LONDON, Nov 25 (Reuters Breakingviews) – The crypto winter is bitterly cold. The freeze began earlier this year with the collapse of Terra, a digital token rumored to be pegged to the US dollar. The recent outage of Sam Bankman-Fried’s FTX exchange has further lowered the temperature. According to CoinMarketCap.com, the aggregate market cap of cryptocurrencies has shrunk by more than $2 trillion, down about 70% from the peak. As institutional investors race higher, financial regulators are closing in. The inevitable question arises: do cryptocurrencies have a future? To which the answer is: not under normal circumstances.
True believers have not lost faith. They point out that cryptocurrencies were originally envisioned as a decentralized alternative to government-issued fiat money that would not require users to trust intermediaries such as banks. Instead, transactions would be recorded in a distributed ledger. In fact, most cryptocurrency trading ended up on centralized exchanges like FTX. The opacity, leverage, illiquidity, and shady dealings in this new financial world resembled the worst on Wall Street.
Believers argue that crypto needs to go back to its roots. However, that is easier said than done. Holding bitcoin or competing tokens in offline digital wallets comes with risks. If the owner loses their encryption key or sends coins to the wrong address, they have no recourse. Additionally, cryptocurrencies are too volatile to serve as money. For this reason, crypto pioneers have developed stablecoins that peg their market price to old-fashioned fiat currencies. But as the collapse of Terra shows, stablecoins have not lived up to their name.
Bankman-Fried seemed aware of crypto’s inherent flaws. The FTX founder agreed that digital tokens couldn’t be valued because they didn’t generate cash flow. He also pointed out the impractically slow speed of transactions over the Ethereum network. In this regard, Bitcoin is slightly better. There is another problem. Most cryptocurrencies require what is known as a “Proof of Stake” where large holders verify transactions. But it’s theoretically possible for these “whales,” as they’re known, to take control of a coin and rob the Plankton of its bet.
Bitcoin has a different design based on proof of work to verify transactions. But this process consumes huge amounts of energy, which is problematic in times of high oil and gas prices. As Hyun Song Shin of the Bank for International Settlements points out, rewards for verifying transactions rise and fall with market turnover. “Crypto only really works when coin prices rise and there are inflows of new buyers,” he concludes. In other words, the entire crypto world has the mechanics of a Ponzi scheme.
Then there is the regulatory backlash. Officials complain that the only practical use for cryptocurrencies is to launder money or demand ransom payments. In August, the US Treasury Department sanctioned Tornado Cash, a company whose software provided crypto users with anonymity. This could be a bigger deal than possible regulations triggered by the FTX collapse. Calderwood Capital’s Dylan Grice suggests that crypto’s founding dream is dead: “Crypto is now de facto permitted, highly centralized and lacking in privacy,” he writes.
To make matters worse, central bankers are reacting to the threat crypto poses to their monetary monopoly. China is testing a digital yuan. More than 50 million Brazilians use the low-cost Pix payment system, operated by the country’s central bank.
However, it is conceivable that central bank digital currencies (CBDCs) will prove to be a salvation for crypto. If money is, as Fyodor Dostoyevsky said, “embossed freedom,” then CBDCs have the potential to create a digital panopticon in which central authorities oversee every transaction. In the wrong hands, a CBDC could be used to sanction stubborn individuals, determine what transactions are allowed, or freeze financial assets without due process. No totalitarian has ever wielded such absolute power.
In such a nightmare scenario, access to a decentralized, anonymized type of digital money could prove indispensable. That is the message of The Network State, a recent book by entrepreneur Balaji Srinivasan. He envisions a world where the United States erupts in civil war and China’s digital yuan is used to track people worldwide. In this world, Bitcoin serves as a lifeboat for civilization, offering protection from both anarchy and the surveillance state.
Whether this dystopian vision is believable is for the reader to judge for themselves. The Covid-19 pandemic has taught us how quickly traditional societal norms can be turned upside down. In China, fintech apps have been adapted to ease lockdowns and provide stay-at-home instructions to individuals. In the West, PayPal (PYPL.O) recently froze accounts of people believed to have violated the online payments company’s “Acceptable Use Policy.” Following Russia’s invasion of Ukraine, Western governments froze President Vladimir Putin’s access to the country’s foreign exchange reserves and restricted Russia’s access to the global SWIFT payment system.
Under less dramatic scenarios, it’s hard to see a future for cryptocurrencies other than perhaps as a token for the online gaming community. In recent years, their main function has been to provide access to a huge online casino. Near-zero interest rates and quantitative easing sparked crypto enthusiasm. Digital tokens have provided the most hyper-real form of wealth – what the French philosopher Jean Baudrillard called a simulacrum, defined as something that merely has the form or appearance of a thing without possessing its substance or intrinsic properties.
Back on planet earth, investors need a store of wealth that offers protection against inflation and economic catastrophe. You’re best off rejecting “digital gold,” as Bitcoin is sometimes called, and embracing the real thing. Like Bitcoin, gold is energy-intensive to produce and has limited availability. Like bitcoin, it is quite difficult to value. Tradition has it that an ounce of gold should buy about 15 barrels of oil or 350 loaves of bread. The gold/oil price ratio is in line with its long-term average. A 650-gram sourdough loaf in UK supermarket Waitrose costs £4.11 ($4.98). Multiplied by 350 times, that’s also close to gold’s current market price of around $1,750 an ounce.
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Edward Chancellor is the author of The Price of Time: The Real Story of Interest.
Edited by Peter Thal Larsen, Streisand Neto and Oliver Taslic
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