Whether gold, silver, wild banknotes, greenbacks, checks, Federal Reserve notes, credit cards, money market funds, electronic funds transfers , smart cards or digital dollars, there is a revolution in the creation and movement of money every several decades that disrupts traditional markets. More than 19,000 cryptocurrencies and dozens of crypto asset exchanges created in the last 13 years alone represent the latest shiny financial objects in this continuing saga.
Interestingly, however, the general euphoria that often accompanies technological advancements has seemingly blinded investors, lawmakers, and policymakers to the red flags that have accompanied the explosion of the crypto industry. Investors and markets are now paying the price. Consider seven such red flags that should have prompted further scrutiny, regulation, or at least someone to throw a warning flag.
Red Flag #1 — Most money products and financial service delivery systems rely on the trust of a government, central bank or highly regulated financial intermediaries.
But since whoever “Satoshi Nakamoto” posted a message including a link to a whitepaper and mined bitcoin’s genesis block on January 3, 2009, its value has gone from a quarter of a penny in 2010 to a high of 68,000. $ in November 2021. All of this happened knowing that bitcoin has no underlying intrinsic value, has no government support of any kind, and has not experienced any intervening economic events that could explain rationally any increase in value.
Red Flag #2 — When inflation and interest rates reached 13.5% and 21% respectively in the early 1980s, securities firms created uninsured money market funds (MMFs), paying interest rates double digits to offer consumers an alternative to the 5.5% they could get from regulated banks. banks and S&L. As money funds took deposits away from them, growing by nearly half a trillion dollars over the next decade, a long list of banking, securities and money laundering laws got in the way. to prevent money market funds from offering such products.
Section 21 of the Glass-Steagall Act, for example, caught everyone’s attention because it made it a federal crime for a securities firm to engage in the business of taking deposits. A legislative and regulatory compromise has been forged. Similarly, in the 1990s there was much debate over the legal status of digital currencies like Mondex and Digicash, which attracted attention and opposition from agencies such as the Financial Crimes Enforcement Network. Cryptocurrencies seemed to have gotten a pass and largely avoided such scrutiny.
Red Flag #3 — The government benefits from seigniorage when it mints money. It is the difference between the cost of minting money and its value when it is distributed in the economy. The cost to consumers is zero. By comparison, cryptocurrencies such as bitcoin are expensive to mine, and the cost only increases as more miners compete and reduce each other’s chances of mining a coin without permanently gaining mining power. additional specialized computing and reliable energy sources. All of this makes the five-year average cost of mining one bitcoin, according to one report, to be around $32,000. Someone has to pick up that cost somewhere in the chain of ownership, making it a ridiculously expensive substitute for cash or investments.
Red Flag #4 – Solving complex mathematical puzzles (the proof-of-work model) is the key to mining cryptocurrency. Ironically, mathematical complexity is also the backbone of the encryption that forms the basis of digital signatures and just about every form of online security we rely on. A hacker’s ability to penetrate computer networks is directly proportional to the time, computing power and knowledge available to do so. Wouldn’t it make sense to carefully consider the implications of a business that relies on penetrating the kinds of mathematical puzzles that also protect our data?
Red flag #5 — According to a recent report that demonstrates the magnitude of the energy challenge created by crypto mining, the average US household consumes around 900 kWh of electricity per month, compared to around 155,000 kWh to mine one bitcoin. Although policymakers don’t seem to understand how proof-of-work cryptocurrencies would add significantly to global energy and environmental challenges, they finally got it.
A July 15, 2022 letter to the heads of the Environmental Protection Agency and Department of Energy from four U.S. Senators and two U.S. Representatives cites recent studies that suggest crypto miners’ electricity demands in upstate New York have increased annual electricity bills by hundreds of millions. of dollars.
The data also suggests that mining of the two biggest cryptocurrencies, bitcoin and ethereum, last year consumed electricity at an annual rate that exceeded that of the whole of the UK and created nearly 80 million tons of carbon dioxide emissions.
Red Flag #6 — The history of bitcoin and its founder, Satoshi Nakamoto, is unique enough to prompt its own set of caveats. But once the industry started churning out Dogecoins and Jesus Coins, it’s hard to imagine how policymakers who understand how money, banking, and commerce work wouldn’t have called a time. stop. Dogecoin was allegedly created by software engineers as a “joke”. This joke now has a market value of $9 billion. Jesus Coin sought to replace morally devoid cryptocurrencies with the unique benefit of providing global access to Jesus as well as forgiveness of sins through outsourcing. Although the founders may have joked, the market seems to have missed the joke.
Red Flag #7 – Crypto is all about money and investing – in short, it’s about caring for and nurturing other people’s money. The oversight and centralization of financial services and payment systems as well as the identity of who can engage in or own a bank, for example, are strictly controlled by law. But the creation, clearing, and settlement of crypto assets is completely unregulated. Even more problematic, these companies are concentrated and controlled by people in various places around the world who are not required to pass any litmus test to earn the privilege of keeping other people’s money. This has always been a recipe for disaster.
1960s rock band Manfred Mann talked about being blinded by light. In the case of crypto, that seems to have been what happened. Everyone was drawn to the sizzle and forgot to parse the steak rationally.
An assessment of what crypto is and how it should be regulated to maximize security and stability finally seems to be underway. Warren Buffet noted that “it’s not until the tide goes out that you find out who swam naked”. It’s not too late for policymakers to put on sunglasses, identify those who swim naked, and channel the most beneficial elements of the crypto business and its delivery systems into safe products and networks that make advance financial systems and benefit consumers.
Thomas P. Vartanian is the author of “200 Years of American Financial Panics: Crashes, Recessions, Depressions, and the Technology That Will Change Everything” and Executive Director of the Financial Technology & Cybersecurity Center. His new book, to be published in February 2023, is “The Unhackable Internet”.