LONDON, Nov 25 (Reuters Breakingviews) – Crypto winter is very cold. The meltdown occurred earlier this year with the collapse of Terra, a digital token pegged to the US dollar. The recent debacle of Sam Bankman-Fried’s FTX exchange has brought the temperature down even further. According to CoinMarketCap.com, the aggregate market capitalization of cryptocurrencies is down nearly 70% from its peak to more than $2 trillion. As institutional investors run for the hills, financial regulators are closing in. The inevitable question arises: is there a future for cryptocurrencies? The answer is: not under anything resembling normal conditions.
True believers have not lost their faith. They note that cryptocurrencies were originally intended to provide a decentralized alternative to government-issued fiat money that did not require users to rely on intermediaries such as banks. Instead, transactions will be recorded in a distributed ledger. In fact, the majority of those who dabbled in cryptocurrencies 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 cryptocurrency should return to its roots. This is easier said than done. Storing bitcoin or competing tokens in offline digital wallets is fraught with risks. If the owner loses the encryption key or sends the coins to the wrong address, they have no recourse. Additionally, cryptocurrencies are too volatile to serve as money. That’s why cryptocurrency pioneers developed stablecoins that align their market prices with old fiat currencies. However, as Terra’s collapse demonstrated, stablecoins have not lived up to their name.
Bankman-Fried became aware of the inherent flaws of cryptocurrency. The founder of FTX agreed that digital tokens cannot be valued because they do not generate any cash flow. He also pointed out the impossibly slow speed of transactions on the Ethereum network. In this regard, bitcoin is slightly better. There is another problem. Most cryptocurrencies require a so-called “proof of stake” where major holders confirm transactions. But theoretically, it is possible to control a coin, depriving the plankton of its share, as these “whales” are known.
Bitcoin has a different design based on “proof of work” to verify transactions. However, this process consumes large amounts of energy, which poses a problem at a time when oil and gas prices are high. As Hyun Song Shin of the Bank for International Settlements points out, fees for verifying transactions rise and fall with market cycles. “Crypto only really works when coin prices go up and there is an influx of new buyers,” he said. In other words, the entire cryptocurrency world has the mechanics of a Ponzi scheme.
Then there is regulatory feedback. Government officials complain that the only practical use of cryptocurrencies is money laundering or demanding ransom payments. In August, the US Treasury program sanctioned Tornado Cash, a firm that provides anonymity for cryptocurrency users. This could be a bigger deal than the potential regulations caused by the FTX collapse. Calderwood Capital’s Dylan Grice suggests that the foundational dream of cryptocurrency is dead: “Crypto is now virtually permissioned, highly centralized, and lacks privacy,” he writes.
To limit all this, central banks are responding to the threat that cryptocurrencies pose to their monetary monopolies. China is testing a digital yuan. More than 50 million Brazilians use Pix, a low-cost payment system operated by the country’s central bank.
However, central bank digital currencies (CBDCs) are thought to be the savior of cryptocurrency. If money is, as Fyodor Dostoyevsky said, “invented freedom,” CBDCs have the potential to create a digital panopticon where central authorities monitor every transaction. In the wrong hands, CBDC can be used to sanction recalcitrant individuals, determine which transactions are permitted, or freeze financial assets without due process. No totalitarian has ever had such absolute power.
In such a dire scenario, access to a decentralized, anonymized digital currency could be invaluable. That’s the message of entrepreneur Balaji Srinivasa’s latest book, The Network State. It envisions a world where the United States is engulfed in civil war and China’s digital yuan is used to track people globally. In this world, bitcoin acts as a lifeboat for civilization, offering protection from both anarchy and surveillance.
Readers must judge for themselves whether this dystopian vision is credible. The Covid-19 pandemic has taught us how quickly long-established societal norms can be changed. In China, fintech applications have been adapted to ease lockdowns and provide individuals with stay-at-home orders. In the West, PayPal ( PYPL.O ) recently froze the accounts of people deemed to have violated the online payments firm’s “acceptable use policy.” After Russia’s aggression against Ukraine, Western governments froze President Vladimir Putin’s access to the country’s foreign exchange reserves and restricted Russia’s access to the SWIFT global payments system.
Under less dramatic scenarios, it is difficult to see the future of cryptocurrencies, except perhaps as omens for the online gaming community. In recent years, their main function has been to provide access to a wide range of online casinos. Near-zero interest rates and quantitative easing have fueled cryptocurrency enthusiasm. Digital tokens have provided the most hyperreal form of wealth—what the French philosopher Jean Baudrillard called a simulacrum, defined as something that does not have the essence or necessary qualities of a thing, but merely a form or appearance.
Investors on planet Earth need a store of wealth that protects them from inflation and economic disaster. It’s better to reject “digital gold” as they’re sometimes dubbed bitcoin and embrace the real thing. Like Bitcoin, gold requires energy to produce and is in limited supply. Like Bitcoin, it is extremely difficult to value. He says 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 the long-term average. At the British supermarket Waitrose, a 650-gram bag of sourdough is sold for £4.11 ($4.98). It multiplied by 350 times, which is close to the current market price of gold ($1,750 per ounce).
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(The author is a Reuters Breakingviews columnist. Opinions expressed are his own.)
Edward Chancellor is the author of The Price of Time: The True Story of Interest.
Edited by Peter Thal Larsen, Streisand Neto, and Oliver Taslic
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