crypto world by storm quickly climbing into the top 100 and reaching a peak market capitalization of half a billion dollars. Powerledger also boasts an energy trading platform. Like most of these markets, PowerLedger runs on a token, POWR, which is tradeable for electricity. In a similiar manner to every other energy token and the free traded energy services offered by Enron, POWR is subject to rampant price fluctuations. With daily price changes in the double digits a normal occurrence, one wonders how this product will fair in a consumer market. This, combined with consumer pressures (recall the protests in California) could lead to strict regulation leaving coins that commoditize electricity in a precarious position.

Key Takeaways

Outside of the issues facing retail tokenization are those facing mass tokenization in general. As I mentioned at the beginning of this article tokenization is leading to the ability to trade everything from time to eSports. This, combined with a mostly retail investment base extremely prone to both FUD and FOMO will lead to the insanity that caused the fall of Enron Online. As a former Enron consultant, Robert McDonald, says what Enron lacked (and what I think the tokens today lack) is  “advanced financial tools to price..derivatives”. As a result of the decentralized nature of crypto coins, this is not possible in cryptomarkets.

If you do decide to enter this volatile market despite the historical risks of retail facing commodities, there are a couple of things you can do to avoid the fate of Enron. Beyond the obvious Buffet-esque investment advice of not investing more than you can lose, there are some things you can do specifically to these kinds of investments: inspired by the mistakes of Enron.

Dale Kutnick, an advocate of these types of commodities, writing about Enron in 2002, said: “Enron could have done extremely well with betting on market inefficiencies and hedging bets”. In other words, when looking at a token of energy, compare it to the real world value of energy for that unit. Look at historic energy prices, and decide that way. If you do decide to trade energy, and other risky commodities tokens hedge. Be careful and don’t repeat the mistakes of the past. Studying Enron might be the best investment guide you can get as we head into unknown territories.

Disclaimer: The views expressed in the article are solely that of the author and do not represent those of, nor should they be attributed to CCN.com.

Last modified: June 11, 2020 10:09 AM UTC

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Jake Sylvestre @jakesyl

Jake Sylvestre is the founder of PhishTrain, a board member on Projectile X (which manages YBC) & a cybersecurity expert who consults for Fortune 500 companies on topics like cybersecurity, blockchain, and marketing. Follow me on Twitter: @jakesyl Jake Sylvestre is also the host of The CCN Podcast