Cryptocurrencies`: Fact or Fiction?

 My scepticism of crypto currencies is not born out of the recent drop in their value, although it does reinforce my long held view about this new class of assets. Back in 1983 when the cryptographer David Chaum first talked of electronic money he called 'ecash' few could have concieved the shape of things to come. In its current form the creation of the first crypto currency is credited to Satoshi Nakamoto back in 2009. He used the cryptographic hash of SHA-256 to record the 'proof of work' scheme which then got built into the blockchain which is an encrypted open ledger system that records transactions. This was the birth of Bitcoin, which remains the dominant crypto in the market place. 

In time alternative cryptos emerged and these are commonly called 'alt coins'. They use their own crypto hash schemes in their proof of work methodology and the subsequent block chains that record their transactions. With the emergence of crypto currencies a host of 'exchanges' have emerged where these assets trade and settle. These exchanges are also largely informal and unregulated as indeed the crypto class of asset is also unregulated. 

Crypto's vary in their pitch to the market place and in recent years some asset back cryptos have tried to create a niche for themselves. Indeed the crypto currency market has become sizeable engaging a plethora of supporters and doubters. In essence these crypto 'assets' possess the following features in varying degrees.

• Cryptos do not require a central regulatory authority and they derive their authenticity based off the openly distributed ledger under the mechanism of different blocks of transactions that form a chain. (hence the name block chain).
• Thus by architecture alone the block chain ensures the ownership is properly recorded and ensures the integrity that comes from traditional custodial services is more than replicated.
• The system set the total number of crypto units that can be issued, and if this total issuance has to be increased then what are the circumstances for additional units to be issued. In this sense the supply is not unlimited and putting a ceiling on the total issued units creates a sense of discipline to the crypto asset. 
• Proof of ownership is crypto encrypted in a manner that it cannot be disputed. Anyone tampering with the ledger would have to find a way to modify all the blockchain entries from the inception of the unit, which in a sense is impossible. (However, there are instances of cryptos being stolen from an exchange).
• The units can trade in multiple fractions allowing smaller holdings.
• The ownership which recorded to a registered and encrypted wallet is always there, the ownership of the wallet holder remains anonymous and in that sense the buyer and seller cannot necessarily be identified. 
• Unlike traditional currencies where the Central Bank of the country which has issued the currency is responsible for regulating the currency, crypto assets a total unregulated. 
• Crypto currencies are not backed by an underlying asset or by the taxing power of a government. Thus monetary interventions to protect a currency are absent in the case of a crypto currency.

Crypto currencies, while touted as a class of assets that will change the topography of the world financial system have many issues. 

1. Crypto currencies are not backed by any assets or the economic performance of an economy. At their inception they valued on the basis of the 'mining' costs, which the total computing power used to create the crypto. For bitcoin alone by end of 2019 the total energy consumption to maintain and update the blockchain was estimated at 7 gigawatts, which is equivalent to the total power consumed in Switzerland. Valuing bitcoin say at $30,000 based on the energy consumed is misleading as one could argue that the total energy consumed by online gaming consoles which is close to 75,000 gigawatts implies that an online gaming console should be 1,000 times more valuable than a bitcoin!

2. Based on the above argument there is no sensible way to value the intrinsic value of a crypto currency. 

3. While there is a new wave of cryptos being created where they are linked to an underlying asset such as gold, or silver these are at best marketing ploys. For instance a crypto linked to say gold raises questions of price correlation and custodial arrangements for the underlying asset. After all a crypto linked to gold will trade in close harmony with the price of gold. Linkage to say gold also creates issues of settlement in the event of settlement for cash, or better still for the asset as the crypto trades in fractions and the gold cannot be fragmented to the same fractions we see in cryptos. 

4. In 2021 total turnover of crypto trading was over $15.8 trillion of which it is estimated that criminal activities were estimated to be $14 billion. While this is a small percentage of the turnover it is in itself alarming since it represents only those transactions what ere accredited to known illegal addresses. It does not cover the transactions which escaped detection. 

5. It is suggested that given the lack of regulation and the architecture of crypto trading the amount of funds that are money laundered through crypto currencies would well be much larger than what is seen in the conventional banking system.

6. There is not doubt that cryptos are the choice means for serious criminals covering crimes such as ransom, drug trafficking and funding of more serious crimes. 

7. When the price of a traditional currency moves, up or down, one can identify measurable fiscal and monetary factors that cause these movements. In the case of crypto currencies there is no such relationship to the underlying economic factors and therefore its movement is entirely emotional. 

Conclusion:

One cannot deny that crypto currencies may well be here to stay. The more pertinent question is what will be the scope and shape of the crypto market. Clearly governments will either crack down on them, as have China and a dozen other countries, or while move to regulate the market. Eventually the leading economies of the world will move through their government agencies to control this asset class. The result of these actions will be that in time cryptos will begin to behave much in line with the traditional currencies. 

Further it is more than likely that the total cryptos issued which are over 1,800 different crypto currency types, will dwindle down to a handful of crypto currencies which will survive. Such adjustments in the market place will not be without their associated pain and financial loss.

Some central banks have moved to issue their own digital currency which is backed by the issuing central bank. This Central Bank Digital Currency (CBDC) is expected to be the major challenge to the current crypto regime we see in the market place. 

What is certain is that for the more sane investors the crypto market is something they would shun. This past weeks drop in their value, which wiped out over $900 billion of value in a couple days shows that the as one cannot explain such massive drops one cannot really explain the charm of an asset that is based on the energy consumed to create it?