Pratip Kar

I was debating whether to retain the title of the piece, or change it to “Down the Rabbit Hole” because the brave new world of bitcoins and cryptocurrencies (for this piece, I will call the two loosely as Cryptos) we will enter, is strange, confusing, defies common sense and logic, but hard to escape. While Bitcoins may have got the geeks and less than 40 age group excited, what about the economists? Nouriel Roubini, a well known US economist, appearing before a US Senate Committee on Banking in October 2018, called Bitcoin “the mother or father of all scams and bubbles” and blockchain, the most “over-hyped — and least useful — technology in human history.” Nobel Laureate Paul Krugman debating on Crypto on November 3, 2018 (video available on YouTube) said the worth of Cryptos depends on what people decide; if people decided it is worthless, as there is no backstop, whole thing can drop to zero.

The US Federal Reserve’s Chairman, Jeremy Powell views these as “really speculative assets.” Despite such strong views, going by the media reports and the websites of Cryptos and the broadcast of the Crypto exchanges globally, one would tend to believe that Cryptos have created a global mania, and the number of people jazzed about these is increasing.

A rational prognosis of whether it is the spring of hope, or the winter of despair, for cryptos, is not easy, for one has to tread between two strong irreconcilable and antithetical views and we must necessarily look only at hard, unassailable facts.

A few hard facts

Cryptos and the likes –

1. are not tangible assets like gold, silver, metals, and though called currencies, these are not fiat currencies like the rupee, pound, dollar. These are complicated computer codes, or hashing algorithms, which are beyond the comprehension of lay persons. To accept these as currencies requires a paradigm shift in our thinking;

2. are not legal tenders, guaranteed or value underwritten by a Central Bank, or the State. So unlike the fiat currencies, Cryptos have no backstops. One may say these are a sort of community currency; its value depends on what the

community says. Recently El Salvador recognised Bitcoin as a legal tender. The IMF is now putting pressure on the country to revoke the recognition;

3. are not issued by any Central Bank. Cryptos, come into existence through a highly energy intensive process called mining, which requires an enormous network of large number of high end computers forming the blockchain which forms is the corner stone of Cryptos;

4. are unregulated. No government, Central Bank, or regulatory body in any country, regulates these. Regulators are only providing broad hints of their intent to enforce regulations; no country except China has banned it. India has been trying to bring a law but has postponed it for the second time. boom and sell dreams. The absence of a regulator may make dabbling in Cryptos exciting; but it is giving rise to cunning businesses attempting to piggyback the crypto boom;

5. are exposed to scams. For example a digital currency based on the Netflix series “Squid Game” soared in value before collapsing dramatically in a few weeks as its promoters quickly pulled out their funds, causing a loss of several million dollars to investors. It was shut down by US SEC:

6. are traded on exchanges which are at best trading platforms, and unlike stock exchanges have no trade guarantee mechanisms or risk containment measures; this exacerbates the inherent riskiness of investments;

7. are inherently volatile with no economically or financially sound explanations for the frenzied volatility. Bitcoin price veered around US$ 60k+ in September 2021; it came down in a roller coaster fall to UD$ 40K+ in December 2021 and is currently trading around US$ 36K+ - impacted by the Fed monetary policy.

An agnostic prognosis

Let me try a “reasonably agnostic prognosis” of the immediate future of Cryptos.

1. The level of usage of a currency determines the confidence people have in the currency. For example the US dollar, can be spent almost anywhere in the world. Despite the surrounding hype, the Cryptos are nowhere even close to wide acceptance and acquiring the same level of confidence of the mainstream fiat currencies.

2. Though Mr/Mrs/Messrs Satoshi Nakamoto had envisioned Cryptos to be above the trust and support of traditional institutions like the Banks, and the US Fed, the behaviour of Crypto prices and the sell off in the past few days before

and after the Fed’s monetary policy announcement, only shows that it would be height of ludicrousness to expect Cryptos to remain insulated from traditional policies which influence financial markets.

3. As Cryptos are risky assets, higher interest rates across the yield curve make risk assets like Cryptos relatively less attractive against higher risk-free returns in new bond positions. That is amply demonstrated by the Crypto prices after the US Fed announced that possibility of rate hike in March 2022.

4. Sudden speculative frenzy may be sparked off by deliberately designed statements on Cryptos by some idiosyncratic super billionaires.

5. Statements by regulators in the US and other developed countries on fresh thrust towards regulation will have an impact on Crypto prices.

6. Banning Cryptos is unlikely to be exercised in any major market.

7. Interest of mainstream companies across industries is expected to remain tepid, though there will be continuous misleading statements and hyped talks from Crypto exchanges. Wait till large companies actually invest.

8. The power generation infrastructure for mining Cryptos and Blockchain consumes enormous amount of energy. Despite the glib talk and Enviromment and Social Governance (ESG) messaging by the Bitcoin mining companies, conscientious investors may be constrained from supporting Cryptos.

9. A catastrophic security breach of the blockchain protocol undermining the confidence in the technology, may wipe out all the data in Crypto wallets.

10. Bitcoin market is reportedly highly centralised. According to Scott Galloway (@profgalloway) “top 2% of accounts own 95% of the $800 billion supply of Bitcoin and 0.1% of Bitcoin miners are responsible for half of all the mining output.”

The best strategy for investors would be to protect their nest eggs and not attempt to chase ephemeral gains from a fictitious asset which has no basis in the real world.

The writer was with the Securities and Exchange Board of India from its inception. He was the organisation’s Executive Director for 14 years from 1992

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