Why Cryptocurrency Is Crazy

by 9SIX

If you were worried about your savings at a time of financial uncertainty—say, the looming threat of inflation—would you hand your money over to Elon Musk? True, the Tesla founder is a brilliant investor and worth a mint, but he is also volatility itself, prone to strange, sudden shifts of opinion. And the fact is if, in recent weeks, you put your money into Bitcoin, a cryptocurrency, you were effectively putting your money into Musk, whose many whimsical tweets and off-handed remarks about cryptocurrencies like Bitcoin—in which he is a major investor—have helped send them seesawing in value.

With his tweets, Musk is “literally making and destroying small fortunes 280 characters at a time,” New York University marketing expert Scott Galloway told CNBC this week.

That, in turn, is proof of what some financial authorities have long been saying: When it comes to being a stable hedge against inflation, Bitcoin and other crypt

ocurrencies are about as safe a bet as going to your local convenience store and buying a lottery ticket. That became doubly clear in recent weeks when China abruptly announced it was banning its banks from bitcoin transactions, again sending the price plummeting.

“If the value of a cryptocurrency can rise or fall by 30 percent because of a change in the stance of Chinese financial regulators or a Tesla announcement, then ‘reliable’ and ‘inflation hedge’ shouldn’t appear in the same sentence,” said Barry Eichengreen, an economist and monetary historian at the University of California, Berkeley.

Sure, cryptocurrencies tend to be deflationary since they’re not tied to central banks that print money—and there is a lot of it being printed now to keep major economies afloat after COVID-19. Global stocks and futures have fallen as rising inflation concerns suggest the Federal Reserve and other central banks may have to raise interest rates. U.S. consumer prices climbed in April, the greatest jump since 2009.

That, on the face of it, might make cryptocurrencies seem attractive as a hedge. But there are so many other problems that make them hot potatoes as market bets—as evidenced by the shift away from cryptocurrencies and into gold in recent days, resulting in a nearly $1 trillion drop in cryptocurrency valuations by mid-week. Just the name “cryptocurrency” is an indication of how dicey Bitcoin’s value is: Divorced from real money and part of a decentralized trading system largely controlled by a few large and mysterious investors, it has no monetary value other than what the market places on it day by day, and that, in turn, is based on a complex system known as blockchain, a type of “distributed ledger.” (More on that later.)

But cryptocurrencies aren’t going away either—on the contrary, they are helping revolutionize finance altogether by threatening to eliminate traditional “middlemen” in transactions, whether that be private banks, lawyers, or even central banks.

As a result, banks are trying to keep up, seeking to outpace cryptocurrencies with a new competitive concept, “stablecoins.” These are digital currencies that are like crypto coinage in some ways, but instead of being decentralized like Bitcoin—which is not overseen or regulated by governments—they are fully backed with safe and liquid assets in a domestic currency. Currently, some 80 percent of countries surveyed by the Bank for International Settlements are studying versions of stablecoins and what have become known as “central bank digital currency” (CBDCs), led by China and Switzerland.

In a speech last August, Federal Reserve governor Lael Brainard noted how the emergence of Bitcoin in 2008 led to the idea of stablecoins—and that, in turn, “has intensified calls for CBDCs to maintain the sovereign currency as the anchor of the nation’s payment systems.”

Yet to a degree few authorities seem to understand, central banks are in a desperate race with crypto-innovators, one they may even eventually lose. This new challenge has risen in a matter of months: Since 2013, the value of all cryptocurrencies in circulation has soared from $1.6 billion to more than $1.6 trillion, according to CoinMarketCap, a market tracking company.

And about $1.4 trillion of that value was added only in the past year.

“They’re reinventing what finance is, and it’s sort of going under the radar of the establishment,” said Carol Alexander, a cryptocurrency expert at the University of Sussex in the United Kingdom. “They’re not using standard products. They’re not using standard trading protocols. … It’s a revolution led by young people, computer science geeks, and they talk a million miles an hour.”

This is creating something close to panic in Washington and other capitals. Governments are concerned as cryptocurrency trading expands, many traders are evading taxes. And as cryptocurrency traders increase, they are moving to cryptocurrency exchanges like Binance, the number one exchange in the world, which was started in China but then fled to the crypto-accommodating Cayman Islands. On Thursday, the U.S. Treasury Department announced it is adopting new policies to crack down on cryptocurrency markets and transactions, saying it will require any cryptocurrency transfers of $10,000 or more to be reported to the Internal Revenue Service. And new Securities and Exchange Commission chairperson Gary Gensler, an expert who taught a course on cryptocurrency at the Massachusetts Institute of Technology (MIT), has indicated he’s considering a whole new regulatory framework. Bitcoin shares were hit yet again on Friday when Chinese authorities called for a crackdown on mining and trading of the cryptocurrency.

The success of cryptocurrencies has also spurred an eagerness worldwide to shift to digital currency. The trend has been accelerated by the COVID-19 pandemic, which has driven home the increasingly antiquated nature of cash money. The problem became clear over the past year as governments failed to transfer relief money to poorer segments of the population that lacked credit cards or bank accounts. “The COVID-19 crisis is a dramatic reminder of the importance of a resilient and trusted payments infrastructure that is accessible to all Americans,” Brainard said last August, announcing her support for a joint study of CBDCs by the Boston Federal Reserve and MIT. All these distribution problems could be solved, Eichengreen noted, with “a Federal Reserve-issued electronic wallet into which digital dollars could be deposited.”

The problem is worldwide. “There are some countries where commercial banks put a sign on the door: ‘Cash not accepted here,’” said Tommaso Mancini-Griffoli, a division chief in the International Monetary Fund’s (IMF) monetary and capital markets department. “So that’s a sign of the incredible pace at which cash use is declining in some countries.”

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