What is the future of cryptocurrencies?

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With the most pop­u­lar cryp­tocur­ren­cy Bit­coin los­ing val­ue, its advo­cates are dis­heart­ened. But cryp­to is here to stay while reg­u­la­tion and tax­a­tion are like­ly coming.

Bitcoin sign
A sign for a Chi­vo Bit­coin auto­mat­ed teller machine on the one-year anniver­sary of Bit­coin adop­tion in San Sal­vador, El Sal­vador, on Sep­tem­ber 7, 2022. One year into El Salvador’s adop­tion of Bit­coin as legal ten­der, and more than 2,000 bit­coins bought by the gov­ern­ment at near highs, the nation has lost more than half the val­ue of its cryp­tocur­ren­cy pur­chas­es so far. © Get­ty Images
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In a nutshell

  • Cryp­tocur­ren­cy is per­ceived as a spec­u­la­tive invest­ment and a store of wealth
  • It is not gain­ing pop­u­lar­i­ty as a means of pay­ment for ordi­nary transactions
  • Ignore, ban or reg­u­late? Gov­ern­ments will like­ly choose the third option

Cryp­tocur­ren­cies have suf­fered a hard beat­ing over recent months. For exam­ple, the U.S. dollar/Bitcoin exchange rate fell from almost $70,000 in ear­ly Novem­ber 2021 to below $20,000 in late June and, despite ups and downs, dipped to $19,733 on Sep­tem­ber 15.

His­tor­i­cal­ly, Bit­coin – by far the most pop­u­lar form of cryp­tocur­ren­cy  – has been a suc­cess sto­ry for those who bought it: the exchange rate ver­sus the dol­lar was below 3,000 five years ago. Yet, many bit­coin advo­cates have been dis­ap­point­ed in two respects. This cryp­tocur­ren­cy has failed to become a wide­spread means of pay­ment and has turned out to be a poor defense of pur­chas­ing pow­er in peri­ods of uncer­tain­ty and infla­tion. This is sur­pris­ing. Bitcoin’s sup­ply is lim­it­ed to 21 mil­lion units. Since more than 19 mil­lion units, or 90 per­cent, have already been issued (“mined”), most peo­ple expect­ed that the cap would have caused a con­stant rise in its dol­lar-denom­i­nat­ed price.

What is the future?

To pre­dict future sce­nar­ios for cryp­tocur­ren­cies, it may be use­ful to con­sid­er what hap­pened in the past and clar­i­fy a few key points. First, the world of blockchain con­sists of cryp­tocur­ren­cies and cryp­to deriv­a­tives. For exam­ple, Bit­coin is a cryp­tocur­ren­cy while sta­ble­coins Teth­er and Ter­raUSD are cryp­to deriv­a­tives. These are “derived” from cryp­tocur­ren­cies and/or pegged to a wide­ly rec­og­nized and cen­tral­ized cur­ren­cy, like the dol­lar. Put sim­ply, a finan­cial investor hands out dol­lars to a com­pa­ny and receives a deriv­a­tive in return. The com­pa­ny con­verts the dol­lars into cryp­tocur­ren­cies and lends them to glob­al bor­row­ers. At the same time, the com­pa­ny promis­es the finan­cial investor to exchange the deriv­a­tives on demand for a fixed amount of a giv­en cryp­tocur­ren­cy, pos­si­bly pegged to the dol­lar, or backed by dollars.

The upshot is that if you have bought bit­coins or oth­er cryp­tocur­ren­cies, you win/lose fol­low­ing the exchange rate of the cryp­tocur­ren­cy in your port­fo­lio. If you have bought a deriv­a­tive, how­ev­er, you may find out that it is not real­ly backed by an ade­quate quan­ti­ty of cryp­tocur­ren­cies or that the dol­lar-con­vert­ibil­i­ty guar­an­tee is porous, to say the least. If so, the deriv­a­tive turns out to be all but worth­less. This is what hap­pened dur­ing the past few months with sev­er­al cryp­to deriv­a­tives. Com­pa­nies issu­ing such prod­ucts are very active on the mar­ket and con­tribute to mak­ing the under­ly­ing assets volatile, espe­cial­ly if they promise stel­lar returns, which boost the demand for cryp­tocur­ren­cies and cryp­to deriv­a­tives. If the deriv­a­tives prod­ucts are poor­ly col­lat­er­al­ized, investors are scared away in bad times.

The 2022 crash in the cryp­to mar­ket has hit the world of deriv­a­tives, pos­si­bly elim­i­nat­ing a major source of volatility.

A sec­ond key point is that cryp­tocur­ren­cies are cur­rent­ly con­sid­ered both a spec­u­la­tive instru­ment and a store of wealth, rather than a means of pay­ment for ordi­nary trans­ac­tions. For exam­ple, more than 60 per­cent of the total bit­coins in cir­cu­la­tion are held in accounts (“wal­lets”) with more than 100 Bit­coins each, and are rarely trad­ed on the mar­ket, oth­er than to adjust port­fo­lios: in late July 2022, only about 250,000 Bit­coins were trad­ed dai­ly and it is like­ly that just a small por­tion relat­ed to com­mer­cial trans­ac­tions. More­over, cryp­tocur­ren­cy hold­ers seem to have a long-term view. For exam­ple, both “shrimps” and “whales” (accounts with less than 1 and over 1,000 Bit­coins each, respec­tive­ly) have tak­en advan­tage of the recent sell-off to buy the dip in large amounts.

Three pre­lim­i­nary con­clu­sions fol­low: (1) the long-run approach of the typ­i­cal cryp­tocur­ren­cy hold­er sug­gests that the cryp­tocur­ren­cy project is not an easy kill, and sur­vives dra­mat­ic volatil­i­ty; (2) volatil­i­ty has been dri­ven by cryp­to deriv­a­tives, the activ­i­ty of which has been mag­ni­fied by the rel­a­tive­ly small amount of cryp­tocur­ren­cies trad­ed on the mar­ket; (3) the 2022 crash in the cryp­to mar­ket has hit the world of deriv­a­tives, pos­si­bly elim­i­nat­ing a major source of volatil­i­ty by killing some mar­ket movers, hit­ting short-run spec­u­la­tors and offer­ing oppor­tu­ni­ties to long-run cryp­to investors.

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Facts & figures

Bitcoin value tumbles

Bitcoin graphic
At its peak, one Bit­coin was worth near­ly $70,000 in Novem­ber 2021, but the val­ue tum­bled to under $20,000 as of Sep­tem­ber 15 with few­er than two mil­lion Bit­coins left to be cre­at­ed before hit­ting the cap of 21 mil­lion units.

Based on ‘nothing’ but worth something

Of course, cryp­tocur­ren­cies are not like stocks and bonds, which are backed by promis­es of future income streams, some­times gen­er­at­ed by a company’s suc­cess­ful mar­ket per­for­mance and some­times by a gov­ern­men­tal com­mit­ment to squeeze tax­pay­ers. Instead, cryp­tocur­ren­cies are mon­e­tary units backed by noth­ing and their val­ue depends on their cred­i­bil­i­ty as a future means of pay­ment to buy goods, ser­vices and oth­er means of payment.

In the end, reg­u­la­tion seems to be the safest strategy.

Cen­tral bankers and pol­i­cy­mak­ers in gen­er­al do not miss a chance to warn the pub­lic that cryp­tocur­ren­cies are a scam. Euro­pean Cen­tral Bank Pres­i­dent Chris­tine Lagarde recent­ly declared that cryp­tocur­ren­cies are “based on noth­ing” (cor­rect) are “worth noth­ing” (incor­rect) and that reg­u­la­tion is required to pre­vent inex­pe­ri­enced investors from los­ing all the mon­ey they put into cryp­tos (incor­rect).

Iron­i­cal­ly, cen­tral bankers offer dig­i­tal cur­ren­cies, which in Pres­i­dent Lagarde’s view are “vast­ly dif­fer­ent” from cryp­tocur­ren­cies. Cen­tral bankers’ dig­i­tal cur­ren­cies are cer­tain­ly dif­fer­ent from blockchain-based cryp­tocur­ren­cies, but not for the rea­son Ms. Lagarde prob­a­bly has in mind. The key issue is that decen­tral­ized cur­ren­cies with a sup­ply cap would elim­i­nate the very notion of mon­e­tary pol­i­cy and trans­form cen­tral bankers into an agency reg­u­lat­ing com­mer­cial bank­ing and pro­duc­ing sta­tis­tics. Under­stand­ably, the world of cen­tral bank­ing is not pleased with the prospect. 

In oth­er words, cen­tral bankers are not hos­tile to cryp­tocur­ren­cies because they are alleged­ly fraud­u­lent. If fraud means “based on noth­ing,” then all cen­tral bankers should be tak­en to court. Rather, their hos­til­i­ty comes from the fact that wide­spread accep­tance of cryp­tocur­ren­cies will even­tu­al­ly under­mine the priv­i­leges of cen­tral bank­ing, with reper­cus­sions, say, on the financ­ing of pub­lic indebtedness.

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Scenarios

Pol­i­cy­mak­ers and cen­tral bankers have three possibilities.

Ignore

They can ignore, out­law or reg­u­late cryp­tocur­ren­cies. The first course of action is the eas­i­est. Why should cen­tral bankers both­er? After all, the world of cryp­tos is high­ly com­pet­i­tive and some cur­ren­cies will dis­ap­pear. More­over, today they are not a real threat to mon­ey. Mov­ing from dol­lars or euros to one or more cryp­tocur­ren­cies is not easy: the cost of each trans­ac­tion is still rel­a­tive­ly high. As long as gov­ern­ments accept cen­tral­ized cur­ren­cies like dol­lars and euros as the only means of pay­ment, a move to cryp­tos would actu­al­ly be equiv­a­lent to switch­ing to a cum­ber­some dou­ble-cur­ren­cy regime that many peo­ple would dis­like. These regimes exist­ed in the past, but for short peri­ods of time.

Outlaw

Out­law­ing cryp­tocur­ren­cies would make lit­tle sense unless the author­i­ties feared that large trans­ac­tions involv­ing cryp­tos could desta­bi­lize the fiat-cur­ren­cy exchange rates. Besides, out­law­ing cryp­tocur­ren­cy must nec­es­sar­i­ly be a glob­al move. It would lose cred­i­bil­i­ty if some coun­tries refused to com­ply. The fun­da­men­tal prob­lem with this approach is that the exis­tence of cryp­tocur­ren­cies and cryp­to deriv­a­tives is not a crime, and it is far from evi­dent that those who buy them are act­ing against the pub­lic interest.

Regulate

In the end, reg­u­la­tion seems to be the safest strat­e­gy. With­out any real­is­tic short-term threat to fiat mon­ey as a means of pay­ment or evi­dence of their use in mon­ey laun­der­ing, the only true con­cern of the author­i­ties is tax­a­tion. This is the sin­gle item on which the reg­u­la­tor is like­ly to focus. It has lit­tle to do with the decen­tral­ized fea­ture of cryp­tos, but rather the tax col­lec­tor has no way to find out how much wealth the tax­pay­er has stored away, and it would be very hard even to know whether an indi­vid­ual has an account. Future reg­u­la­to­ry efforts will go in the direc­tion of forc­ing greater trans­paren­cy with the aim of track­ing and tax­ing this form of wealth.

In ear­ly July, the Euro­pean Par­lia­ment approved the Mar­ket-in-Cryp­to-Assets pro­pos­al. If imple­ment­ed on a glob­al scale, cryp­to-asset providers will not be allowed to oper­ate with­out autho­riza­tion. This autho­riza­tion will undoubt­ed­ly come with strings attached – in the­o­ry, to pro­tect investors from fraud, in prac­tice, to force them to make their accounts vis­i­ble. This is only the begin­ning unless tech­nol­o­gy makes autho­rized deal­ers redundant.

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