If it were to survive, cryptocurrencies would have to convince central bankers
Last week, the Securities and Exchange Commission (SEC) filed separate charges against two leading crypto companies, Binance and Coinbase Global. They are accused of operating unauthorised U.S. exchanges for unregistered financial securities and illegally mixing brokerage and clearing.
In truth, the market for digital tokens such as Bitcoin was already at its end. Prices have collapsed since the peak of the speculative mania in November 2021, and the total value of cryptocurrencies has fallen by almost two-thirds, while trading volume is less than 10% of its peak.
In retrospect, it is obvious that these electronic securities were the most extreme beneficiaries of the „everything bubble” that drove valuations of financial assets with negligible or even non-existent cash flow to astronomical heights.
The end of zero interest rates, quantitative easing and pandemic-era fiscal stimulus has brought prices back down to earth. Rising real interest rates have proven to be kryptonite for cryptocurrencies, as it has for so many other speculative assets.
Still, investors should think twice before completely writing off cryptocurrencies. The normalisation of interest rates may have hurt cryptocurrency in its recent incarnation as a get-rich-quick scheme.
But it may also be exactly what is needed to revive the original selling point as a technological breakthrough that would facilitate the global circulation of privately issued currencies capable of transferring economic value across time and space more securely, efficiently and freely than ever before.
This may sound like a tall order. If cryptocurrencies are to disappear from the scene again, they will have to extricate themselves from the reputational swamp of a market structure that the chairman of SEC, Gary Gensler, described last week as „rife with fraud, abuse and non-compliance.”
Digital currencies will also have to convince central bankers that they pose no threat to monetary policy or existing payment systems – something that Facebook owner Meta Platforms’ ill-fated Libra project, for example, failed to do.
However, the structural reasons for the popularity of cryptocurrencies are as strong as ever. In both democratic and authoritarian political systems, public trust in elites and institutions continues to crumble.
Trust in the traditional financial system never recovered from the 2008 global crisis and has been further damaged by the recent failure of central banks to predict inflation and the need for another round of taxpayer-funded bailouts. Meanwhile, the digitization of our daily lives is advancing at a rapid pace.
The real appeal of cryptocurrency is that it is right at the centre of all these secular trends, offering a seductive vision of how technology can empower citizens to take back political and financial control in the age of digital surveillance.
Balaji Srinivasan, author of the crypto bible „The Network State,” puts it succinctly, „End the wars. End the Fed. End-to-end encryption.”
It’s easy to dismiss such crypto-maximalist manifestos as prime examples of the concept’s crankiness. Yet they speak to the powerful forces behind the popularity of cryptocurrencies, which were originally intended as a platform for alternative global currencies.
Investors should take this seriously, especially because neither the idea of private money circulating alongside state currencies nor the idea that this could play a constructive economic role are remotely new.
From continent-wide experiments like the „écu de marc” used by mediaeval European merchants to conduct international trade, to the humble baby-sitting circle cit popularised by economist Paul Krugman, to myriad community currencies like the Ithaca Hours and the Brixton Pound, privately issued money has always been a feature of capitalist economies.
Historically, however, two constraints have limited its reach. First, the lack of government backing has limited their acceptance to users who know and trust each other as partners in a common commercial or social project.
Second, the establishment of central private counterparties responsible for issuing, clearing, and settling currencies is time-consuming, costly, and difficult.
But modern technology has made these obstacles a thing of the past. With 5 billion people connected to the Internet, communities centred around even the most esoteric interests can now number in the tens of millions.
The combination of cryptographic certification and public digital ledgers means that clearing and settlement can be automated and central counterparties eliminated altogether.
The thesis that the circulation of private currencies could be economically beneficial has also been around for some time. Friedrich Hayek’s 1976 book, „The Denationalisation of Money, argued that the circulation of foreign and privately issued currencies alongside national currencies would improve monetary stability by putting competitive pressure on central banks.
Hayek’s scheme formed the basis for the 1989 proposal by the British Treasury to introduce the euro by initially allowing it to circulate alongside existing European currencies.
The underlying argument goes back at least to the 18th century, when the pioneering Scottish economist James Steuart called competition through private money „the most effective bridle ever invented against the folly of despotism.”
History shows, however, that it usually takes more than the existence of viable alternatives for privately issued currencies to achieve critical mass. The official, national currency must also be more difficult to obtain.
The golden age of private currencies in the United States occurred during the Great Depression of the 1930s. As the Federal Reserve maintained its tight monetary policy, the liquidity of the U.S. dollar dried up.
As a result, businesses and households quenched their thirst with privately issued cash currencies. The sky-high interest rates imposed by Argentina’s central bank to stabilise the exchange rate after the January 2002 devaluation had the same effect. By March, private currencies accounted for nearly a third of all money in the country, replacing the peso, which had become too expensive to obtain.
It is precisely when access to official, national currencies becomes prohibitively expensive that privately issued alternatives have historically had a chance to thrive.
The Federal Reserve and SEC have teamed up to kill off cryptocurrencies, but perhaps their time as the Internet of Money has not yet come. Crypto is dead. Long live crypto?