“It’s hard not to marvel at the imagination that went into this gigantic madness. If there must be madness, there is something to be said for having it on a heroic scale.” — John Kenneth Galbraith
The cryptocurrency exchange FTX filed for bankruptcy on November 11, 2022 when Sam Bankman-Fried’s estimated net value fell from $16 billion to about $0. Although I’ve all the time been a crypto skeptic, I tempered my opinion because I didn’t understand the technical fundamentals or fully grasp the broad use cases. This caused me to disregard the plain: that the crypto craze had all of the signs of a speculative bubble and that cryptocurrencies didn’t meet any of the critical requirements needed to interchange major currencies or function “digital gold.”
Regardless of the worth of the technical innovation that spawned them, cryptocurrencies suffer from two major and intractable problems that make it extremely doubtful that they are going to ever replace fiat currencies or be used because the underlying commodity to which a currency’s value is tied .
Problem 1: The Alchemist’s Paradox
One of the keys to crypto’s value proposition is the concept of supply constraints. According to their proponents, cryptocurrencies can’t be minted ad infinitum, as is supposedly possible with paper currencies. Any cryptocurrency can supposedly be constrained by programmatic constraints that prevent arbitrary increases in supply and preserve a cryptocurrency’s scarcity value. This sounds great in theory, nevertheless it only applies to individual cryptocurrencies. Because crypto technology is really easy to breed, there may be nothing stopping entrepreneurs from introducing recent cryptocurrencies. This is strictly why there at the moment are around 12,000 varieties circulating in cyberspace.
This is identical problem that ancient alchemists would have faced in the event that they had found out learn how to make gold from lesser elements. Once the key was revealed – and it might come to light – gold would lose its rarity and not function a reliable store of value. The same rule applies to cryptocurrencies. The technology that gave rise to Bitcoin was recent, but has since been imitated by other cryptocurrencies. This clear lack of supply constraints has resulted in cryptocurrencies being a poor store of value overall.
Problem 2: Central Bank Sovereignty
The next hurdle to the widespread adoption of cryptocurrencies is central banks. They must accept cryptocurrencies as a viable type of reserves. To do that, they might first should abandon the present system of fiat currencies that the majority use and peg their currencies to a different commodity. It is unlikely that any major central bank will do that voluntarily and, contrary to popular belief, for good reason. This would significantly limit their ability to regulate the cash supply in response to financial crises. It was precisely this constraint from the gold standard that prolonged the Great Depression within the Thirties and caused repeated panics and depressions within the nineteenth and early twentieth centuries. Central bankers won’t voluntarily reintroduce this structural weakness into their financial systems.
Second, even when central banks were to eliminate fiat currencies, they might should determine that a cryptocurrency, quite than gold, silver, or something else, was the perfect asset to peg their currency to. In what scenario would a significant central bank willingly peg its currency to something over whose supply it could exercise no control? At least for gold, the availability is restricted by significant natural limitations. The last time, to my knowledge, that a significant sovereign country gave up control of its money supply was in early 18th century France, when the regent of Louis XV. handed over the cash supply, tax collection system, and control of the Mississippi Company’s stock to John Law. The ensuing Mississippi Bubble decimated the French economy and had lasting effects until the tip of the century. Louis XV suffered an unlimited lack of wealth and his successor, Louis XVI, lost his life. This is something central bankers wouldn’t dare repeat.
Descent into the shadows of the financial world
Without widespread acceptance by central banks, cryptocurrencies will probably be permanently relegated to the fringes of monetary markets. The black market, failed or failing nation-states, and 24-hour casinos operated by FTX-like firms may find limited uses. But even when these are viable, we will only guess at how large the potential market may be and which or what number of cryptocurrencies will emerge as viable mediums, so buying and selling these currencies stays nothing greater than speculation. What’s worse, those that play this game must accept the danger of bank robberies, bank robberies and fraud without the protection of a well-regulated banking system.
I hold no grudge against those that made their fortunes on this seedy market. Every bubble has its share of winners. But those trying to make crypto fortunes needs to be aware that there are much more bankman-frieds lurking within the shadows, and whether and when they are going to reveal the true value of their assets or steal your assets stays unclear.
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