With the decline in value of the most popular cryptocurrency, Bitcoin, its proponents are discouraged. But crypto is here to stay as regulation and taxation likely arrive.
In a word
- Cryptocurrency is seen as a speculative investment and store of wealth
- It is not gaining popularity as a means of payment for ordinary transactions
- Ignore, prohibit or regulate? Governments will likely choose the third option
Cryptocurrencies have suffered a severe blow in recent months. For example, the US dollar/Bitcoin exchange rate fell from nearly $70,000 in early November 2021 to below $20,000 in late June and, despite ups and downs, dropped 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 against the dollar was below 3,000 five years ago. Yet many bitcoin advocates have been disappointed on two counts. This cryptocurrency has failed to become a popular means of payment and has proven to be a poor defense of purchasing power in times of uncertainty and inflation. It is surprising. Bitcoin supply is limited to 21 million units. Since over 19 million units, or 90%, have already been issued (“mined”), most people expected the cap to cause its dollar-denominated price to rise steadily.
What is the future?
To predict future scenarios for cryptocurrencies, it may be helpful to consider what has happened in the past and clarify a few key points. First, the blockchain world consists of cryptocurrencies and crypto derivatives. For example, Bitcoin is a cryptocurrency while the stablecoins Tether and TerraUSD are crypto derivatives. These are “derived” from cryptocurrencies and/or pegged to a widely recognized and centralized currency, such as the dollar. Simply put, a financial investor distributes dollars to a company and receives a derivative in return. The company converts 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 result is that if you bought bitcoins or other cryptocurrencies, you win/lose depending on the exchange rate of the cryptocurrency in your wallet. If you have purchased a derivative product, you may find that it is not really backed by an adequate amount of cryptocurrencies or that the dollar convertibility guarantee is porous to say the least. If so, the derivative turns out to be practically worthless. This has happened in recent months with several crypto derivatives. Companies issuing such products are very active in the market and help make the underlying assets volatile, especially if they promise stellar returns, which drives demand for cryptocurrencies and crypto derivatives. If derivatives are poorly collateralized, investors are scared off in difficult times.
The 2022 crypto market crash hit the derivatives world, perhaps eliminating a major source of volatility.
A second key point is that cryptocurrencies are currently seen as both a speculative instrument and a store of wealth, rather than a means of payment for ordinary transactions. For example, more than 60% of the total bitcoins in circulation are held in accounts (“wallets”) of more than 100 bitcoins each, and are rarely traded in the market, except to adjust the wallets: at the end of July 2022, only about 250,000 Bitcoins were traded daily and it is likely that only a small part is related to commercial transactions. Moreover, cryptocurrency holders seem to have a long-term view. For example, “shrimp” and “whales” (accounts with less than 1 and more than 1,000 Bitcoin each, respectively) took advantage of the recent selloff to buy the drop in large amounts.
Three preliminary conclusions follow: (1) the long-term approach of the typical cryptocurrency holder suggests that the cryptocurrency project is not easy to kill and survives dramatic volatility; (2) volatility was fueled by crypto-derivatives, the activity of which was amplified by the relatively small amount of cryptocurrencies traded in the market; (3) the 2022 crypto market crash hit the derivatives world, perhaps eliminating a major source of volatility by killing off some market players, hitting short-term speculators and providing opportunities for investors in long-term cryptography.
Facts and figures
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 strong market performance and sometimes by a government 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 purchase goods, services and other means of payment.
In the end, regulation seems like the safest strategy.
Central bankers and policy makers in general do not miss an opportunity to warn the public that cryptocurrencies are a scam. European Central Bank President Christine Lagarde recently said that cryptocurrencies are “based on nothing” (correct) worthless (incorrect) and that regulation is needed to prevent inexperienced investors from losing all their fortune. money they put into cryptos (incorrect).
Ironically, central bankers are offering digital currencies which, according to President Lagarde, are “very different” from cryptocurrencies. Central banker digital currencies are certainly different from blockchain-based cryptocurrencies, but not for the reason Ms. Lagarde probably has in mind. The key problem is that decentralized currencies with a supply cap would eliminate the very notion of monetary policy and turn central bankers into an agency for regulating commercial banks and producing statistics. Naturally, the central banking world is not happy with this prospect.
In other words, central bankers are not hostile to cryptocurrencies because they are allegedly fraudulent. If fraud means “out of nothing”, then all central bankers should be brought to justice. Rather, their hostility stems from the fact that the widespread acceptance of cryptocurrencies will eventually undermine the privileges of the central bank, with repercussions, for example, on the financing of public debt.
Policymakers and central bankers have three options.
They can ignore, ban or regulate cryptocurrencies. The first action plan is the simplest. Why should central bankers care? After all, the crypto world is highly competitive and some currencies will disappear. Moreover, today they do not pose a real threat to money. Switching 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 the dollar and euro as the only means of payment, switching to cryptos would effectively amount to moving to a cumbersome dual currency regime that many people would not appreciate. These schemes existed in the past, but for short periods.
Banning cryptocurrencies would make little sense unless authorities are concerned that large transactions involving cryptos could destabilize fiat currency exchange rates. Also, banning cryptocurrency must necessarily be a global decision. It would lose credibility if some countries refused to comply. The fundamental problem with this approach is that the existence of cryptocurrencies and cryptographic derivatives is not a crime, and it is far from clear that those who buy them are acting against the public interest.
In the end, regulation seems like the safest strategy. With no realistic short-term threat to fiat currency as a means of payment or evidence of its use in money laundering, the authorities’ only real concern is taxation. This is the only element on which the regulator is likely to focus. This has little to do with the decentralized functionality of cryptos, but rather the tax collector has no way of knowing how much wealth the taxpayer has stored away, and it would even be very difficult to know if an individual has an account. Future regulatory efforts will move in the direction of mandating greater transparency in an effort to track and tax this form of wealth.
At the beginning of July, the European Parliament approved the Market-in-Crypto-Assets proposal. If implemented globally, crypto-asset providers will not be allowed to operate without permission. This authorization will undoubtedly be accompanied by conditions – in theory, to protect investors against fraud, in practice, to compel them to make their accounts visible. This is only the beginning, unless technology makes authorized dealers redundant.