Bitcoin’s last stand

November 30, 2022

By Ulrich Bindseil and Jürgen Schaaf

Amid the widespread downturn in cryptocurrency markets following the collapse of a major cryptocurrency exchange, the ECB Blog takes a look at where we stand with Bitcoin.

Bitcoin’s value reached $69,000 in November 2021 before falling to $17,000 in mid-June 2022. Since then, the value has hovered around $20,000. For supporters of Bitcoin, the apparent stabilization indicates that it is breathing its way to new highs. However, it’s more likely that this is an artificially generated last gasp before the road to irrelevance – and it was predictable before FTX went bust and sent the price of bitcoin well below $16,000.

Bitcoin is rarely used for legitimate transactions

Bitcoin was created to eliminate the current monetary and financial system. In 2008, the pseudonymous Satoshi Nakamoto published the concept. Since then, Bitcoin has been marketed as a global decentralized digital currency. However, Bitcoin’s conceptual design and technological shortcomings make it questionable as a means of payment: real Bitcoin transactions are difficult, slow and expensive. Bitcoin has never been used significantly for legitimate real-world transactions.

By the mid-2010s, the hope that bitcoin’s value would inevitably rise to ever-new heights began to dominate the narrative. But Bitcoin is also not suitable as an investment. It does not generate cash flow (like real estate) or dividends (like stocks), cannot be used productively (like commodities) or provide social benefits (like gold). Thus, the market price of Bitcoin is purely based on speculation.

Speculative bubbles rely on incoming new money. Bitcoin has also repeatedly benefited from waves of new investors. Manipulations by individual exchanges or stablecoin providers during the first waves are well-documented, but after the likely bursting of the bubble in the spring there are fewer stabilizing factors.

Big Bitcoin investors have the strongest incentives to keep the euphoria going.

Big Bitcoin investors have the strongest incentives to keep the euphoria going. At the end of 2020, isolated companies began promoting Bitcoin at corporate expense. Some venture capital (VC) firms are also still investing heavily. Despite the ongoing “crypto winter,” VC investments in the cryptocurrency and blockchain industry totaled $17.9 billion by mid-July.

Regulation can be misconstrued as approval

Big investors also fund lobbyists who push their case with lawmakers and regulators. The number of crypto lobbyists in the US alone has almost tripled from 115 in 2018 to 320 in 2021. Their names sometimes read like a who’s who of US regulators.

But to influence lobbying activities, a voting board is needed. Indeed, lawmakers have sometimes facilitated the flow of funds by touting Bitcoin’s supposed advantages and proposing regulation that gives the impression that crypto-assets are just another asset class. However, the risks of cryptocurrencies are undisputed among regulators. In July, the Financial Stability Board (FSB) called for crypto assets and markets to be subject to effective regulation and supervision commensurate with the risks they pose, in line with the “same risk, same regulation” doctrine.

However, crypto-asset legislation has been sometimes slowly ratified in recent years, and implementation often lags behind. Moreover, different jurisdictions do not move at the same pace and with the same ambition. While the EU has agreed on a comprehensive regulatory package with the Markets in Crypto-Assets Regulation (MICA), Congress and US federal authorities have yet to agree on consistent rules.

The belief that innovation must be accommodated at all costs continues stubbornly.

The current regulation of cryptocurrencies is partly shaped by misconceptions. The belief that innovation must be accommodated at all costs continues stubbornly. Bitcoin would have high transformational potential as it is based on a new technology – DLT/Blockchain. First, these technologies have so far produced limited value for society—no matter how great the expectations for the future. Second, the use of promising technology is not a sufficient condition for the added value of the product based on it.

The supposed regulatory sanction has also tempted the traditional financial industry to make it easier for customers to access bitcoin. This applies to asset managers and payment service providers, as well as insurers and banks. The entry of financial institutions shows small investors that investments in Bitcoin are sound.

It should also be noted that the Bitcoin system is an unprecedented polluter. First, all economies consume energy at scale. Bitcoin mining is estimated to consume electricity per year comparable to Austria. Second, it produces a lot of hardware waste. One Bitcoin transaction consumes hardware comparable to that of two smartphones. The entire Bitcoin system generates as much e-waste as the entire Netherlands. This inefficiency of the system is not a defect but a feature. Guaranteeing the integrity of a fully decentralized system is one of its features.

Promoting Bitcoin carries a reputational risk for banks

Since Bitcoin appears to be neither a payment system nor a form of investment, it should not be considered for regulation and therefore should not be legalized. Similarly, the financial industry should be wary of the long-term damage of promoting Bitcoin investments – despite their short-term gains (even if they have no skin in the game). The negative impact on customer relationships and damage to the reputation of the entire industry could be huge once Bitcoin investors suffer more losses.

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This ECB Blog post appeared as an opinion piece in Handelsblatt. The views expressed in each blog post are those of the author(s) and do not necessarily reflect the views of the European Central Bank or the Eurosystem.

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