The crash in Bitcoin and other cryptocurrencies transfixing global markets has intensified scrutiny of the claims made for these virtual currencies by their many enthusiastic proponents. Is it time to call time on the crypto craze or is there still some merit in crypto as a long-term investment?
When crypto bellwether Bitcoin slumped below $US20,000 recently, extending its losses since the record highs of last year to more than 70%, its most fervent fans on social media were consoling themselves with a logarithmic chart showing the many times it had variously been described as either a bubble or dead.
Certainly, there is almost a messianic zeal among the true believers in cryptocurrencies, which are a form of decentralised money based on a technology called blockchain, a type of digital public ledger that securely records transactions across computer networks without the need for verification by a third party.
The most ardent fans of cryptocurrencies often come to it with an ideological disposition against central banks and “fiat” currency, the money issued by sovereign governments that for the vast majority of people is what constitutes real money.
Many other fans, however, became interested in crypto not for political reasons, but for interest in the technology or simply the opportunity to make quick returns. And when you look at the price history of bitcoin, you can understand the impetus, particularly when interest rates were so low.
As little as 12 years ago, Bitcoin was worth virtually nothing. By late 2013, the price had rocketed to around $US1200 for one coin. Four years later, it had passed $20,000. Within a year, however, it had slumped all the way back down to $3000. From the COVID crash in equity markets, however, Bitcoin stormed back to reach record highs of nearly $67,000 in October last year.
Bitcoin’s popularity led to the creation of thousands of other cryptocurrencies, including the infamous Dogecoin, created by a couple of software engineers as a joke based on an internet meme incorporating the image of a Shiba Inu dog.
One of the creators of Dogecoin, Sydney-based Jackson Palmer, has since disowned the whole crypto phenomenon as “an inherently right-wing, hyper-capitalistic technology”. Palmer has even launched a webcast called Griftonomics which criticises the trend of celebrities openly endorsing such schemes for cash.
Real money being lost
All this might be funny but for the fact that real investors are losing real money trading Bitcoin and other cryptocurrencies.
In recent months, and particularly since central banks starting hiking interest rates to rein in runaway inflation, crypto has been in virtual freefall. Rarely has a supposed “solid asset” shown a greater propensity for going up by the escalator and down via the mineshaft. So much for “fortune favours the brave”, as Matt Damon told us.
We’ve seen crypto bust its boiler before, but this time something fundamental has arguably broken in the underlying plumbing. In May this year, Terra — a blockchain that lets users create so-called “stablecoins” linked to fiat money — collapsed. Stablecoins are digital tokens pegged to the value of traditional asset such as the US dollar. They were often used as safe havens for crypto traders during times of heightened volatility.
Then, a month later, the crypto lending platform Celsius Network froze withdrawals, citing “extreme” market conditions and leaving its 1.7 million customers unable to redeem their assets. In the US, state security regulators launched an investigation. Celsius has now filed for bankruptcy.
For most people, this is mind-boggling stuff. A totally unregulated wild west universe of computer-driven financial speculation by techno-nerds was seen to be threatening the very monetary system it set itself up against. As British-born TV comedian John Oliver quipped, this was “everything you don’t understand about money combined with everything you don’t understand about computers”.
While there are certainly respectable avenues to invest in these new virtual currencies, the truth is the total value of crypto assets has dropped to less than $1 trillion from $3 trillion in the space of months. US federal regulators say that since the start of 2021, more than 46,000 people have reported losing more than $1 billion in crypto scams.
The crypto criticism intensifies
It’s not surprising then that questions about crypto are mounting up, starting with what is exactly for? One of the biggest critics is Nobel Prize-winning economist Paul Krugman, who sees uncomfortable parallels to the subprime crisis of 2008, where small investors were fleeced by overly complex financial instruments that few people understood.
“There’s growing evidence that the risks of crypto are falling disproportionately on people who don’t know what they are getting into and are poorly positioned to handle the downside,” Krugman wrote in his New York Times column earlier this year.
“Still, crypto has been effectively marketed: It manages both to seem futuristic and to appeal to old-style goldbug fears that the government will inflate away your savings. So crypto has become a large asset class even though nobody can clearly explain what legitimate purpose it’s for.”
Microsoft founder and billionaire Bill Gates is another sceptic, expressing the common view that crypto is just another Ponzi scheme relying on the “greater fool” theory. In other words, the only way of profiting from it is to hope that someone more gullible than you will buy it for an even higher price.
Cryptocurrencies are not backed by an issuing authority. There is no associated income or underlying value. They are clearly not an inflation hedge, as has been shown in the past year. There is no reliable basis for valuation. And, as has been seen, they are unlikely to ever be a mainstream medium of exchange, given their extreme volatility.
There is also the small matter of the use of cryptocurrencies by terrorists, money launderers, illicit arms dealers, drug smugglers and other criminals. Recently, US Deputy Treasury Secretary Wally Adeyemo warned of bad actors supporting illicit activity using crypto amid suspicions Russia was resorting to crypto to circumvent financial sanctions over its invasion of Ukraine.
So what should investors do?
Given the volatility and uncertainty around cryptocurrencies, and the lack of back-up, it would seem foolhardy to invest significant capital in them. Perhaps they make sense as a speculative punt with play money, but beyond there?
Certainly, the tone of regulators around the world is one of extreme suspicion. In the UK, the Financial Conduct Authority has warned people it has no oversight over direct investments in crypto assets and non-fungible tokens.
In the US, the Securities and Exchange Commission has recently doubled its team responsible for protecting investors in crypto markets, warning that retail investors are bearing the brunt of abuses in this space.
The European Central Bank, meanwhile, has come out directly to say that crypto is unsuitable for retail investors and has urged European Union authorities to approve new rules for crypto assets as “a matter of urgency”.
Against that background, anyone wanting to invest their savings in crypto assets might want to speak to a financial adviser first.
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