Rishabh Sidana Year 12
In an ever-evolving modern economy, cryptocurrencies appear to have been the epicentre of this transition to the digital realm since the conception of Bitcoin in 2009. Their existence, however, has been one subjected to swathes of fluctuations over the years, from Bitcoin’s meteoric rise of 416% in 2020 (Binance, 2024), to widespread criticism of their handling during the FTX collapse. On one side the sceptical, among whom are Nobel Laureate Robert Merton (PBS, 2018), and JP Morgan Chase CEO Jamie Dimon (CNBC, 2024); they emphasise the illegitimacy of cryptocurrencies, with Merton discussing how their decentralised nature disqualifies them from being legal tender, one of the fundamental criteria of any currency. On the other are the advocates, among whom is former Binance CEO Changpeng Zhao, who argues that Bitcoin’s decentralisation enables it to overcome the barrier of borders, hence permitting for globalised liquidity. This essay aims to explore the intricacies of traditional banking and financial systems, whilst evaluating the potential for cryptocurrencies to open up these otherwise rigid structures. It will further evaluate the socioeconomic impacts of this step taken towards liberalisation.
The Allure of Cryptocurrencies
The primary factor in the meteoric rise of cryptocurrencies such as Bitcoin and Ethereum is the very attribute that has been subjected to controversy, decentralisation. However, it is possible to deduce why decentralisation has appealed to many investors. Whilst traditional banking systems are able to provide an extensive physical presence through nationwide branches, cryptocurrencies possess near-unparalleled accessibility; they offer investors the ability to carry out globalised transactions from anywhere with an Internet connection, in HICs and LICs alike. One such measure used to quantify the global use of cryptocurrencies is the annual Global Crypto Adoption Index; as shown in the map below, increasing adoption of crypto has begun in countries in almost every continent, from the USA in North America, with an index of 0.540 to Nigeria in Africa, with an even higher index of 0.694. Hence, once adoption of crypto increases on a widespread scale, it may be so that it becomes the preferred medium of exchange for international transactions, due to the welcome absence of the red-tape and high transaction fees currently implemented in traditional banking systems.
(Chainalysis, 2024)
In some ways, cryptocurrencies may be perceived as the epitomisation of Adam Smith’s free market ideology, albeit going one step even beyond this. Whilst Adam Smith favoured a ‘laissez faire’ state attitude in regards to interventions in the market, cryptocurrencies have no state intervention whatsoever in regards to their usage. Some may even argue that cryptocurrencies are not only the epitomisation of a free market, but of democracy as a whole; the majority of cryptocurrencies are open-source projects (Montague Law), allowing regular investors to have trust in the handling of their money, whilst also facilitating improvement and maintenance of their function. This posited notion that cryptocurrencies epitomise democracy is further supported by their inclusivity. As opposed to the significant barriers and administrative difficulties faced in traditional banking systems, such as credit checks, which can have wider repercussions on an individual’s life, cryptocurrencies adhere to no such procedures. This leads to widespread accessibility, particularly necessary for those whose circumstances impede their ability to access traditional banking services.
Another advantage of the implementation of privately-issued cryptocurrencies is the prevention of government complacency by provision of competition. The challenge to the government-dominated monopoly would act as a deterrent of sorts towards irresponsible fiscal behaviour, due to the presence of another option. Surprisingly, however, competition would also, to an extent, lighten the burden on the government’s shoulders, as the presence of alternative currencies could act as a reliable backstop in the case of government failure. For example, decentralised cryptocurrencies would prove an invaluable asset in hyperinflation-ridden economies such as Zimbabwe. Instead of widespread economic pain, there would be a feasible alternative for the public to utilise as a precautionary measure when implementing large-scale economic reforms. This competition would also be a mutually beneficial one, with cryptocurrencies and centrally issued currencies complementing one another, rather than replacing; as Friedrich Hayek stated, “Money is the one thing competition would not make cheap, because its attractiveness rests on it preserving its ‘dearness’.” (Forbes, 2012)
The general public appear to be drawn into cryptocurrencies due to these very reasons - some view them as an opportunity to rebel against higher authorities, whilst some view them as an opportunity to avoid excessive transaction fees.
Autonomy is achieved - at what cost?
However, in this quest for regaining autonomy in the economy, deposit-holders may be disregarding the benefits of state control that they forgo, and only in their absence do we realise their true importance. A pertinent example is that of deposit insurance; the very umbrella of government control that some believe to be constraining to economic growth and globalisation provides the very safety net that acts as a guarantor for investor welfare. Take, for example, the FDIC in the United States and the FSCS in the United Kingdom, who insure up to $250,000 (FDIC, 2024) and £85,000 (FSCS, 2018), respectively, of bank deposits. Both the aforementioned organisations have, however, quelled any hope of insuring cryptocurrencies for the near future, with one crucial consequence to this. In the case of ‘default, insolvency or bankruptcy of any non-bank entity, including crypto custodians’ (FDIC, n.d.), the state will take no measure in protecting deposits.
Consequently, the absence of government intervention in regards to the handling of cryptocurrencies has contributed to the rise in financial crime, from petty fraud to large-scale exploitation, such as the deception conducted by Sam Bankman-Fried in his running of the FTX (The Guardian, 2024). These activities appear counterintuitive to the founding purpose of cryptocurrencies, as the autonomy that was believed to be conducive to profit for all investors, leads to those with malintent exploiting the funds of regular investors. As has been the case for centuries, strategies of this nature can only result in a rise in inequality, as the rich become ever richer at the expense of the lower and middle classes.
Considering the digital nature of cryptocurrencies, an additional investigation into the cybersecurity threats facing cryptocurrencies, and their economic repercussions, is also warranted. Similarly to the aforementioned issue regarding large-scale financial crime, cybercrime is also an area wherein the preventitative ability of investors is limited to an extent. In the present day, where technological warfare is becoming an increasingly common method used in quasi-proxy wars between countries, the risk facing digital wallets is immense. To fully understand the danger presented, a brief understanding of the mechanism behind cryptocurrencies is required. Put succinctly, in order to access a digital currency and process transactions, an alphanumeric code called a key is needed, which is typically stored locally. Now, if this device were to be hacked, the hacker would be able to access the unique key, hence gaining access to the crypto portfolio as well. Once again taking into consideration that cryptocurrencies are decentralised, the victims of such criminal activity are provided no respite by the state. Furthermore, this unchecked cybercrime may lead to money being funnelled to the underground economy, reduced taxation revenue (since the underground economy is undetected by state authorities), and consequently increased inequality (since taxation-funded state benefits and other public goods are the primary means of wealth redistribution to the lower income groups).
Another concern that arises for holders of cryptocurrencies, especially among the lower and middle class investors and deposit-holders, is their volatility. To an extent, empirical evidence attests to the validity of this concern; as shown in the below chart, 10-Year volatility of Bitcoin consistently measures at approximately 5 times the volatility of gold (Forbes, 2024). A particular reason for this could be the ‘novel factor’, as immature investors are more likely to act upon short-term stimuli in the market than those familiar with such fluctuations. In the long-term, however, irrespective of whether these stimuli are acted upon, the final outcome is somewhat similar. Ergo, this is another element to be considered in the usage of cryptocurrencies: regarding economics as a social science requires looking beyond purely quantitative growth and profit, and also considering the extra mental toll this may have on consumers. This presents a stark contrast to the sense of security that comes inherently with currencies used in traditional banking.
(Forbes, 2024)
Regarding this notion of accounting for the emotional toll upon consumers in holding cryptocurrencies, the painful absence of authority can also be felt through the overwhelming lack of customer support. As opposed to traditional banking systems,wherein teams are dedicated to customer support, be it problems accessing a portfolio or recommending financial products tailored to the needs of an individual, very few crypto providers offer the same level of services, if any. This may act as a deterrent to new investors, left seemingly to fend for themselves in an insecure, tumultuous whirlwind of a market.
Finally, an equally severe challenge regarding cryptocurrencies arises after the holding stage, when investors desire to liquidate.The two key determinants of a currency’s liquidity are its abundance and global demand, both of which encumber cryptocurrencies. Considering that all cryptocurrencies account for merely 0.56% of global money supply (Investopedia, 2024), scarcity is evidently a problem; the aforementioned volatility of Bitcoin also suggests that global demand for cryptocurrencies is subject to large fluctuations. Both these factors combined lead to decreased liquidity in comparison to traditional currencies, and increased risk of liquidity crises in periods of manic. For example, when its rescue prospects fell through, the FTX exchange placed a hold upon all withdrawals (The New York Times, 2022). Crises of this nature could prove catastrophic in the case that cryptocurrencies are implemented on a widespread scale within traditional banking systems, with pensioners and savers forced to live in a constant state of worry regarding the stability of their accounts, and their futures. All of the above factors have led to Bitcoin being termed a speculative investment by some, unable to qualify as a store of value.
What is the way to proceed?
The aforementioned drawbacks of cryptocurrencies emphasise the necessity of some extent of state regulation to be implemented, particularly for the preservation of investor security. A venture that has been undertaken by an increasing number of countries globally is Central Bank Digital Currencies(CBDCs). These are a form of digital currencies that preserve most of the advantages of cryptocurrencies whilst effectively mitigating the other risks associated with them. These digital currencies are pegged to the value of the cash currency, and are all issued by a central bank. In addition to reliability, another key benefit of the issuance by a central bank is the ability to track all transactions on a ledger, hence reducing financial crime due to the loss of anonymity. This type of currency has been implemented by several countries, from the Digital Euro across Europe (European Central Bank, 2021) to the Digital Rupee and e-CNY in India (Saleem, 2024) and China (HKMA, 2024), respectively.
Closing Remarks
To conclude, cryptocurrencies are a growingly prominent option in a global economy with abundant opportunities, however bringing with them a vast array of risks and caveats. What this essay is arguing, however, is that the extreme apprehension with which governments have regarded cryptocurrencies may prove equally detrimental to economic growth. With this apprehensive attitude, we risk exaggerating the disadvantages and disregarding the indubitable benefits of such currencies. In fact, the attitude of some state policies, such as the aforementioned policies of the FSCS and FDIC, and the rejection of cryptocurrencies as a method of deposit or repayment for mortgages (The Telegraph, 2021), border more on prohibitive rather than apprehensive, seemingly alienating cryptocurrencies as an investment route. Sustained, stable growth of cryptocurrencies, necessitates regulation, but also acceptance as a medium of exchange. For maturity in investors to develop, it is a prerequisite for maturity to first develop in the government, and that can only be achieved by some extent of normalisation in attitudes to cryptocurrencies. A likely consequence of such integration into regular activities will be a transition away from entirely decentralised cryptocurrencies to fiat-backed stablecoins and CBDCs in stable economies, and an incoming era of dominance of ‘unbounded crypto’ among crisis-ridden economies.
Referencing Style: Harvard
Word Count (Excluding references and titles): 1967
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