It should be common knowledge by now that the world is moving towards a cashless society.
More and more, digital currencies will permeate every aspect of commerce and other aspects of life. Where it gets tricky is when people who understand more about technology and less about economics start offering financial advice to people who understand little of either.
Since cryptocurrencies exploded into the global consciousness there has been a lot of speculation and sadly misinformation. There is absolutely no question that digital currency will soon replace paper flat currency but unregulated cryptocurrency is simply not the answer. It is the Napster to today’s iTunes and Spotify; it has shown the way but probably wont make the trip.
Most who advocate unregulated cryptocurrency do not truly understand the purpose or mechanisms used by a central bank and/or have anarchist leanings towards marginalising the “evil, monolithic banking system.”
What exactly is a central bank?
A central bank or monetary authority is a monopolised and often nationalised institution given privileged control over the production and distribution of money and credit. In modern economies, the central bank is usually responsible for the formulation of monetary policy and the regulation of member banks. (https://www.investopedia.com/terms/c/centralbank.asp)
Monetary policy consists of the actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as modifying the interest rate, buying or selling government bonds, and changing the amount of money banks are required to keep in the vault (bank reserves). (https://www.investopedia.com/terms/m/monetarypolicy.asp)
Central banks manage the supply of money in an economy in an effort to boost the economy when there are downward forces and to slow the economy when there are inflationary forces; they keep the economy on an even keel. How would any central bank manage the money supply through monetary policy if private and corporate entities or individuals were able to move money out of the system unfettered?
A toothless central bank is a recipe for economic chaos. Also, why would any government allow a system capable of undermining its economy to operate? A system where transactions could not be traced or taxed? Just doesn’t make sense. Unregulated cryptocurrencies have already been banned in China, Russia, Vietnam, Bolivia, Colombia, Ecuador… note that many of these countries have strict currency controls. If that isn’t bad enough cryptocurrency prices have shown a level of volatility that should completely exclude them from being considered as a form of money.
In 2017, the price of Bitcoin (the most popular of unregulated cryptocurrencies) went from below US$1,000 to nearly US$20,000. An astronomical appreciation considering almost any asset class. In 2018, the price of Bitcoin collapsed by roughly 70 per cent with advocates advising the uninformed to “buy the dip” or to HODL.
In the world of investing, buying the dip maybe some of the worst possible advice.
Buy the dip on what?
Would they have bought the dip in the stock price of Enron, Worldcom, or Lehman Brothers as they sank into oblivion? Of course not. HODL is slang for holding on to your stash of cryptocurrency regardless of how low the price goes. You would have been better off drinking Jim Jones Kool-Aid than holding on to your crypto in the past year as many lost the majority of their value. The greatest challenge is in understanding exactly what purpose cryptocurrency is supposed to serve. What is it?
Money has historically served four major functions: medium of exchange, measure of value, standard of deferred payment and as a store of value. Unregulated cryptocurrencies fail all of these tests. Due to speculative investing, most crypto owners have not been using them as a form of exchange; why would one spend something that could double in value tomorrow?
Also, why would one accept payment in something that could see its value cut in half overnight?
Either scenario is unacceptable. Cryptocurrency advocates, realising the folly of claiming cryptocurrencies as an actual currency and form of exchange, began referring to it as digital gold (a store of value), where more problems ensued.
Gold is an industrial metal with widespread use that has the ability to maintain a stable value over an extended period of time.
Many of the older folks in T&T understood this basic concept when they regularly converted their cash savings into gold for long-term storage and safety. Many sophisticated investors use gold to preserve their gains and returns when markets begin to decline in what is called a “flight to safety”.
Gold is considered a safe haven due to its returns being uncorrelated to the general broad market of securities- when the markets are going down gold usually maintains its value and in some cases even appreciates. It is gold’s lack of volatility that gives it utility (use) as a store of value. Which cryptocurrency can make this claim?
Recent market declines have shown that the values of cryptocurrencies are very much in step with the overall markets (correlated returns), so what’s the point? Crypto does not have the attributes required for them to function as digital gold.
Unregulated cryptocurrencies aren’t currency or digital gold, so what are they?
This is exactly the problem; due to the absence of utility most crytocurrencies lack intrinsic value. Most investors decide whether to buy, hold or sell an asset by calculating its intrinsic value and comparing it to its market value; if market value is below intrinsic value it’s a buy, if more than intrinsic value it’s a sell, and if similar it’s a hold. Legendary former US Fed Chairman Alan Greenspan stated “The notion that cryptocurrency doesn’t need intrinsic value is nonsense, because market value always depends in part upon intrinsic value. Currencies to be exchangeable have to be backed by something. Without intrinsic value, nobody would have assigned Bitcoin a value in the first place.”
How does one calculate the intrinsic value of an investment with no utility, cash flows or enough transparency to determine true equilibrium of demand and supply? Figure that out and you would probably be in line for a Nobel Prize. Security issues have also become a major concern.
According to Carbon Black Inc, one of the largest cybersecurity firms in the world, roughly $1.1 billion worth of cryptocurrency was stolen in the first half of 2018. They continued, “criminals use what’s known as the dark web to facilitate large-scale cryptocurrency theft. There are now an estimated 12,000 marketplaces and 34,000 offerings related to cryptotheft for hackers to choose from.” The necessary malware costs an average of US$224 but can be priced as low as US$1.04. That marketplace has emerged as a $6.7 million economy, according to the study.
Exchanges were the most popular target for cybercriminals, making up 27 per cent of attacks this year. The dark web is a part of the World Wide Web accessible only through special software. It lets users remain anonymous and largely untraceable…just like many cryptocurrencies.
What good can come from that?
What recourse is there for those who have been hacked?
Can unscrupulous individuals manipulate crypto prices?
A 2018 study stated that at least half of the jump in bitcoin prices in 2017 was due to co-ordinated price manipulation. University of Texas finance prof John Griffin, who has a 10-year track record identifying financial fraud, conducted the study.
Prof Griffin and his team examined millions of transactions on cryptocurrency exchange Bitfinex. They deduced that another cryptocurrency (tether) was used to buy bitcoin after large price falls. His team also discovered periods of suspicious bitcoin price activity tied to the issuance of tether.
“It was creating price support for bitcoin, and over the period that we examined, had huge price effects,” Griffin said. “Our research would indicate that there are sophisticated people harnessing investor interest for their benefit.”
In other words, there are tech savvy people in the world propping up the price of bitcoin in an attempt to defraud other investors. This is a jailable offense in many developed countries.
Cryptocurrencies lack a true economic purpose or intrinsic value. Most of its value is based on pure speculation giving the instrument more of a Ponzi scheme feel than that of a true financial instrument. In a Ponzi scheme early investors are paid with the contributions of those entering the fund after them. With cryptocurrencies speculative investors earn a return based solely on the increase in demand caused by those purchasing after them. Not much of a difference. At this point, cryptocurrencies create more questions than they answer.
Next time there will be an explanation of the major cryptocurrencies and what attributes differentiate them. Till then, just say no.