Are cryptocurrencies on their last legs? The leader of the pack, Bitcoin, has lost almost half its value since reaching an all-time high in mid-April, and others have also collapsed in the wake of the Chinese government’s decision to crack down on all cryptocurrency-related transactions. The Securities and Exchange Commission has also signaled tougher oversight. Despite the market gyrations, crypto’s champions continue to see these currencies as an ideal market-generated solution as questions arise about the future viability of paper currencies in a global economy characterized by sky-high indebtedness and bloated government/central bank balance sheets. Enthusiasts behind Bitcoin, Ethereum, Tether, Dogecoin, and a host of other cryptocurrencies, seem to think that the wonders of 21st century financial technology (aka “fintech”) will enable these digital creations to stand as alternative stores of value outside the control of our central banks, whose actions (they have claimed since the days of Austrian economist Friedrich von Hayek) regularly debase traditional paper currencies.
An appealing narrative to be sure, but does it stack up to reality? Ironically, cryptocurrencies share many of the features that its libertarian adherents decry in so-called government-created currencies. Like our traditional currencies—the dollar, yen, pound, or euro—created by government “fiat,” cryptocurrencies are backed by nothing. Participants effectively exchange a legal tender dollar or some other real asset for a digitally created token, which has no intrinsic value or yield (and the supply of which is artificially controlled by a complex computer algorithm). Furthermore, the creation of these currencies has an environmental cost (some more than others); they trade outside of a regulated financial system, making them ripe for fraud (e.g., hacking investors’ crypto wallets to steal their currency, setting up fake wallets to bilk counterparties, or setting up phony crypto exchanges to steal customers’ money), money laundering, and tax avoidance. (The IRS announced last week its intention to pursue crypto-related taxes aggressively).
Even as a medium of exchange, the use of cryptocurrencies is unpredictable. As of a couple of weeks ago, you can no longer use Bitcoin Bitcoin to buy a Tesla, less than two months after Elon Musk helped to further fuel a renewed speculative frenzy in the market when he announced that his company would begin accepting Bitcoin as payment. The resultant plunge points to a problem of using these digital tokens as an alternative store of value (unless, of course, you’re a criminal with limited options). It also highlights another issue raised by Naked Capitalism’s Yves Smith: “The cost and time involved in validating Bitcoin transactions makes it unusable in retail transactions.”
Musk’s change of heart comes as the (literally) dirty little secret about cryptocurrencies is becoming more widely appreciated: “Mining” for cryptocurrency is even worse than traditional mining. According to the Pennsylvania branch of the Sierra Club, “Bitcoin alone produces 36.95 megatons of carbon dioxide (CO2) annually (comparable to New Zealand) and it is estimated that in 30 years Bitcoin could alone increase global temperatures 2 degrees Celsius.”
Left unchecked, mining for crypto is bound to grow (and as a result cause more environmental harm) as its use is expanded. There are many pejoratives one can ascribe to so-called easy money–peddling central bankers, but “environmental vandal” is usually not one of them.
As for the technology behind crypto, central banks are increasingly appropriating digital technology for their own “paper” currencies. As they do, they are increasingly trying to regulate the use of cryptocurrencies. The People’s Bank of China, for example, just announced tighter restrictions to ban financial institutions and payment companies from providing services related to cryptocurrencies, marking a fresh crackdown on digital money. Other countries—such as Algeria, Bolivia, Morocco, Nepal, Pakistan, and Vietnam—have already banned cryptocurrencies on the grounds that they enable criminals and terrorist organizations to move value around the world out of sight of national governments and law enforcement. At the same time, United States Federal Reserve Chairman Jerome Powell has also announced consideration of a possible digital version of the dollar that would be controlled by the US central bank (suggesting that it wants to appropriate the technology but maintain control of currencies).
From the perspective of non–fintech experts, a crucial and valuable difference is that central bank–issued currencies will come with the added advantage that they would be issued and regulated by the competent monetary authority of the issuing country. Central bank–created digital currencies would simply constitute a digital version of the very same currencies that our populations have learned to trust. Think of e-mail versus physical postal mail. The transactions would be instantaneous, but still safe because the electronic debits and credits would still be controlled and monitored by the central banks.
Will a further collapse in the value of cryptocurrencies crash the financial system as, say, mortgage-backed securities did in 2008? Not necessarily.
As the economist/venture capitalist William Janeway has persuasively argued, financial bubbles are always with us. Sometimes, they leave a legacy of productive assets (eg., railways in the 19th century, or broadband and the vast expansion of the Internet in the wake of the dotcom bubble of the 1990s). At other times, such as 2008, “bubble extremes can transcend the capital markets and suck in the institutions, [such as banks], that accept deposits and provide the credit that fuels the ordinary workings of the market economy.” To judge from the comparative resilience of the financial markets in the wake of significant recent falls of many leading cryptocurrencies, the latter do not yet appear to have infected the broader credit system. But left alone, they could well do so, which is why we should applaud moves by our monetary authorities and regulators to bring them to heel.
On the plus side, cryptocurrencies may well have accelerated the central banks’ expansion into digital currencies. That specific innovation could be very good for our economy, as our transactions become increasingly virtual and electronic. But by proactively appropriating the digital technology, while simultaneously clamping down relatively quickly on privately created, unregulated cryptocurrencies, financial regulators are likely to prevent said instruments from infecting our credit system, thereby mitigating vast collateral damage as a result.
In our increasingly technologically dominated economy, innovation is often seen as an end in itself. But increasing financial innovation (as we saw in 2008) should never be viewed that way, especially when it comes to cryptocurrencies. Instead, the embrace of digital currencies should be viewed as the handmaiden of a financial system that is geared toward supporting rather than subverting the real economy. Elon Musk, among other crypto proponents, does not object to the idea of a privately created cryptocurrency; he just wants it to be less environmentally toxic. That’s not enough; it is doubtful that any sovereign country that issues its own currency would, or should, willingly sacrifice its currency monopoly; to do so would be a recipe for monetary chaos and systemic instability. Libertarians love to talk about “freedom,” but absent a supportive framework, freedom can quickly dissolve into anarchy. The sooner we get rid of something that has become a charter for fraud, tax avoidance, and illegal monetary transactions, the better.