Cryptocurrencies: from fringe to mainstream… and back?

Although the hype has died down a bit in the last few weeks, cryptocurrencies still are a major development in the finance industry. This article aims to provide an introduction to this issue’s Spotlight to explain the driving ideological forces behind cryptocurrencies and to introduce some of the main arguments on their utility.

Most proponents of cryptocurrencies argue that the decentralized nature of cryptocurrency can bring about a brave new world where property and free trade are guaranteed without the legal authority of the state or the market power of corporations. This belief is based on libertarianism or anarcho-capitalism, an ideology stemming from Austrian School economists such as Hayek and Rothbard as well as public figures and politicians such as Ayn Rand, Ron Paul and his son Rand (now a Republican representative in the US). The main idea is that states and corporations are inefficient and tyrannical in nature, that they only exist as parasites, and that everyone would be better off in a society driven by self-interest. They argue that the ideal society is one of private individuals and private wealth where everyone is able to trade with everyone, on anything, at any price, and however they please without impediment; they believe that private interests would produce the most desirable outcome. In short, it is an extreme form of Smithian liberalism, oblivious to the shortcomings of market interactions when providing safety and welfare, and to the sometimes-rotten character of humans.

Cryptocurrencies are seen by their libertarian founders as a means to bring forward this new society of free, unbounded exchange. The ability to provide a decentralized control for currency has been the Holy Grail for libertarians as it would remove the material hurdles and the need for trust in the other agents they previously struggled with. With this tool, they hope to finally get rid of the governmental control of money. This is also bound to their distrust of the state as they are eager to put forward failures of monetary policy and practices in authoritarian states such as Venezuela as examples, while disregarding the constitutional independence of central banks in most advanced economies.

Many disagree with this stance, notably figures of the “establishment” such as Nobel Prize winners Jean Tirole and Joseph Stiglitz, and professionals like Jamie Dimon (CEO of JP Morgan) or Warren Buffet (investor and business magnate). To focus on a local personality, Jean Tirole argued in the Financial Times that bitcoin was a pure bubble devoid of intrinsic value but worse than that it prevents countercyclical monetary policies and constitutes a privatization of money, a return to a form of feudality where private interests drive monetary policy in complete disregard for the public interest. His argument relies around the way bitcoin and most other currencies are “created” by private individuals who compete for energy, as the more energy you have the more money you can create and sell. In addition, these miners are also rewarded by transaction fees so cryptocurrencies do not fix this issue but make it worse as the more transaction are made, the more users have to compete to attract the attention of miners with higher transaction fees.

Among the issues raised by cryptocurrencies a very practical one is their extreme computational requirements that translate into huge energy spending. This is far from the energetic frugality needed in a context of global warming and resource rarefaction. Another problem is the anonymity of bitcoin users; law enforcement authorities took some time to learn how to use the structure of blockchains to their advantage. In its infancy, bitcoin was emblematic of the libertarian “every trade is fair trade” outlook, it was essentially a fringe currency, mostly popular among hackers and criminals. Before its shutdown by the FBI in 2014, The Silk Road—a dark web platform for trading drugs weapons and hacking services—accounted for 5% of the total bitcoin transactions. Today, bitcoin has shed this image to become more mainstream (used by everyday savers and investment banks), but other currencies such as Monero, Zcach, or Dash are reportedly still favoured by criminals because they offer an extra layer of anonymity.

Although supposedly safe, cryptocurrencies have not been immune to theft. An illustration of this is the collapse of Mt Gox back in 2014, one of the most popular bitcoin exchange platforms at the time. Private keys were stolen to some of the wallets it used for business as early as 2011, and the thieves used them until discovered in 2014, when company filed for bankruptcy. The issue here was with the human factor, keys left unattended, but it had resounding consequences for the cryptocurrency market as for the first time their business resonated outside of the specialized press. In Japan (where Mt Gox was located) the case was even raised in the National Diet (the Japanese Parliament) and the government was forced to take notice and regulate. Today Japan has one of the most advanced legislations when it comes to cryptocurrencies: it has been made clear that their trade is legal but that it must follow every bit of regulation attached to financial assets. In April 2017 it went as far as to change their definition to a “form of payment”.

The debate on the nature of bitcoin, whether it is a currency, an asset or a commodity is at the core of the legal challenges it faces. For instance, some Russian courts have classified bitcoin as a currency, which would make it illegal to use in Russia as only the ruble is legal. Making it a proper currency would make it illegal in many countries. Is it a currency from an economic point of view?

In economics, a currency has to satisfy three functions: unit of count, intermediate of exchange, and store of value. There is no discussion as to whether bitcoin can be a unit of count, it can. The other two functions are harder to satisfy.  Regarding the storing of value, there is an issue with the volatility of cryptocurrencies, even compared with gold (a common analogy made by bitcoin traders). Regarding the means of exchange function, the problem lies with the need for a critical mass of users, especially since the increase in the value of bitcoin has led some actors that previously accepted bitcoin payment to remove this option (e.g. Steam).

Is it a commodity or an asset then? A commodity is simply a standardized asset; an agent is willing to exchange commodities at a rate of one to one (ore is typically a commodity while houses are not). Tax administrations and jurisdiction usually classify cryptocurrencies as commodities on which VAT (value added tax) must be paid when bought and sold. Authorities have also been really clear that the innovative character of cryptocurrencies was not an excuse to not pay tax on capital gains.

The issue of regulation has been made more pressing by the ICOs craze of late 2017, an ICO (Initial Coin Offering) is somehow the crypto-twin of initial public offerings in regular finance. ICO enthusiasts present it as a way to raise funds for start-ups. Instead of money from investors being exchanged for shares in a company, cryptocurrencies are exchanged against tokens giving rights on the finished product of the start-up. In most cases these ICOs are used to create new cryptocurrencies, the tokens being units of the future currency. The emergence of the Ethereum platform where ICOs are proposed and the rising price of cryptocurrencies has made some investors extremely interested in this kind of deals. However, they have always been risky and have worried authorities. Indeed, the founder of this same Ethereum platform says that most ICOs proposed on his website are probably scams. Many countries such as China, Russia, and South Korea have strongly limited these coin offerings in order to protect consumers (or reinforce their monopoly depending on who you ask) and it is understandable. China went as far as to block access to trading platforms.

ICOs have accompanied the shift in perspective of cryptocurrencies. This craze—or bubble as we can now call it since it has largely collapsed—can also be seen as a shift from the traditional users to a broader audience. This shift hasn’t happened by accident, but under the combined effect of media attention and aggressive marketing. This aggressive—if not feral—marketing is exemplified in two cases. One of them is the creation of an idol group in Japan where each member is representing a cryptocurrency, the goal being to make cryptocurrency trendy and to appeal to consumers who are not necessarily financially literate. In France, reality TV personality Nabila Benattia advertised bitcoin on Snapchat to her teenage audience, a practice that warranted her a warning from the market authority.

With the recent developments on the cryptocurrency market, the bubble bursting and the end of what looks like a very short-lived trend, cryptocurrencies may go back to their ideologically motivated, fringe roots. However, their collapse and the subsequent media and public attention has revealed many of their adverse effects to regulation authorities and consumers. On the other hand, the supposed freedom from states that it was supposed to bring has mostly been enjoyed by criminals, while the claims of libertarian proponents remain theoretical. Furthermore, this ideology is not widespread outside of the United States, and the global political trend seems to be a return to protectionism, or even to nation-states.

By Joël Bréhin


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