Post No.: 0937
Cryptocurrencies are digital or virtual currencies that use cryptography to secure transactions. They don’t have a central issuing or regulatory bank, or use banks to verify transactions, but instead use a distributed public ledger called a blockchain to record transactions and issue new units.
New units of cryptocurrency are created through a process called mining. Miners share their computers’ computing power to solve complicated mathematical problems. This process essentially validates information on and maintains the integrity of the blockchain. As a reward, miners receive coins.
Some cryptocurrencies have no maximum supply of units, like Ethereum. Others have a predetermined maximum limit, like Bitcoin (these coins are infinitely divisible however). Once the maximum quantity has been mined, it’ll be anticipated that miners will be rewarded via fees instead.
Cryptocurrencies can also be purchased from brokers. They’re stored on digital wallets. Crypto coins can be spent anywhere that accepts them. It’s a peer-to-peer system that can enable anyone, anywhere, to send and receive payments. Even countries, with El Salvador being the first, have started to formally permit Bitcoin as legal tender. They probably won’t ever replace credit or debit cards but could be a parallel payment option in many contexts.
Traditional financial institutions sensed a threat to their businesses so first lobbied hard to try to get cryptocurrencies regulated. As time went by, a few private banks started thinking ‘if you can’t beat them, join them’ and have been developing their own digital currencies too.
Many central banks, like the US Federal Reserve, have also been considering their own digital currencies called central bank digital currency (CBDC). These hope to offer the benefits of cryptocurrencies without the associated risks. As a fiat currency (a government-issued currency that isn’t backed by a commodity like gold), and like the US dollar and most other paper currencies, it allows central banks greater control over the economy because they can control how much currency is created.
Yet the idea of a decentralised peer-to-peer currency, so that central and corporate banks (third parties) aren’t required, appears laudable. However, it’s unfortunate that cryptocurrencies are deeply associated with criminal activities like contraband trade on the dark web (like on the Silk Road online black market, which was shut down by the FBI in 2013), money laundering and ransomware.
Cryptocurrencies – especially like Monero, a privacy coin that was specifically designed to preserve user transaction anonymity – are attractive for criminals precisely because they obscure the flow of money across their networks thus hiding the identities of criminals. Most crimes are facilitated by anonymity. Criminals typically steal in the dark or wear balaclavas rather than bark out their names and show their faces while committing felonies for obvious reasons!
Because the ledger is public, there are ways to potentially trace account holders if there’s a lead. Analytics firms can combine the information there with publicly available information to make inferences about which exchanges the criminals are using, and then law enforcement can demand information from these exchanges to assist their investigations. But it’s a constant cat-and-mouse game – for instance mixers mix the coins of many users together before redistributing them to different blockchain addresses at different times, which makes particular transactions even harder to track. (This echoes a typical money laundering strategy – move money around so much that the trail is hopefully obfuscated.)
Those with the most powerful computers will mine the most coins, which is a classic ‘the rich find it easier to get richer’ scenario – well, depending on the value of a coin and the cost of electricity because mining is hugely energy-intensive. Which brings us to one of the biggest problems – the carbon footprint and e-waste of cryptocurrencies. It’s been reported that the carbon footprint for just a single Bitcoin transaction is about the equivalent of a passenger flying from London to New York! Or ~1.5-2 million credit card transactions for comparison!
It’s like a lottery that runs every 10 minutes on average, and it takes more energy to mine the more miners there are too because only the miner who completes the cryptographic hash problem for a transaction the fastest will receive a small reward for their efforts.
The ‘proof of work’ for recording transactions and mining coins is intentionally inefficient because this is basis of its security.
There’s a ‘proof of stake’ blockchain method that’s far less energy intensive but the disadvantage is that it’s less secure. And it’s still more energy intensive than centralised systems.
Sufficiently green energy sources may eventually make mining carbon neutral one day – but that day isn’t today. Hence it shouldn’t be something done today, otherwise one could use the same argument for all other polluting activities e.g. flying a thousand air miles daily is fine today because the activity will hopefully be carbon neutral one day(!) Arguing that crypto mining incentivises renewable energy production is like arguing that sexual predators incentivise the conversation about and regulation of sexual harassment(!)
When a baker bakes bread, this feeds other people, not just bakers, in return for profit. If a shoemaker mends shoes, this gives other people, not just shoemakers, functional items in return for profit. If a musician plays music, this entertains others, not just musicians, in return for profit. Mining for minerals is useful because we extract raw materials that can make other useful products. In other words, their economic activity adds real value to the wider world. Meanwhile, mining cryptocurrencies is an activity that merely serves others who have cryptocurrencies. It’s not like solving these algorithmic puzzles is important for wider society – they only self-serve the cryptocurrency system itself. It’s kind of like making lots of wooden religious figurines just for the purpose of serving a religion that says one must make these figurines if you want this fuzzy religion to persist.
Some have built entire computing farms purely to do crypto mining. Mining drove up the demand for and prices of graphics processing units (GPUs), which could’ve been used for more wider-value-adding economic activities instead.
Non-fungible tokens (NFTs) – where digital assets like ‘one-of-a-kind’ gifs, jpegs and even tweets be can traded – use blockchain technology and are therefore also unsustainable. NFTs are strange because these digital assets can, and have in almost all cases, been copied endlessly like any other digital file that’s been on the web, hence possessing official ownership merely has sentimental level. They don’t even typically grant copyright. Yes, sentimental value can be traded with others who also ascribe sentimental value to something, but this bubble has burst – and many experts predict that this collapse is permanent. (Unlike a piece of memorabilia like a baseball card, Jack Dorsey’s first tweet is still in the public domain for anyone to enjoy for free! And the person who bought the NFT of that tweet for $2.9M in 2021 now struggles to get offers of more than a pawful of dollars for it in 2023.)
Some entrepreneurs view blockchain technology like a panacea for anything they think will benefit from decentralised control. But investors have already lost millions on such ventures, like blockchain technology for a Long Island iced tea company! It’s like people 3D printing things for the USP when they’re goods that don’t benefit from 3D printing at all.
This is all on top of how extremely volatile and unstable cryptocurrencies can be. They’re inherently risky investments. There have been at least a couple of so-called ‘crypto winters’ already.
All investments are risky, and the monetary value of anything isn’t objective but is simply whatever people are willing to pay for it – but cryptocurrencies have no intrinsic value, in addition to not being backed by any government. Their value can all disappear into nothing as quickly as they can appear from nothing, unlike tangible assets like property.
Cryptocurrencies have also been described as like pyramid schemes in the sense that, as they get more popular, and thus their value goes up, they need to become ever more popular to sustain that growth. But there’ll always be a limit and so they’ll fall, and falling values signal low confidence, which urges others to sell in a vicious spiral. Volatile booms and busts are thus the norm.
Naturally, those who have current investments in particular cryptocurrencies and NFTs will obviously say that they’re here to stay and that everyone should start investing in them too, because increased demand will increase the value of each coin out there, including in their wallets – to a price these investors might then decide to cash out on for something that’s less volatile, while you’re jumping on the boat when the price is high, and perhaps just about to plummet! So they’re not impartial financial advisors and it’s a case of ‘but you would say that though’.
When the wider markets crash, so do cryptocurrencies too because during such times, people turn to something like gold.
And the lack of regulation and cash reserves has meant that many cryptocurrency firms have collapsed and left their customers out of pocket.
Stablecoins are cryptocurrencies that are linked to some kind of fiat currency or something like gold, in order to stabilise their volatility. Yet they aren’t that stable – in mid-2022, TerraUSD and Tether, which are linked to the US dollar, fell to under $1 each!
Although not the only ones, cryptocurrency exchanges have been known to manipulate prices artificially by virtue of shutting down trading whenever they deem there’s ‘extreme’ selling behaviour. But who are these ‘centralised’ gatekeepers and arbiters to interfere whenever they decide that the markets are behaving ‘extremely’?(!) Why not just leave a cryptocurrency to devalue precipitously if the free market decides so? Governments are told to not interfere with the markets, yet private financial institutions will meddle with and obstruct the actions of their customers whenever it suits their own narrow self-interests. It’s like ‘don’t tell me what to do, but I’ll tell others what to do’ or it’s ‘I don’t want power centralised elsewhere, because I want it centralised around me’!
Essentially anyone can set up a cryptocurrency, and there has been a spate of sizeable scams like OneCoin. There have also been hacks on cryptocurrency exchanges and blockchains like Binance and the Ronin Network, where millions were lost. There was the collapse of the FTX platform, BlockFi and more. North Korea has stolen millions of dollars worth of various cryptocurrencies because it’s relatively low hanging fruit for them – hence it has funded an authoritarian regime too.
Although again not exclusive to cryptocurrencies but any kind of hyped-up ‘investment opportunity’ – wash trading, pump and dump, and rug pull, scams are common. Market activity is fabricated, stocks are artificially inflated, and investors are lured in then a business runs off with their money.
The death of the founder of QuadrigaCX left millions of dollars of cryptocurrency locked in a digital wallet to which (apparently) only he had the key to! If you lose your private key to your digital wallet, you’ll lose all the coins that were in it. One incident apparently lost someone half a billion dollars worth of Bitcoins!
How do we economically sanction, say, a warmongering State that uses decentralised cryptocurrencies extensively when the whole point of them is that no one should have the centralised control to inhibit transactions? The traceability of cryptocurrency transactions has improved over time but it still requires cryptocurrency exchanges to cooperate with applying those sanctions so that sanctioned States don’t use them as a way to continue trading with the rest of the world or funnel money in/out.
And like any other asset, it just mostly concentrates in the hands of a relative few – with a few cryptocurrency millionaires and billionaires, and the rest of the population with little or none at all.
Woof. Crypto is still a heavily evolving space regarding product, practice and regulation hence it’s hard to know how they’ll pan out in the future. This is all reflected in the volatility of their prices.