LONDON, Nov 25 (Reuters Breakingviews) – The crypto winter is bitterly cold. The frost set in earlier this year with the collapse of Terra, a digital token supposedly pegged to the U.S. dollar. The recent failure of Sam Bankman-Fried’s FTX exchange has further lowered the temperature. The aggregate market capitalisation of cryptocurrencies has shrunk by more than $2 trillion, a fall of some 70% from the 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 under anything resembling normal circumstances.
True believers haven’t lost faith. They point out that cryptocurrencies were originally intended to provide a decentralised alternative to government-issued fiat money, which didn’t require users to place their trust in intermediaries such as banks. Instead, transactions would be recorded on a distributed ledger. In fact, most dealing in cryptocurrencies ended up on centralised exchanges such as FTX. The opacity, leverage, illiquidity and shady dealings in this new financial world resembled the very worst of Wall Street.
The believers argue that crypto must return to its roots. That’s easier said than done, though. Holding bitcoin or competing tokens in offline digital wallets is fraught with risks. If the owner loses their encryption key or sends coins to the wrong address, they have no recourse. Furthermore, cryptocurrencies are too volatile to serve as money. That’s why crypto pioneers developed stablecoins, which peg their market price to old-fashioned fiat currencies. But, as Terra’s collapse demonstrates, stablecoins haven’t lived up to their name.
Bankman-Fried appeared aware of crypto’s inherent flaws. The FTX founder agreed that digital tokens were impossible to value since they generated no cash flow. He also pointed out the impractically slow speed of transactions over the Ethereum network. In this respect, bitcoin is little better. There’s another problem. Most cryptocurrencies require a so-called “proof of stake” where large holders verify transactions. But it’s theoretically possible for these “whales”, as they are known, to take control of a coin, depriving the plankton of their stake.
Bitcoin has a different design, based on “proof of work” for verifying transactions. But this process consumes vast 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 rise and fall with market turnover. “Crypto only really works when coin prices are going up 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’s the regulatory blowback. Public officials complain that the only practical use for cryptocurrencies is laundering money or demanding ransom payments. In August, the U.S. Treasury sanctioned Tornado Cash, a firm whose software provided anonymity for crypto users. This could be a bigger deal than potential regulations spurred by the collapse of FTX. Dylan Grice of Calderwood Capital suggests that crypto’s foundational dream is dead: “Crypto is now de facto permissioned, highly centralised and lacking in privacy,” he writes.
To cap it all, central bankers are responding to the threat crypto poses to their monetary monopoly. China is trialling a digital yuan. More than 50 million Brazilians use the low-cost Pix payments system, run by the country’s central bank.
It’s conceivable, however, that central bank digital currencies (CBDCs) will turn out to be crypto’s salvation. If money, as Fyodor Dostoevsky said, is “coined liberty”, then CBDCs have the potential to create a digital panopticon where the central authorities surveil every transaction. In the wrong hands, a CBDC could be used to sanction obdurate individuals, determine which transactions are permissible or freeze financial assets without due process. No totalitarian has ever wielded such absolute power.
In such a nightmare scenario, access to a decentralised, anonymised type of digital money could prove indispensable. That’s the message of “The Network State”, a recent book by the entrepreneur Balaji Srinivasan. He envisages a world in which the United States erupts in civil war and China’s digital yuan is used to track people globally. In this world bitcoin serves as the lifeboat for civilisation, offering protection against both anarchy and the surveillance state.
Readers must judge for themselves whether this dystopian vision is credible. The Covid-19 pandemic taught us how quickly long-established societal norms can be upended. In China, fintech apps were adapted to facilitate lockdowns and issue individuals with stay-at-home orders. In the West, PayPal (PYPL.O) recently froze accounts of those deemed to have violated the online payments firm’s “acceptable use policy”. After Russia’s invasion of Ukraine, the Western governments froze President Vladimir Putin’s access to the country’s foreign exchange reserves and restricted Russian access to the SWIFT global payments system.
Under less dramatic scenarios, it’s hard to see a future for cryptocurrencies, except perhaps as tokens for the online gaming community. In recent years, their prime function has been to provide access to a vast online casino. Near-zero interest rates and quantitative easing unleashed crypto enthusiasm. The digital tokens have provided the most hyperreal form of wealth – what the French philosopher Jean Baudrillard called a simulacrum, defined as something that has merely the form or appearance of a thing, without possessing its substance or proper qualities.
Back on planet Earth, investors need a store of wealth that provides protection against inflation and economic catastrophe. They’re best off rejecting “digital gold”, as bitcoin is sometimes dubbed, and embracing the real thing. Like bitcoin, gold is energy-intensive to produce and limited in supply. Like bitcoin, it’s pretty hard to value. Lore has it that an ounce of gold should purchase around 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 the British supermarket Waitrose costs 4.11 pounds ($4.98). Multiplied 350 times that’s also close to gold’s current market price of around $1,750 per ounce .
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