Electronic transfers

Cryptocurrencies Must Die – NRI Affairs

After the incessant hype about Bitcoin and other cryptocurrencies such as Ethereum, Solana, Dogecoin, LUNA, etc., over the past two years, we are now witnessing their complete collapse. The hype was mainly driven by dramatic increases in the valuations of all major cryptocurrencies. Bitcoin had risen from around $4,000 to $64,000, or sixteen times more, in 20 months. Other cryptocurrencies have seen even more ridiculous price increases over the same period – Ethereum has gone up 50x, Solana has gone up 500x and LUNA has gone up 1000x. Now these cryptocurrencies are collapsing . Bitcoin fell 55%, Ethereum over 60%, Solana 85% and LUNA went all the way to 0.

So how do you make sense of these complex and mysterious things that have seen their combined valuations reach into the trillions of dollars? And are they being touted as the future of currencies in the digital age? Are these just highly speculative Ponzi schemes? Or do they have a legitimate use in a world where digital transactions are increasingly prevalent?

Let’s start by looking at the rationale for having cryptocurrencies. In theory, they are supposed to allow electronic payments without an intermediary, ie peer-to-peer cash transactions. The problem with transferring money electronically between two parties is how to determine the balances after the transaction. To start, the party sending the money must have the required amount. After the transaction is completed, the amount must also be deducted from the balance of the sending party and added to the balance of the receiving party. We actually have digital money that’s been working for decades, and they’re working quite well, dealing hundreds of thousands of transactions per second. Debit and credit cards, wire transfers, UPIs, and digital wallets all serve this function. But all have central intermediaries, in most cases banks, to determine and adjust balances.

So what is the problem with such intermediaries? After the 2008 financial crisis, the Western banking sector collapsed. Western central banks have undertaken massive money printing through quantitative easing to revive and support the banking sector and the economy as a whole. This has led to a collapse of trust in big banks among much of the population and fear that this money printing will devalue the fiat currencies of major economies. Cryptocurrency was supposed to solve these problems by enabling digital transactions without intermediary banks and thus getting rid of the need for banks, at least in the minds of their proponents. The problem of currency devaluation has been “solved” by limiting the supply of cryptocurrencies (Bitcoin is limited to 21 million coins) and removing the role of central banks in money creation.

So how are these currencies created? It has been proposed that these currencies are created purely algorithmically through a process called “digital mining”. As we immediately see, this objective itself is extremely problematic from a political point of view. The role and sovereignty of the state over its currency and money supply is sought to be eliminated and replaced by private entities. Also, “digital mining” requires powerful computers and tons of electricity to run them. Thus, people with increasingly powerful computers capable of buying very large quantities of electricity would have the monopoly of monetary creation, replacing the State in this role. This libertarian dream is the driving force behind cryptocurrencies, with many of its core proponents subscribing to libertarianism. Libertarianism is an American far-right political philosophy that opposes the role of the state except for the maintenance of public order and the protection of private property.

Let’s go back to the problem of how Bitcoin and other cryptocurrencies operate without central intermediaries. They deal with the problem of checking and maintaining balances by making them public but under a pseudonym. Thus, you are no longer “you” in the crypto world. Unlike traditional banking systems, there is no KYC here. Instead, you are represented by a sequence of very long computer-generated random numbers, acting as your pseudonym. Numbers are randomized to ensure anonymity. And a record of everyone’s balances is placed in the public domain but identified by these pseudonyms. This public register is called the “blockchain”.

When a transaction is made between two parties, the blockchain is reviewed and updated to make the necessary credit and debit balances. But since the blockchain is public and there are no central intermediaries, how does it ensure that someone is not tampering with transactions? Or just add money to their own balances?

This is where the notion of “mining” comes in. Transactions are verified by solving cryptographic problems (essentially complex mathematical problems using computers). The nature of these problems is such that they require an enormous amount of computation time and resources to solve. But once solved, anyone can check the solution. Miners are incentivized to do this by rewarding them with cryptocoins each time they successfully solve the cryptographic verification problem – thereby creating or “mining” new coins. Thus, a huge amount of computing resources, electricity and time has to be spent to verify transactions and mine new coins. It is estimated that the Bitcoin network alone consumes as much electricity as a medium-sized country. And it can only process between 4 and 7 transactions per second, compared to credit card networks, which handle tens of thousands of transactions per second. So, in our time of global warming, we’ve supposedly built a system of the future that wastes a ton of electricity and is orders of magnitude slower than systems that have been around for decades.

Another problem is that since there are no trusted intermediaries, cryptocurrency transactions made by mistake or through fraud or theft through hacking attacks cannot be undone. There are no authorities or mediators to complain to!

Given these issues, cryptocurrencies cannot really be used to transact online. Moreover, as we have seen, their prices fluctuate wildly, which makes them useless as a store of value or as a medium of exchange. They don’t even act as inflation guards. As we have seen in these times of high inflation, cryptocurrencies have fallen sharply in nominal terms, let alone in real terms. This was one of the main stated motivations for creating them in the first place – to hedge against inflation caused by the massive printing of money by central banks. There are many stories of vulnerable people from countries with high inflation rates, such as Argentina, Nigeria, and Pakistan, who invested their savings in stablecoins (cryptocurrencies advertised as being pegged to the dollar) to hedge against inflation, then lose everything.

So what can cryptocurrencies accomplish? Due to the anonymity they provide through the use of pseudonyms, they can be used for criminal activities such as demanding ransom after hacking attacks (ransomware attacks) and for money laundering and tax evasion.

The other category of things they are widely used for is Ponzi schemes. These schemes, as with all Ponzi schemes, are financial frauds that earn initial investors high returns by taking funds from new investors. They inevitably collapse once they run out of gullible new investors, and hence their flow of new funds. With governments and central banks around the world not acting fast enough to fight these “currencies”, they have remained outside the scope of financial, banking and stock market regulations, which protect people from Ponzi and other predatory schemes. This has provided enormous opportunities for all sorts of financial entities, including hedge funds and venture capitalists, to pour billions of dollars into this space to reap supernormal profits through financial speculation and such Ponzi schemes.

One such scheme caused two cryptocurrencies – LUNA and TerraUSD – run by the Terra Foundation to go bankrupt last month, evaporating more than $50 billion. And yet these schemes are not only allowed to continue, but are actively touted by all manner of celebrities such as Kim Kardashian and actor Matt Damon, tech billionaires such as Elon Musk, Twitter founder Jack Dorsey and other internet influencers. These influencers are either paid huge sums to market these cryptocurrencies or are given early access and cash-in once the cryptocurrencies get hyped and rise in value.

Cryptocurrencies are like the cancers of financial systems. They serve no useful purpose, suck up huge amounts of resources like electricity and computing power, and have enabled all sorts of illegal activities. They have created a multi-trillion dollar industry that allows powerful financial entities such as hedge funds to engage in predatory activities, sucking people’s life savings into Ponzi schemes. Governments around the world must recognize and address these risks. In this regard, China has taken the initiative to ban all cryptocurrency mining and transactions. The Indian government, having talked about banning them, now seems cold-blooded and would seek to regulate and tax them as legitimate financial instruments. This cancer should not be regulated but should be eliminated.

While banning cryptocurrencies, China has also launched a “Central Bank Digital Currency” called e-Yuan or the Digital Yuan to meet the legitimate needs of its burgeoning digital transaction space. Central bank digital currencies (CBDCs) should not be confused with cryptocurrencies. Unlike cryptocurrencies, CBDCs are largely backed by the state, with the central bank acting as an intermediary and scaling up to thousands of transactions per second without the need for hugely expensive digital mining. As for cryptocurrencies, they must die!

First published on dialectically.substack.com.

Follow NRI cases on Facebook and Twitter and YouTube.

Advertisement