LONDON, Nov 25 (Reuters Breakingviews) – The cryptocurrency winter is very cold. The chill began earlier this year with the crash of Terra, a digital token allegedly pegged to the US dollar. The recent failure of Sam Bankman-Fried’s FTX exchange has further turned the heat down. The aggregate cryptocurrency market cap has shrunk by more than $2 trillion, a roughly 70% drop from its peak, according to CoinMarketCap.com. As institutional investors run for the hills, financial regulators are closing in. The inevitable question arises: Do cryptocurrencies have a future? To which the answer is: not in anything resembling normal circumstances.
True believers have not lost faith. They point out that cryptocurrencies were originally intended to provide a decentralized alternative to government-issued fiat money, which did not require users to place their trust in intermediaries such as banks. Instead, transactions would be recorded on a distributed ledger. In fact, most cryptocurrency exchanges have ended up on centralized exchanges like FTX. The opacity, leverage, illiquidity, and shady dealings in this new financial world resembled the worst of Wall Street.
Believers argue that cryptography needs to go back to its roots. That’s easier said than done, though. Holding bitcoin or competing tokens in offline digital wallets is fraught with risk. If the owner loses the encryption key or sends coins to the wrong address, he has no recourse. Also, cryptocurrencies are too volatile to serve as money. That is why cryptocurrency pioneers have developed stablecoins, which peg their market price to the old fiat currencies. But, as the Terra crash shows, stablecoins have not lived up to their name.
Bankman-Fried seemed aware of the inherent flaws of cryptocurrencies. The FTX founder agreed that digital tokens were impossible to value as they did not generate cash flow. He also pointed out the impractical speed of transactions on the Ethereum network. In this regard, bitcoin is slightly better. There’s another problem. Most cryptocurrencies require a so-called “proof of stake” where large holders verify transactions. But it’s theoretically possible that these “whales,” as they’re called, take control of a coin, stripping the plankton of their stake.
Bitcoin has a different design, based on “proof of work” to verify transactions. But this process consumes huge amounts of energy, which is problematic at a time of high oil and gas prices. As Hyun Song Shin of the Bank for International Settlements points out, the rewards for verifying transactions wax and wane with market turnover. “Crypto only really works when coin prices go up and there are influxes of new buyers,” he concludes. In other words, the entire cryptocurrency world has the workings of a Ponzi scheme.
Then, there’s the regulatory backlash. Public officials complain that the only practical use of cryptocurrencies is money laundering or demanding ransom payments. In August, the US Treasury sanctioned Tornado Cash, a company whose software provided anonymity to cryptocurrency users. This could be a bigger deal than the potential regulations spurred by the collapse of FTX. Calderwood Capital’s Dylan Grice suggests that the foundational dream of cryptocurrencies is dead: “Crypto is now de facto licensed, highly centralized and privacy-free,” he writes.
To top it all off, central bankers are responding to the threat cryptocurrencies pose to their money monopoly. China is experimenting with a digital yuan. More than 50 million Brazilians use the low-cost payment system Pix, operated by the country’s central bank.
It is conceivable, however, that central bank digital currencies (CBDCs) will prove to be the salvation of cryptocurrencies. If money, as Fyodor Dostoyevsky put it, is “minted 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 fine stubborn individuals, determine which transactions are permitted, or freeze financial assets without due process. No totalitarian has ever wielded such absolute power.
In a nightmare scenario, access to decentralized and anonymous digital money could prove indispensable. This is the message of “The Network State”, a recent book by entrepreneur Balaji Srinivasan. Imagine a world where the United States erupts in civil war and China’s digital yuan is used to track people globally. In this world, bitcoin serves as a lifeboat for civilization, offering protection from both anarchy and the surveillance state.
Readers must judge for themselves whether this dystopian vision is believable. The Covid-19 pandemic has taught us how quickly established social norms can be overturned. In China, fintech apps have been adapted to ease lockdowns and give people stay-at-home orders. In the West, PayPal (PYPL.O) recently froze the accounts of those it believed had violated the online payment company’s “acceptable use policy.” Following the Russian invasion of Ukraine, Western governments froze President Vladimir Putin’s access to the country’s foreign exchange reserves and limited Russian access to the SWIFT global payments system.
In less dramatic scenarios, it’s hard to see a future for cryptocurrencies, except perhaps as a token for the online gaming community. In recent years, their main function has been to provide access to a large online casino. Near-zero interest rates and quantitative easing have sparked enthusiasm for cryptocurrencies. Digital tokens have provided the most hyperreal form of wealth – what the French philosopher Jean Baudrillard called a simulacrum, defined as something that simply has the shape or appearance of a thing, without possessing its own substance or qualities.
Back on planet Earth, investors need a wealth reserve that provides protection against inflation and economic catastrophe. They’d be better off rejecting “digital gold,” as bitcoin is sometimes dubbed, and embrace the real thing. Like bitcoin, gold is energy intensive to produce and limited in supply. Like bitcoin, it is quite difficult to value. Tradition has it that one 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 at UK supermarket Waitrose costs £4.11 ($4.98). Multiplied by 350, that’s also close to the current market price of gold at about $1,750 per ounce.
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Edward Chancellor is the author of “The Price of Time: The Real Story of Interest”.
Editing by Peter Thal Larsen, Streisand Neto and Oliver Taslic
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