Cryptocurrency – From a prodigal exponent to a lethal experiment

Cryptocurrency has been in the news again. For the wrong reasons though. Many nations, including India, intend to ban cryptocurrency. In fact, cryptocurrency has been in the news for quite some time all over the world. Recently Elon Musk invested USD 1.5 billion in bitcoin. With this came the announcement that Tesla would accept bitcoin as payment for its products in the future. And they’re not alone. Wikipedia, Microsoft, Burger King, KFC, Subway, Dallas Mavericks, Virgin Galactic and Norwegian Air make it seem like Tesla was late to the party.

In all this, many are left wondering what’s the hoopla all about and others are championing the cause of cryptocurrency as the savior and democratizer of currency worldwide. There’s a third category, too. Those who will profit millions, if not billions.

In my view, cryptocurrency is trying to break what ain’t broke. The worldwide currency structure has supported lives of billions well enough. In comes a new form which has the volatility of a black mamba. Case in point, bitcoin value dropped by 10% on 22 February 2021.

Bubbles of cryptocurrency are frothing

Given that there can only be a finite number of crypto-coins of any form of cryptocurrency one may think that there can only be a small number of people who would ever get to have cryptocurrency. But one could hold 0.001 of a bitcoin (equivalent to USD 58.35 at the time of this article). Thus, making the possible number a thousand fold of the total number of crypto-coins available.

This means that there could be enough number of people who could lose a lot of money. And this will happen once the cryptocurrency is shorted. Cryptocurrency will soon start appearing in numerous balance sheets. Once the institutionalization reaches a critical mass, single short by an individual or ‘cryptofund’ could destabilize the cryptocurrency value. This will result in people losing their shirt. And yes, cryptofunds are a thing. In 2018, there were about 170 hedge funds investing solely in cryptocurrencies.

One may say that shares are shorted, too and people lose money there, too. But shares rise back up reasonable well because each share of a company represents an inherent value that can be seen in the operations of the company and measured against present / past performance. Cryptocurrency on the other hand is volatile. A single tweet by a celebrity may devalue the cryptocurrency. This could be significant enough to send it into a downward spiral. This is when the cryptocurrency will be shorted.

Sell it at a high, bring it down and buy it again at low. This yo-yo could make a select few a few billions. But many could lose their life savings. This is when the bite becomes as toxic as a black mamba.

Hedging and laundering

All this while, the big guys would find exciting new ways to find esoteric insurance solutions to hedge their risks. To the unsuspecting institutions who invested heavily in cryptocurrency, their inflated balance sheet and stock prices could deflate faster than a pricked fat balloon.

And that’s not all of it. When public institutions start investing, it’s the people’s money at risk. A private investor backed by his own money may never bite more than he can chew. But unregulated public institutions could ride the wave till it comes crashing down. Some would say but they will be insured. Of course, they may be. But the insurer and reinsurer itself could be a public institution.

This is all ignoring the present usage of cryptocurrency in money laundering, on the dark web and possibly by criminals. One could say that usage of cryptocurrency by criminals is a bit braindead as all transactions are recorded in a public ledger open for all to see.

Therein lies the case of truly anonymous cryptocurrency. Like Monero. Yes, there exist cryptocurrencies where transaction public ledgers are obfuscated, and no outside observer can tell the source, amount, or destination. To add fuel to fire, it is estimated that in the first six month of 2018, the amount of money laundered through cryptocurrency channels had crossed USD 700 million. In a study by Oxford Law[1] approximately 25% of all users are associated with illegal activity.

Should we power two Hong Kong-s

While all the global warming and doomsday predictions continue, mining cryptocurrency consumes electricity. As per a recent article in The Guardian[2], ‘Cambridge’s Centre for Alternative Finances estimates that bitcoin’s annualized electricity consumption hovers just above 115 terawatt-hours while Digiconomist’s closely tracked index puts it closer to 80 terawatt-hours.’ This is because of the 256-bit encryption used by cryptocurrencies like bitcoin and computers consume a lot of power to mine each coin.

The total electricity consumption of Hong Kong in 2019 was 44.8 terawatt-hour[3]! What’s the gain to society? The electricity consumption will rise till such time quantum computing isn’t mainstream.

Regulation and taxation or banning

All this while the taxmen are looking bewildered at taxing cryptocurrency. The fact is that cryptocurrency or crypto-coin may be traded over and over again in a year. And even the simple act of mining yields crypto-coin to the miner.

I agree that the above points make cryptocurrency look like the evil rising from hell and surely doesn’t paint a rosy picture. But it is cases like these where policymakers should have an open discussion on the pros and cons. Possibly, publish a white paper on what they plan to do. Many people still don’t understand how the 2008 world economy collapse took place. One’s who understand (and were of sane mind) question, why were the banks and stock markets not regulated.

Herein lies the need for regulation. With more and more cryptocurrencies onboard, it becomes more difficult to regulate. And regulation is a must because a single shorting event to multiple cryptocurrencies could lead to a 2008-like situation.

Obviously, banning cryptocurrency is the simplest and quickest form of regulation in this case. But that may not be enough in case other ‘favorable jurisdictions’ become safe haven for such investments.

Whatever be the form of regulation, it should be done before cryptocurrency investment is institutionalized in India or before Wall Street or Dalal Street create a CDO out of it.

[1] ‘Sex, drugs, and bitcoin: How much illegal activity is financed through cryptocurrencies?’, dated 19 February 2018

[2] ‘Electricity needed to mine bitcoin is more than used by entire countries‘, dated 27 February 2021

[3] One terawatt-hour is 1,000,000,000 kilowatt-hours.

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