“In real life, the aspect of the battle between good and evil is determining which is which.” (Game of Thrones)

Over time, the evolution of society was based precisely on the ability to develop, innovate, to adopt new products and systems to meet historical needs.

In the field of financial markets, especially in the last 20 years, there has been an appetite for the development of new instruments, sometimes simple, sometimes sophisticated, to meet investment needs.

Unfortunately, however, quick profits were often sought first. Still, ease of use and the implementation of technological progress were in many cases an objective basis for increasing the efficiency of using new products.

When discussing the causes and results of this development the analytical and objective approach is most helpful. We should not reject new financial products and services a priori, because in many cases, financial innovation has been a factor of progress.

That is why the new proposals generated within the financial industry must be analyzed, studied, and even tested, including through practical applications on a controlled scale to see the extent to which they correspond to market requirements and respond to the imperatives of protecting consumers of financial services and products.

It is equally true that a cautious approach on the part of consumers is preferable; the consumers must apply a very simple rule, namely, not to use products or services about which they do not know enough and whose mechanism they do not understand. But in practice, this rule has proven to be quite difficult to follow.

The global financial crisis, which began in 2007-2008, demonstrated how wrong it is to invest in sophisticated financial products that are not understood or poorly presented.

1. Value of money and financial assets

If we refer to the latest creations of financial products that have become relatively popular among certain categories of users, we must return to the idea of ​​value of money.

Thus, fiat currencies are traditionally used in the financial system today. The value of fiat currency is derived from the relationship between supply and demand, the credibility of the issuing central bank, the stability of the government of the issuing country, the robustness and performance of the economy rather than the value of a physical or financial asset that supports it.

Most modern currencies in circulation (both scriptural and physical – paper, polymer, metal coin) are fiat currencies, including the US dollar, Euro and other major global currencies.

The so-called cryptocurrency (perhaps the best-known category of cryptoassets), it bears repeating, is an exclusively digital form of payment and a method of storing value. It does not have the characteristics of a currency guaranteed by an institution part of the classical financial system.

Essentially, this new concept relies on a secure and decentralized digital ledger – called blockchain – to record transactions, record the issuance of new “coins” or “tokens”, and prevent fraud and counterfeiting.

Although there are thousands of such so-called cryptocurrencies, Bitcoin is by far the most well-known and oldest in use today, despite having a not-so-transparent backstory involving an enigmatic creator named Satoshi Nakamoto, whose existence and identity have never been established.

The Bitcoin blockchain was designed so that only 21 million “virtual coins” are “issued”. This so-called type of verifiable scarcity (essentially a limitation on the quantity/supply of this asset) has contributed to the steep increase in the price of the currency in anticipation of future demand that will greatly exceed supply.

The emergence and development of the cryptoasset market has generated contradictory reactions and positions among economists, practitioners with experience in the financial field, as well as among different categories of financial market participants, including some institutions active in the field. Famous economists and businessmen have drawn attention to the fact that we are facing a huge speculative bubble.

For example, businessman Warren Buffet said in 2020 that cryptocurrencies are practically worthless. You cannot do anything with them except sell them to someone else.

Also, Bill Gates stated that digital assets are one hundred percent based on fool theory, that is, they can only work as long as you find someone else who is willing to buy more expensively from you something worthless.

Well-known economist Paul Krugman argues that investors are being sold speculative crypto products without really understanding the risks they are taking. Robert Merton asserts that the only possible legal tender is one controlled by the government.

Fiat currencies actually have intrinsic value because by law they can be used to settle all tax and other payments to the government and must be accepted as payment for obligations denominated in that currency. Nouriel Roubini, a long-time critic of Bitcoin, has argued that it is destined to end up in the “museum of failed coins” with all other digital currencies.

He said Bitcoin is “not scaleable, not secure, not decentralized”. And yet, despite these firm and unequivocal views on the pyramid scheme nature of cryptoassets, there is still a consistent market. What can drive an investor to buy cryptoassets? Maybe just the mirage of huge quick wins…

2. To the Moon and back

We are already used to seeing large fluctuations, spectacular rises and falls in the cryptoasset market. The market growth was considerable, seemingly implausible; in a short time, the market capitalization reached to the moon and back.

And if we think about the last major crash of the cryptocurrency Luna, the metaphor seems perfectly apt – the price of Luna crashed in a single week in May of this year, from US$87 to US$0.0005.

And then, a number of questions seem legitimate – What is the value of cryptoassets? Who vouches for them? What are the risks and advantages they entail? What is the growth potential of this market, is the “sky” the limit? And these are just some of the questions that specialists (and not only specialists) ask themselves.

There is certainly a solid basis and strong case for considering cryptoassets as speculative instruments, with increased price volatility and a host of other associated risks: for example, credit/counterparty risk, liquidity risk, anti-money laundering risk and of the prevention of terrorist financing, reputational risk, cyber risk, etc.

They are digital assets that are not regulated or guaranteed by recognized institutions. Responsibility rests entirely with the owner. No one guarantees these investments, no one can be held responsible for their loss.

Paradoxically, cryptoassets’ biggest advantage can also become their biggest risk – the lack of regulation makes transactions easier and faster, but means no one can step in and fix something that is not working properly.

An undeniable plus is given by the fact that the underlying technology is considered to have a very high degree of cyber security. However, it is clearly not infallible.

And if we accept the fact that cyber security techniques are constantly opposed by hacking techniques, which are developing at the same frenetic pace as cyber security, it is difficult to estimate how protected the users are in reality.

Extremely high volatility is another major risk that cryptoassets pose. Prices rise or fall dizzyingly, from one day to the next, which makes trading difficult due to the time that must be spent analyzing prices, developments, trends.

Even so, after two recent spectacular crashes, the market stands at nearly $1 trillion. Optimists believe that the market will stabilize, pessimists believe that such stabilization is unlikely.

There is also real concern over the energy consumption associated with cryptoassets and extensive debate regarding their impact on the environment.

They involve different protocols for verifying transactions, and they cause significant energy consumption. According to estimates, the Bitcoin mining network would have consumed during 2018 an amount of energy similar to that consumed by Hungary (de Vries, 2019).

Studies identify Bitcoin as the main consumer of energy in the universe of cryptoassets, accounting for 2/3 of the total energy consumed, but it is obvious that the impact of the other components should not be neglected either (Gallersdörfer et al., 2020).

Beyond the previously mentioned disadvantages, there is also a legitimate concern for the not negligible possibility of using them to finance illegal activities, such as terrorism for example.

On the other hand, security of operations and transparency are two advantages claimed by supporters of cryptocurrencies. They cannot be forged, as is the case with traditional banknotes, transactions are perfectly anonymized, the holder of cryptocurrencies can track his transactions himself, avoiding intermediaries.

The holder can use them anywhere, they are not tied to a specific space like fiat currencies are. The price is determined by the market, based on the law of supply and demand.

But the attractiveness is commensurate with the risks. The market has grown at a frenetic pace and beyond the spectacular crashes recorded, the market capitalization is still significant. From its peak at the end of last year to date, the crypto market has dropped $2 trillion, heralding a new crypto winter.

3. And yet, this time, the winter seems different…

Essentially, crypto winter is the popular name for the crypto version of a bear market in the stock market sense. Crypto winter indicates a period of low market performance characterized by negative investment sentiment and low coin values.

There have been several crypto winters, but this time, the crypto winter seems to be different. A number of reasons can be listed that give a different character to the coming winter.

Perhaps first of all, it strikes the unprecedented magnitude of this crash, which marks a 60% drop in market cap from nearly $3 trillion at the end of 2021 to below $1 trillion in June 2022 (coinmarketcap.com).

Then there is the different general framework upon which this decline is projected, namely, a framework defined by a series of overlapping crises.

We are discussing the specter of an economic crisis of significant dimensions, the conflict in Ukraine which has already lasted for five months without a solution being evident for now, the pandemic crisis that seems to be returning, the omnipresent climate crisis, all profiled against the background of a global environment characterized by uncertainty at different levels – political, social, economic.

Another reason, essentially a natural result of overlapping crises, is related to changing consumer behavior. A revaluation on their part is expected, an increase in risk aversion, which determines a different approach to cryptoassets, contrasting with the enthusiasm shown previously.

Moreover, compared to the previous crypto winter, this time there are a significant number of institutional investors in the crypto market, and the interconnection with the traditional financial system is much more extensive.

4. Beyond the crypto winter, the perspective of making the most of the technology advantages

However, what the experience of cryptoassets as an economic utility has demonstrated is not necessarily related to their actual use, but to the indisputable advantages of the technology behind them – DLT.

Moreover, the crypto experience brought up for the first time the possibility of a digital alternative to the traditional system. This revelation, although not necessarily recent, shows that the discussion on the future of the monetary system cannot avoid digital transformation.

We can consider DLT technology to meet the criteria of a disruptive innovation. Although launched about a quarter of a century ago, the theory on disruptive innovation (Christensen, 1997) has attracted extensive debates and interpretations regarding the content of the theory and the implications for business models.

The inclusion of DLT among disruptive innovations also raises a number of questions about the future of the financial system – how can DLT transform the financial system? How can the indisputable advantages of the technology be preserved while at the same time diminishing the risks and shortcomings? And last but not least, how will our world change once this technology is incorporated into the traditional financial system?

We have already witnessed a dot.com crisis in the late 1990s, which had different coordinates than the previous ones, as a result of the large-scale adoption of information technology.

With the development of the Internet, on the cusp of exponential growth in the number of personal computer owners, a new era of speculative investment began.

As expected, the inevitable happened, investors suffered spectacular losses, and many companies did not survive. All of this happened because the bottom line was lost, which was the real value that should have been behind those multi-million dollar transactions.

The natural conclusion is that we should find approaches to prevent the recurrence of such speculative crises. At the same time, we must not forget that even after the dot.com crisis, a number of technologies and business models that emerged at that time have survived and thrived, proving their usefulness for the global economy and currently becoming examples of success at international level.

We cannot rule out that even after this “crypto winter”, a number of technologies and business models or payment circuits will still prove their viability and contribute to the future of the financial system, even though many of the current components of the cryptoasset universe will probably disappear completely or will retain only a marginal existence.

The Bank for International Settlements (BIS) is concerned with these questions and published an analysis of cryptocurrencies and stablecoins as well as an outlook on the future of the monetary system in its annual report, which appeared in June 2022.

The document mentions the possibility that the technology behind cryptographic assets could be the catalyst to transform the monetary system by including a digital currency issued by the monetary authority (CBDC), capitalizing on the obvious advantages and eliminating the imperfections.

Central bank digital currency is actually the digital version of a fiat currency. Even though it is a digital currency, CBDC is fundamentally different from a cryptocurrency in that it is issued by a central bank, guaranteed and backed by the trust of that central bank.

CBDC therefore benefits from all the characteristics of fiat currency, but issued in digital format and presenting the specific advantages arising from this digital format – increasing the speed of transactions and decreasing their related cost, high efficiency of international transfers.

This would be an example of superior use of digital transformation at the level of central banks, and many countries have already issued or are considering issuing such a currency.

The US Federal Reserve published a report entitled “Money and Payments: The US Dollar in the age of Digital Transformation” (January 2022) in which it dedicates a chapter to CBDC, presenting its functions, use, potential advantages, but also the challenges such a coin entails.

The discussion is therefore more relevant than ever, and the role of central banks is fundamental in the midst of these rapid transformations that we are witnessing.

The metaphor used by the BIS is that of a tree whose trunk represents the solid support of the central banks for the functioning of the financial system, to which the other authorities with attributions in this field also make a significant contribution.

Starting from this trunk, it is expected that in the near future new ramifications will develop in the form of products and systems based on new technologies, which will better respond to the needs of the participants, in accordance with the innovations brought by the digital transformation.

However, the precondition of the existence of a solid trunk as a supporting structure of the monetary system remains essential. In this improved architecture of the financial system, based on new technologies, it is difficult to imagine that the role of central banks could be diminished compared to the current situation, but on the contrary, it is precisely the central banks that will provide the element of robustness necessary to strengthen credibility and to consolidate financial stability.

For this, it is important to concretize as quickly as possible the current intentions and efforts at European and international level, in order to regulate cryptoasset markets, as provided for by the recently published draft of the European MiCA directive or that of the Financial Stability Board (FSB), considered for the autumn of this year and which support a collaboration and a division of responsibilities between the various competent national authorities and European / international institutions with a role in the functioning of the financial system.

Carrying forward the BIS metaphor of the trunk represented by central banks, regulation and capitalization of the advantages brought by digital transformation can represent the roots necessary to support and organically grow the financial system.

This regulatory process, however, must refer not only to the regulation of the transactions themselves, but also to the characteristics that a cryptoasset must fulfill. Simply issuing volatile cryptoassets does not provide them with a use value.

That is why we have to see if the existence of a collateral is necessary for the stabilization of its price in relation to the classic currencies under reasonable conditions.

On the other hand, if we refer to cryptoassets with a stable value, a model that can be considered a solid anchor for their price stability is that of the liquidity and solvency regulations applicable to some types of entities in the classical financial system, such as funds on the monetary market or other supervised financial institutions.

Therefore, the regulatory approach to stable value cryptoassets must go beyond the requirements of consumer protection, anti-money laundering, and the prevention of terrorist financing and address the needs of ensuring financial stability, as a result of the existing interconnections between the traditional financial system and the universe of cryptoassets with stable value and considering its dimensions.

Beyond all these considerations, it is important not to lose sight of the essence of what an architect of technological change, in some cases disruptive, Steve Jobs, said, namely, „it’s not a faith in technology, it’s faith in people”.