LONDON, Nov. 25 (Reuters Breakingviews) — Cryptocurrency winter is very cold. The cold started earlier this year with the collapse of Terra, a digital token allegedly pegged to the US dollar. The recent failure of Sam Bankman-Fried’s FTX exchange has pushed temperatures further down. According to CoinMarketCap.com, the combined market capitalization of cryptocurrencies has shrunk by more than $2 trillion, about 70% less than its peak value. While institutional investors are running into the unknown, financial regulators are closing in. The inevitable question arises: is there a future for cryptocurrencies? To which the answer is: under no circumstances resembling normal.
True believers have not lost their faith. They note that cryptocurrencies were originally intended to provide a decentralized alternative to government-issued fiat money, which did not require users to trust intermediaries such as banks. Instead, transactions will be recorded on a distributed ledger. In fact, most of the cryptocurrency transactions 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 cryptocurrency should return to its roots. Although this is easier said than done. Storing bitcoins or competing tokens in offline digital wallets is fraught with risks. If the owner loses his encryption key or sends the coins to the wrong address, he will not have the opportunity to ask for help. In addition, cryptocurrencies are too unstable to serve as money. This is why the pioneers of cryptography have developed stablecoins whose market price is pegged to old-fashioned fiat currencies. But, as the collapse of Terra shows, stablecoins have not lived up to their name.
Bankman-Fried seemed to be aware of the inherent disadvantages of cryptocurrencies. The founder of FTX agreed that digital tokens cannot be valued because they do not generate cash flow. He also pointed to the impractically low transaction speed on the Ethereum network. In this regard, bitcoin is slightly better. There is one more problem. Most cryptocurrencies require a so-called “proof of stake” where large holders verify transactions. But theoretically, these “whales”, as they are called, can take possession of the coin, depriving the plankton of their share.
Bitcoin has a different design based on “proof of work” to verify transactions. But this process consumes a huge amount of energy, which is problematic in the face of high oil and gas prices. According to Hyun Sung-shin of the Bank for International Settlements, the fee for verifying transactions rises and falls depending on the turnover of the market. “Cryptocurrency only really works when coin prices rise and there is an influx 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. Government officials complain that the only practical use of cryptocurrencies is money laundering or ransom demands. In August, the US Treasury Department sanctioned Tornado Cash, a firm whose software provided anonymity for cryptocurrency users. This may be a bigger issue than the possible rules caused by the FTX crash. Dylan Grice of Calderwood Capital suggests that the founding dream of cryptocurrencies is dead: “Cryptocurrency is now de facto allowed, highly centralized and lacking privacy,” he writes.
To top it off, central banks are responding to the threat that cryptocurrencies pose to their monetary monopoly. China is testing a digital yuan. More than 50 million Brazilians use Pix, a low-cost payment system run by the country’s central bank.
However, it is quite possible that central bank digital currencies (CBDCs) will prove to be the lifesaver of cryptocurrencies. If money, as Fyodor Dostoevsky said, is “a fictional freedom,” then the CBDC has the potential to create a digital panopticon in which every transaction is watched by central authorities. Once in the wrong hands, a CBDC can be used to punish uncompromising individuals, determine acceptable transactions, or freeze financial assets without due process. No totalitarian has ever wielded such absolute power.
In such a nightmare scenario, access to a decentralized anonymous type of digital money could be indispensable. This is the message of The State of the Network, a recent book by entrepreneur Balaji Srinivasan. He envisions a world where the United States breaks out into civil war and China’s digital yuan is used to track people around the world. In this world, bitcoin serves as a lifeboat for civilization, offering protection from both anarchy and government oversight.
Readers must judge for themselves whether this dystopian vision is credible. The Covid-19 pandemic has taught us how quickly long-established social norms can be changed. In China, fintech apps have been adapted to make it easier to self-isolate and give people home orders. In the West, PayPal (PYPL.O) recently froze the accounts of those deemed to have violated the online payment firm’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 is difficult to see the future of cryptocurrencies, except perhaps tokens 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 have fueled crypto-enthusiasm. 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, but lacks its substance or proper qualities.
Back on planet Earth, investors need a wealth buffer that provides protection against inflation and economic disaster. Their best bet is to abandon “digital gold,” as bitcoin is sometimes called, and embrace the real thing. Like bitcoin, gold production requires a lot of energy and supply is limited. Like bitcoin, it is quite difficult to value. According to legend, an ounce of gold can buy about 15 barrels of oil or 350 loaves of bread. The ratio of gold and oil prices is in line with the long-term average. A 650-gram sourdough loaf costs £4.11 ($4.98) at UK supermarket Waitrose. Multiplied by 350, this is also close to the current market price of gold, which is around $1,750 per ounce.
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Edward Chancellor is the author of The Price of Time: A Really Interesting Story.
Edited by Peter Tal Larsen, Streisand Neto and Oliver Taslich
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