If you were worried about your savings at a time of financial uncertaintyâsay, the looming threat of inflationâwould you hand your money over to Elon Musk?
True, the Tesla founder is a brilliant investor and worth a mint, but he is also volatility itself, prone to strange, sudden shifts of opinion. And the fact is if, in recent weeks, you put your money into Bitcoin, a cryptocurrency, you were effectively putting your money into Musk, whose many whimsical tweets and off-handed remarks about cryptocurrencies like Bitcoinâin which he is a major investorâhave helped send them seesawing in value. With his tweets, Musk is âliterally making and destroying small fortunes 280 characters at a time,â New York University marketing expert Scott Galloway told CNBC this week.Â
That, in turn, is proof of what some financial authorities have long been saying: When it comes to being a stable hedge against inflation, Bitcoin and other cryptocurrencies are about as safe a bet as going to your local convenience store and buying a lottery ticket. That became doubly clear in recent weeks when China abruptly announced it was banning its banks from bitcoin transactions, again sending the price plummeting.
âIf the value of a cryptocurrency can rise or fall by 30 percent because of a change in the stance of Chinese financial regulators or a Tesla announcement, then âreliableâ and âinflation hedgeâ shouldnât appear in the same sentence,â said Barry Eichengreen, an economist and monetary historian at the University of California, Berkeley.Â
Sure, cryptocurrencies tend to be deflationary since theyâre not tied to central banks that print moneyâand there is a lot of it being printed now to keep major economies afloat after COVID-19. Global stocks and futures have fallen as rising inflation concerns suggest the Federal Reserve and other central banks may have to raise interest rates. U.S. consumer prices climbed in April, the greatest jump since 2009.
That, on the face of it, might make cryptocurrencies seem attractive as a hedge. But there are so many other problems that make them hot potatoes as market betsâas evidenced by the shift away from cryptocurrencies and into gold in recent days, resulting in a nearly $1 trillion drop in cryptocurrency valuations by mid-week. Just the name âcryptocurrencyâ is an indication of how dicey Bitcoinâs value is: Divorced from real money and part of a decentralized trading system largely controlled by a few large and mysterious investors, it has no monetary value other than what the market places on it day by day, and that, in turn, is based on a complex system known as blockchain, a type of âdistributed ledger.â (More on that later.)Â
But cryptocurrencies arenât going away eitherâon the contrary, they are helping revolutionize finance altogether by threatening to eliminate traditional âmiddlemenâ in transactions, whether that be private banks, lawyers, or even central banks.
As a result, central banks are trying to keep up, seeking to outpace cryptocurrencies with a new competitive concept, âstablecoins,â which the United States, China, and other major central banks are now developing. These are digital currencies that are like crypto coinage in some ways, but instead of being decentralized like Bitcoinâwhich is not overseen or regulated by governmentsâthey are fully backed with safe and liquid assets in a domestic currency. Currently, some 80 percent of countries surveyed by the Bank for International Settlements are studying versions of stablecoins or what have become known as âcentral bank digital currencyâ (CBDCs), led by China and Switzerland.Â
In a speech last August, Federal Reserve governor Lael Brainard noted how the emergence of Bitcoin in 2008 led to the idea of stablecoinsâand that, in turn, âhas intensified calls for CBDCs to maintain the sovereign currency as the anchor of the nationâs payment systems.â
Yet to a degree few authorities seem to understand, central banks are in a desperate race with crypto-innovators, one they may even eventually lose. This new challenge has risen in a matter of months: Since 2013, the value of all cryptocurrencies in circulation has soared from $1.6 billion to more than $1.6 trillion, according to CoinMarketCap, a market tracking company.
And about $1.4 trillion of that value was added only in the past year.Â
âTheyâre reinventing what finance is, and itâs sort of going under the radar of the establishment,â said Carol Alexander, a cryptocurrency expert at the University of Sussex in the United Kingdom. âTheyâre not using standard products. Theyâre not using standard trading protocols. â¦ Itâs a revolution led by young people, computer science geeks, and they talk a million miles an hour.âÂ
This is creating something close to panic in Washington and other capitals. Governments are concerned as cryptocurrency trading expands, many traders are evading taxes. And as cryptocurrency traders increase, they are moving to cryptocurrency exchanges like Binance, the number one exchange in the world, which was started in China but then fled to the crypto-accommodating Cayman Islands. On Thursday, the U.S. Treasury Department announced it is adopting new policies to crack down on cryptocurrency markets and transactions, saying it will require any cryptocurrency transfers of $10,000 or more to be reported to the Internal Revenue Service. And new Securities and Exchange Commission chairperson Gary Gensler, an expert who taught a course on cryptocurrency at the Massachusetts Institute of Technology (MIT), has indicated heâs considering a whole new regulatory framework. Bitcoin shares were hit yet again on Friday when Chinese authorities called for a crackdown on mining and trading of the cryptocurrency.
The success of cryptocurrencies has also spurred an eagerness worldwide to shift to digital currency. The trend has been accelerated by the COVID-19 pandemic, which has driven home the increasingly antiquated nature of cash money. The problem became clear over the past year as governments failed to transfer relief money to poorer segments of the population that lacked credit cards or bank accounts. âThe COVID-19 crisis is a dramatic reminder of the importance of a resilient and trusted payments infrastructure that is accessible to all Americans,â Brainard said last August, announcing her support for a joint study of CBDCs by the Boston Federal Reserve and MIT. All these distribution problems could be solved, Eichengreen noted, with âa Federal Reserve-issued electronic wallet into which digital dollars could be deposited.â
The problem is worldwide. âThere are some countries where commercial banks put a sign on the door: âCash not accepted here,ââ said Tommaso Mancini-Griffoli, a division chief in the International Monetary Fundâs (IMF) monetary and capital markets department. âSo thatâs a sign of the incredible pace at which cash use is declining in some countries.âÂ
Money, of course, can be based on any agreed-on source of valueâas what happened with gold. As a rare, attractive metal that doesnât corrode, gold willy-nilly assumed the role of money over many centuries because societies agreed to assign common value to it. Many investors are placing value on Bitcoin because, like gold, it is also rareâthere are 18.7 million bitcoin in circulation, and only a total of 21 million are available to be tradedâand because it hasnât been hacked thanks to its secure blockchain technology, which requires âminersâ of Bitcoin to use enormous amounts of computing power to verify transactions. This is known as âproof of work.â
How does âproof of workâ work? Blockchains consist of âblocksâ of data that are âchainedâ together as a computerized ledger of transactions. This cannot be altered by hackers or criminals since each block has a time stamp that creates an irreversible chronology of the inputted data. All users collectively retain control, and only those with the necessary computing power can take part. Any tampering would be easily observable: Every computer involved, called ânodes,â contains the entire history of all Bitcoin transactions, so if one user tries to falsify a transaction, all the other nodes would be able to cross-reference one another and discover the false information. Thus, blockchain constitutes a new form of shared value or money that is valuable because it cannot be breached or questioned. It is, in a way, digital gold.
But in the case of Bitcoin, that also means huge amounts of electricity are used to âmineâ it on the internet. By the IMFâs estimate, the millions of calculations needed to mine Bitcoin amounts to more than the annual energy use of Chile. As a result, even Musk has raised concerns about climate damage from the fossil fuel usage necessary to run and cool down these giant computer systems. (This is one reason Musk has taken the market on a wild ride in the last few weeks: First, he announced Tesla would accept bitcoin as payment for carsâa huge breakthrough for cryptocurrency. Then, he did an about-face and said Tesla has halted purchases with bitcoin due to concerns over the ârapidly increasing use of fossil fuels for Bitcoin mining.â)
Yet Bitcoin is already an aging technologyâin some ways the dinosaur of cryptocurrency, even though it remains the largest cryptocurrency with a recent valuation of more than $1 trillion. Newer types of blockchain cryptocurrencies, like that employed by Ethereum, donât use electricity because they are based on âproof of stakeââhow much money investedârather than âproof of work.â Unlike Bitcoin, which is merely seen as digital gold to hold onto, Ethereum is also a blockchain-based platform for developers to build and operate apps that offer âsmart contractsâ for traditional financial products, like insurance or loans, without the need for intermediaries like brokerages or banks. Ethereum and other so-called public blockchains also offer ânonfungible tokensâ (NFTs), which have allowed artists, musicians, and even baseball card collectors to sell directly to the public without intermediaries like banks, record labels, publishers, or lawyers.Â
âThis is where the real threat to banks is coming fromâand to lawyers and insurance companies, all the main establishment greedy fat cows,â Alexander said. âThereâs no stopping it now.â
Alexander and other experts say all this innovation is plainly where the future of global finance lies. âIt feels like crypto is close to ready for the mainstream in a way that it wasnât even four years ago,â Ethereumâs creator, Vitalik Buterin, told CNN earlier this week. âCrypto isnât just a toy anymore.â
In the past year, Ethereum has gained about 1,600 percent in market value compared with Bitcoinâs 300 percent, according to the Motley Fool, a market analysis firm. In April, the European Investment Bank, the lending arm of the European Union, used Ethereum technology for the first time to issue $121 million in digital bonds.
Griffoli and other experts say cryptocurrency and its underlying technology are helping to change the way governments and central banks think about the nature of money. Their solution: stablecoins. âStablecoins have many of the advantages of crypto assets in the sense that you can transfer them easily digitally peer to peer, but they also have some advantages of fiat currency, i.e., stability,â Griffoli said. âThe promise is for these to be more stable than crypto assets.â
The argument central banks make is, as currently constituted, private distributed ledger technology cannot be fully relied on without assurances that in a crisis, the holder of cryptocurrency assets will be recompensed if the issuer goes bankrupt. Central banks can offer such insurance as well as the liquidity necessary to make good on the assets. In addition, privately run cryptocurrency is inefficient as a payment system because many different computer servers are involved. If, instead, central banks run the technology with just a few servers owned and controlled by central banks, payments can be made far more swiftly. Such a new kind of network would also allow users to âprogramâ money in a way that is not possible now. Currently, payment systems run by central banks require an intermediary, say a bank, between buyer and seller. But digital ledgers could put both payment and delivery for purchase of a stock on a blockchain, where the transaction happens instantaneously with no need for an intermediary.Â
Itâs not just banks that could be cut out of the financial system. In an April 14 article, Martin Enlund of Denmarkâs Nordea Bank wrote the United Statesâ âmonetary capacity could be eroded by growing competition from, cryptocurrencies.â But the greater threat, he said, is from Chinaâs forthcoming digital currency. âAs Chinaâs GDP and role in world trade continue to grow, it seems natural to expect that countries, especially its neighbouring countries, will to a larger and larger extent start to use Chinaâs currency as both invoicing and financing currency,â he wrote.
China is trying to find a way around the U.S. currencyâs global reserve status by trying out a digital yuan and will likely have it up and running by next year. Some fear if the United States doesnât keep up, the ease of using Chinaâs digital currency in cross-border transactions will erode the dollarâs position as the dominant international currency. (Currently, Chinaâs currency accounts for a mere 2 percent of global cross-border payments, a tiny share compared to the U.S. dollarâs 38 percent.)Â
Most experts believe Beijing is merely trying to curb rampant money laundering, which is rife on Bitcoin and other cryptocurrency platforms. Yet U.S. and international financial officials are so worried about the threat from cryptocurrencies, especially with China aggressively pursuing its own digital currency, they have set in motion a slew of studies on the phenomenon.Â
In late February, Federal Reserve chairperson Jerome Powell and U.S. Treasury Secretary Janet Yellen said the United States was studying the issue hard, with Powell telling Congress that a digital currency developed by the Federal Reserve is a âhigh priority project for us.â
Although the United States is still just studying the issue, other central banks are moving ahead. Along with Chinaâs central bankâs pilot programs, Thai and Hong Kong central banks are currently engaged in a joint project to conduct common transactionsâsay, dollars for eurosâusing distributed ledgers like blockchains. The Swiss National Bank also has an active program underway. Other central banks like those in less developed countries in the Caribbean and elsewhereâwhere much of the population doesnât have traditional bank accountsâare also forging ahead with these technologies.
Meanwhile, there are new private ventures trying to go beyond Bitcoin and ally themselves with traditional currency. Among the new stablecoins with potential global reach was Facebookâs Libra, which has morphed from a digital store of value tied to multiple actual currencies to a new concept called Diem. Facebook plans to relaunch Diem later this year as a U.S. dollar-based stablecoin with 26 commercial companies and nonprofit organizations.
There are pitfalls to going digital. Although digital dollars could address the exorbitant cost of cross-border money transfers, Eichengreen recently wrote for Project Syndicate that âforeign governments might be reluctant to permit their nationals to install the Fedâs digital wallet, because that would leave them and their central banks unable to enforce their capital controls.â And if people shift their savings from banks to digital wallets, he added, banksâ ability to lend will be hamstrung. Some banks will close, and small businesses that rely on banks for credit will have to look elsewhere. Brand new forms of lending will have to be createdâperhaps digitally.
But that may be what happens after a revolution.