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Cryptocurrencies will be the Architects of their Own Demise

With the formal financial sector responding to their challenge, cryptocurrencies will simply become illicit currency for illicit trade.

Views on cryptocurrencies – a digital currency operating independently of a national central bank – vary considerably. For some, they offer the promise of cheaper, faster and more secure transactions; for others, they are an opportunity for organised crime and terrorist financing.

Yet, thus far, the reality has lagged the hype by some distance. For bad actors, cash and the use of money service businesses and remittance companies remain dominant; for benign users, the complexity and limited opportunity to use cryptocurrencies to transact payments remains tiresome, making them attractive for their novelty value, rather than their other potential advantages.

Given the extent to which near-field communication technology, which allows credit card and smartphone users to ‘tap-and-pay’, has simplified payments, cryptocurrencies have a long way to go before they are a credible payment competitor.

But one issue above all others challenges users. Cryptocurrencies, as most commonly conceived, are created by independent actors and not backed by the ‘full faith and credit’ of a government, its economy and central bank, and are thus prone to wild swings in value.

A dollar is worth a dollar and, subject to inflation, holds its value. The value of a Bitcoin is determined by market demand and its credibility is contingent on a sufficiency of supply and demand and the integrity of the decentralised system that supports the currency’s creation and transfer.

If the ATM network suffers a glitch, the value of a national currency remains unchanged, despite the aggravation this causes. If a cryptocurrency’s distribution and transfer system is hacked or otherwise disrupted, however, the resulting crash in the currency’s value can be ruinous.

Cryptocurrencies are not ‘currencies’ in the traditional sense; they are commodities or stock market investments whose value floats freely, and are entirely and solely subject to market forces

When Bitcoin exchange Bitfinex suffered a security breach in August 2016, the price of Bitcoin fell 20% in one day to less than $500 per Bitcoin. Today, the price stands at around $2,700, having reached a high of nearly $3,000 earlier in the month.

Put simply, cryptocurrencies are not ‘currencies’ in the traditional sense; they are commodities or stock market investments whose value floats freely, and are entirely and solely subject to market forces.

Perhaps contrary to the traditional view, therefore, it is unlikely that, as currently conceived, cryptocurrencies will attain the status that the hype would have you believe. They will certainly be revolutionary, but most likely in a manner that will trigger their own demise, or at least relegate their use to those who want to operate outside the legal financial system. Here’s why.

If there is one thing at which the financial sector excels, it is innovation. Not always for the better (it was 'innovation’ that led to the 2008 Global Financial Crisis), but the innate instinct of ‘survival of the fittest and smartest’ courses through the financial services industry.

When bankers spot the good ideas of others, they are quick to co-opt them as their own, stress them and improve on them. Joseph Schumpeter’s ‘creative destruction’ and the desire for profit led to relentless progress, limited only by the intervention of regulation.

Take internet banking. Ubiquitous today but not the invention of the high street banks, internet banking emerged under brands such as ‘egg’, ‘first-e’ and ‘smile’. These good ideas caught the public imagination before the larger banks woke up and devised their own offerings or bought the new arrivals as they began to stumble due to the burden of success.

Consider also the plethora of innovations in payments technology (commonly known as ‘FinTech’) emerging today. These ideas, cooked-up in garages and cafés, are slowly being co-opted and nurtured by the formal financial sector.

Indeed, often those that have sought to disrupt the formal financial sector – such as Swedish payment service company Klarna, which in June acquired a banking licence – have, ultimately, realised that they need to join the formal sector in order to continue to expand.

The simplification of making payments has accelerated in recent years. Plastic now outstrips cash for retail payments in the UK; train tickets are bought using smartphones and thumb print identification; foreign exchange is sent across the globe by consumers at market-rates with a few taps on a screen.

Cryptocurrencies are inefficient as a form of payment, volatile in price and not guaranteed to hold their value as they are not backed by the full faith and credit of a national government

However, ‘innovative’ as these experiences may seem, they all rely on the formal banking system and the trust and confidence users have that their funds will be kept safe, maintain their value and be accessible when needed.

In advanced, sophisticated economies where cash usage has been on the decline for years, it seems inevitable that digital payments will eventually eradicate cash. Some argue for actively getting rid of paper money. Enforced extinction seems unlikely; but the evolution of users and the innovation of the formal financial sector (whether home-made or co-opted) will eventually achieve the same outcome.

Which brings us back to contemporary cryptocurrencies. What is their point? They are inefficient as a form of payment, volatile in price and not guaranteed to hold their value as they are not backed by the full faith and credit of a national government.

As currently conceived, and as amply illustrated by the $1 billion-worth of cryptocurrency that flowed through online black market AlphaBay (recently shutdown by law enforcement) since it was founded in 2014, cryptocurrencies have but one sustained use when it comes to payments: a perceived anonymous payment method for those with something to hide.

However, even anonymity is not assured. Witness the seizure by the FBI and US Drug Enforcement Agency of millions of dollars of cryptocurrency belonging to AlphaBay founder Alexandre Cazes.

Today’s cryptocurrencies are playing a valuable role in spurring creativity in the formal sector, but it seems most probable that they will quickly present value only to those who are seeking to hide their identity and operate, like the currencies themselves, outside the law.

 

Channel website: https://rusi.org

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