What is the future of cryptocurrencies?

With the most popular cryptocurrency Bitcoin losing value, its supporters are put off. But cryptocurrencies are here to stay while regulation and taxation are likely to come.

A sign for a Chivo Bitcoin ATM on the first anniversary of the adoption of Bitcoin in San Salvador, El Salvador, on September 7, 2022. One year after the adoption of Bitcoin as legal tender by El Salvador and more of 2,000 bitcoins bought by the government is nearing the highest level, the nation has lost more than half the value of its cryptocurrency purchases so far. © Getty Images
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In short words

  • Cryptocurrency is perceived as a speculative investment and a deposit of wealth
  • It is not gaining popularity as a means of payment for ordinary transactions
  • Ignore, ban or regulate? Governments will likely choose the third option

Cryptocurrencies have taken a hit in recent months. For example, the US dollar / Bitcoin exchange rate fell from nearly $ 70,000 in early November 2021 to less than $ 20,000 in late June and, despite ups and downs, it fell to $ 19,733 on September 15.

Historically, Bitcoin – by far the most popular form of cryptocurrency – has been a success story for those who bought it: the exchange rate against the dollar was less than 3,000 five years ago. However, many bitcoin proponents have been disappointed in two respects. This cryptocurrency has failed to become a popular means of payment and has proved to be a poor defense of purchasing power in times of uncertainty and inflation. This is surprising. The supply of Bitcoin is limited to 21 million units. Since more than 19 million units, or 90 percent, have already been issued (“mined”), most people expected that the cap would cause its dollar-denominated price to rise steadily.

What’s the future?

To predict future scenarios for cryptocurrencies, it can be helpful to consider what happened in the past and clarify some key points. First, the blockchain world is made up of cryptocurrencies and cryptographic derivatives. For example, Bitcoin is a cryptocurrency while the Tether and TerraUSD stablecoins are crypto derivatives. These are “derived” from cryptocurrencies and / or pegged to a widely recognized and centralized currency, such as the dollar. Put simply, a financial investor distributes dollars to a company and receives a derivative in return. The company converts dollars into cryptocurrencies and lends them to global borrowers. At the same time, the company promises the financial investor to exchange derivatives on demand for a fixed amount of a certain cryptocurrency, possibly pegged to the dollar, or backed by dollars.

The result is that if you have bought bitcoin or other cryptocurrencies, you win / lose by following the exchange rate of the cryptocurrency in your wallet. If you’ve bought a derivative, however, you may find that it’s not actually backed by an adequate amount of cryptocurrencies or that the dollar convertibility guarantee is nothing short of porous. If so, the derivative turns out to be entirely worthless. This is what has happened in the past few months with several crypto derivatives. The companies that issue such products are very active in the market and help make the underlying assets volatile, especially if they promise stellar returns, which increase the demand for cryptocurrencies and crypto derivatives. If derivatives are poorly guaranteed, investors are scared in difficult times.

The cryptocurrency market crash of 2022 hit the world of derivatives, eliminating perhaps a major source of volatility.

A second key point is that cryptocurrencies are currently considered both a speculative tool and a deposit of wealth, rather than a means of payment for ordinary transactions. For example, over 60 percent of total bitcoins in circulation are held in accounts (“wallets”) with more than 100 bitcoins each and are rarely traded on the market, except to adjust wallets: at the end of July 2022, only about 250,000 Bitcoins were traded every day and it is likely that only a small fraction involved commercial transactions. Furthermore, cryptocurrency holders appear to have a long-term view. For example, both “shrimp” and “whales” (accounts with less than 1 and over 1,000 Bitcoins each, respectively) have taken advantage of the recent sell-off to buy large falling amounts.

Three preliminary conclusions follow: (1) the long-term approach of the typical cryptocurrency holder suggests that the cryptocurrency project is not an easy kill and survives dramatic volatility; (2) volatility was driven by crypto derivatives, whose activity was amplified by the relatively small amount of cryptocurrencies traded on the market; (3) The cryptocurrency market crash of 2022 hit the derivatives world, likely eliminating a major source of volatility by killing some market movers, hitting short-term speculators, and providing opportunities for long-term cryptocurrency investors.

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Facts and figures

The value of bitcoin collapses

Bitcoin chart
At its peak, one Bitcoin was worth nearly $ 70,000 in November 2021, but the value dropped to less than $ 20,000 on September 15 with less than two million Bitcoins left to create before hitting the 21 million mark.

Based on “nothing” but worth something

Of course, cryptocurrencies are not like stocks and bonds, which are backed by promises of future income streams, sometimes generated by a company’s successful market performance and sometimes by a government commitment to squeeze taxpayers. Instead, cryptocurrencies are monetary units backed by nothing and their value depends on their credibility as a future means of payment for purchasing goods, services and other means of payment.

In the end, regulation appears to be the safest strategy.

Central bankers and politicians in general do not miss an opportunity to warn the public that cryptocurrencies are a scam. European Central Bank President Christine Lagarde recently stated that “nothing based” (correct) cryptocurrencies are “worth nothing” (incorrect) and that regulation is needed to prevent inexperienced investors from losing all the money they have invested in. cryptocurrencies (incorrect).

Ironically, central bankers offer digital currencies, which according to President Lagarde are “very different” from cryptocurrencies. Central bankers’ digital currencies are certainly different from blockchain-based cryptocurrencies, but not for the reason that Ms. Lagarde probably has in mind. The key issue is that decentralized currencies with a supply limit would eliminate the very notion of monetary policy and turn central bankers into an agency that regulates commercial banks and produces statistics. Understandably, the central banking world is dissatisfied with the prospect.

In other words, central bankers are not hostile to cryptocurrencies because they are allegedly fraudulent. If fraud means “based on nothing”, then all central bankers should be brought to court. Rather, their hostility stems from the fact that widespread acceptance of cryptocurrencies will eventually undermine central bank privileges, with repercussions, for example, on public debt financing.

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Scenarios

Politicians and central bankers have three options.

Ignore

They can ignore, outlaw or regulate cryptocurrencies. The first course of action is the simplest. Why should central bankers worry? After all, the cryptocurrency world is highly competitive and some currencies will disappear. Moreover, they do not pose a real threat to money today. Switching from dollars or euros to one or more cryptocurrencies is not easy: the cost of each transaction is still relatively high. As long as governments accept centralized currencies like dollars and euros as their only means of payment, switching to cryptocurrencies would actually be tantamount to switching to a cumbersome dual-currency regime that many people would not like. These regimes existed in the past, but for short periods of time.

Outlaw

Outlawing cryptocurrencies wouldn’t make much sense unless authorities feared that large transactions involving cryptocurrencies could destabilize fiat currency exchange rates. Furthermore, banning cryptocurrency must necessarily be a global move. It would lose credibility if some countries refused to comply. The fundamental problem with this approach is that the existence of cryptocurrencies and cryptographic derivatives is not a crime, and it is far from obvious that those who buy them are acting against the public interest.

Regular

In the end, regulation appears to be the safest strategy. With no realistic short-term threat of fiat money as a means of payment or proof of its use in money laundering, the authorities’ only real concern is taxation. This is the only point the regulator is likely to focus on. It has little to do with the decentralized feature of cryptocurrencies, but rather the tax collector has no way of finding out how much wealth the taxpayer has stored and it would be very difficult to even know if an individual has an account. Future regulatory efforts will go in the direction of forcing greater transparency with the aim of tracking and taxing this form of wealth.

In early July, the European Parliament approved the Market-in-Crypto-Assets proposal. If implemented on a global scale, cryptocurrency providers will not be able to operate without authorization. This authorization will undoubtedly come with constraints: in theory, to protect investors from fraud, in practice, to force them to make their accounts visible. This is just the beginning, unless technology makes authorized resellers superfluous.

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