Cryptocurrency Concerns. What’s Going On?   Updated 2/14/22 (Scroll down to bottom)

By Whitman Knapp written Feb. 9, 2022

(Update. Whit’s comment to Y62 Communications Team member Bill Weber concerning the recent cryptocurrency criminal arrests in New York: hackers always exist, but the good news is that in this instance they were traced and arrested. The arrested hackers are alleged to have laundered 3.6 billion.)

The new year has not been kind to the cryptocurrency world. In January 2022, bitcoin and other major cryptocurrencies lost 50% of their value from the market high of $2.3 trillion in November 2021. Some of those losses have been clawed back, but much of the market has still lost over 25% of its value.

What happened? A number of factors stand out.

Probably the greatest negative impact on the market has come from China. First, China banned crypto mining. Taking advantage of sources of cheap electricity in China, vast computer farms which provide the foundational activity of crypto currencies (the mining or creation of new coins) were established in China over the past years. At its height in 2019, 76% of all bitcoin mining worldwide was carried out in China. Adding insult to injury, not only was crypto mining shut down, but the Chinese government has now banned all crypto activity within the country.

The Chinese shutdown of crypto mining has focused increasing negative attention on its tremendous use of energy. The amount of energy used to mine bitcoin in one month is equal to all the energy consumed in one month in Denmark. The rise of green and GSE advocates has now added pressure to curtail or stop crypto mining worldwide.

In much of the world the crypto industry has flourished, thanks to the absence of regulation. Now a number of countries led by the US and Europe are considering putting regulations in place to protect not only the consumer, but the country’s monetary system. Regulation could place a severe damper on crypto’s ability to operate as it has in the past, with near total disregard for normal market rules and constraints.

Concern over an impending rise in interest rates has also negatively impacted crypto’s valuation. Investors who had looked to crypto in search of “yield” are now returning their focus to the fiat world, where they can begin to earn at least some return on their funds, a happy change from the zero to negative interest rate environment of recent times.

Finally, the collapse of the much-touted Facebook cryptocurrency adventure, Libra, has shaken the confidence of even some of the most hard-core crypto brows. Libra was supposed to replace the current central bank-based fiat currency money system with a private blockchain-based stablecoin (my nomination for the greatest oxymoron of the century) money system. One consequence of this Facebook misadventure is that monetary authorities worldwide have been alerted to the danger of their money systems being controlled by a private enterprise, Facebook no less. In response, led by the Bank for International Settlement, the central banks of the world are now actively working to create their own digital currency based on their own fiat currency, known as the CBDC, central bank digital currency. More on this later.

Combined, all the above put a damper on the wild speculation and nosebleed increase in value that marked the crypto market in 2021.
What are the chances that the “good old days” of dizzying rises in crypto will return? The answer to that question will depend not only on how willing investors are to overlook the fundamental issues revealed above, but on how the investing public responds to a couple of emerging issues facing crypto.

Two new fields in crypto, DeFi and NFTs, have been the source of much of the increase in crypto activity and value, adding new tables to the crypto casino.

DeFi, or decentralized finance, has created a plethora of new coins, and now accounts for almost 80% of the crypto market valuation. These coins support DeFi activities such as payment, lending, and investing, traditional financial activities but without the historic intermediaries such as banks, brokers, or exchanges. These traditional financial activities are now conducted on blockchains facilitated by “smart contracts.” We will not go into my view that “smart contract” is the joint candidate, with “stablecoin,” for the century’s greatest oxymoron award. DeFi has proven open to hacking. On a distressingly regular basis significant DeFi hacks, accessed via holes in “smart contacts,” are coming to light, with investors losing major amounts of value. Net/net, there is increasing awareness that one of the areas of greatest growth of crypto activity may be built on feet of clay. NFTs (Non-fungible tokens) are cryptographic coins on a blockchain with unique identification codes and metadata that distinguish them from each other. They are bought, sold, and traded on crypto exchanges. They can represent assets as varied as real estate, comic book characters and digital art. Beauty is in the eye of the beholder. While there may be genuine use cases for digitalization of traditional assets, recent serious academic sponsored research is suggesting that here too, NFTs may have feet of clay and that the ownership of recently created NFT tokens may not, in fact, be non-fungible tokens.

The wild west activities highlighted above should not overshadow the fact that there are a significant number of important additions to the financial world coming from crypto technology. The most important of these, the CBDC, will, I believe, ultimately replace the vast majority of crypto currencies, and provide a sound basis for the world’s money system. There are, however, significant and fundamental issues which need to be resolved before CBDCs are enterprise ready. Questions of scalability, identity, privacy, security, maintenance of the two-tier banking system, and cross border interoperability are crucial issues to be resolved. But some of the world’s best minds in the scientific, academic and the financial communities have now turned their attention to these issues. They will be solved. Perhaps not tomorrow, but within a reasonable time frame.

Watch this space.

(To read Whit’s earlier essay on cryptocurrency, choose this link. His video interview with us is here.)

 

Update Feb. 14, 2022 (written Feb. 13)

Crypto hit the front page of the Sunday New York Times today – Inside the Bitcoin Laundering Case That Confounded the Internet – with what is hard to distinguish between a Bonnie and Clyde story and something out of a spy novel.

The press and the crypto twittersphere have gone into overdrive on this wild west story but ignored a key learning from all this excitement. Crypto and the blockchain world are not the shadow world often portrayed. While cryptocurrency is commonly linked to criminal activity, this example shows how it is, in fact, ill-suited for that purpose.

The original hack took place in 2016 when bitcoins with a value of approximately $4.6 million at that date, were stolen from one of the early crypto exchanges – Bitfinex. The Bonnie and Clyde couple arrested this week are not charged with the original hack – at least not yet – but with money laundering. With minor exceptions, the original hacked “money” was not moved until the end of last year, but once it was on the move it was all tracked very closely by the Feds on the blockchain, reminding us that an open public database – a blockchain – is a poor tool for illicit activities. Additionally, reading the Statement of Facts attached to the indictment – Two Arrested for Alleged Conspiracy to Launder $4.5 Billion in Stolen Cryptocurrency – Statement of Facts (justice.gov)– reveals that Bonnie and Clyde had an extremely difficult time converting bitcoins into fiat currencies at exchanges. It is at this point, in any hack or indeed in any crypto investment, that the difference between the crypto world and the fiat world becomes real, reminding us once again that you may have a fortune in the crypto world but when you try to realize that fortune in the real world, the world that we live in, your fortune may not be there.

 

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