It has been a torrid fortnight for cryptocurrencies, as their spectacular rise in value was reversed by a combination of Elon Musk and the People’s Bank of China (PBoC). Musk, whose Tesla Inc made two-thirds of its profits from cryptocurrency operations last year, said the company would no longer accept bitcoin to purchase its cars. The PBoC, meanwhile, ruled last week that traders in China, where around 60% of the world’s bitcoins are mined, could not offer prices in cryptocurrencies as they are not “real currencies”. $1.3tr has been wiped off the combined cryptocurrency market value in the last week alone, with bitcoin down 50% on its April highs.
Since the first bitcoins were put into circulation back in 2009, crashes and surges have been the norm. Cryptocurrencies have always attracted an extraordinary amount of hype and with it, wild, speculative bubbles. What makes this different from previous crypto-manias is that it concludes a period in which cryptocurrencies have moved from the fringes of financial markets to their centre – inviting major interventions by central banks.
Musk cited environmental concerns as the reason for his dumping bitcoin; it’s been reported that climate breakdown was a similarly deciding factor for China. These concerns are justified: rising demand for electricity for virtual mining has driven up demand for actual mining, resulting in shuttered coal mines being reopened and a reported jump in deaths in mines.
Bitcoin’s energy demands are notorious. The coin’s design is modelled on gold or silver: initially, the precious metals are easy to mine, with seams closer to the ground. Over time, mining them becomes harder, forcing up the value of the metal. Bitcoin simulates this effect by allowing a coin to be “mined” only after a computer solves an increasingly difficult algorithm. A decade or so after the first coins were mined, the computing power needed to produce bitcoins – and now other cryptocurrencies – are astonishingly large, about the same energy consumption as Sweden (131 terawatt-hours per year).
Bitcoin proponents claim that a significant chunk of that electricity consumption comes from hydroelectric dams and other renewable sources. But renewables account for only 40% of the energy used in bitcoin mining. Various technical solutions have been proposed to reduce the computing power cryptocurrency production requires but to little avail.
Yet environmental concerns aren’t the only factors for Musk or China. Another is crypto’s move over the last year from being a relatively marginal, highly speculative asset favoured by smaller traders to an integral part of major institutions’ wealth-building strategies. This is in part due to fears over inflation in so-called “fiat”, or government-supported, currencies. Traditionally, gold -a commodity that always keeps its value whatever is happening to money – has been favoured as a hedge against this. Now, major institutions are pivoting to bitcoin.
Cryptocurrencies attract their fair share of enthusiasts. Their decentralised, market-dominant design fits neatly into the worldview of the free-market right. The grand hope of the crypto-faithfuls is that as inflation risks rise, cryptocurrencies will become the main way in which we buy, sell and hold wealth. This will permanently sever the major institutions of capitalism from the state, creating a truly decentralised market. And if cryptocurrencies contain their own programmable “smart contracts”, as many now do, the role of government is even further reduced. The anarcho-capitalist future awaits on the shores of the Danube.
Could this actually happen, though? Potentially, though it would require cryptos to become very much more widely accepted than they are today. Ultimately, cryptocurrencies would need to displace the dollar, the currency used in around 60% of all global trade, and accepted in cash form in most places on the planet – a prospect that seems unlikely without either action from states such as China that are clearly opposed to cryptos, or the implosion of the US economy.
If you hold cryptocurrencies today, the likelihood is that you intend to convert them into fiat money at some point in the future, since they cannot be used in most transactions. This could change but until it does, fiat currencies will win out. Even crypto’s use as an insurance policy against inflation in fiat currencies underlines the point: the demand for cryptocurrencies is there because of what is happening with fiat currencies. That’s why Tesla and the PBoC are targeting crypto’s use in day-to-day transactions: it’s their Achilles Heel.
One reason cryptocurrencies are unlikely to supplant fiat currencies – for now at least – is that, with both a plausible argument for protecting the environment and an imperative to protect their own power, central banks will move to stop them.
Central Bank Digital Currencies (CBDCs) are emerging as an important weapon in their armouries. CBDC is new, electronic money, approximately equivalent to holding a bank account with a central bank. China has been running real-world CBDC trials in several cities since last year, whilst the Bank of England is looking into launching its own pilot, named, inevitably, “Britcoin”. The advantages of a stable, central bank-backed digital currency over an unstable, decentralised cryptocurrency are likely to prove overwhelming. Those cryptocurrencies that combine currency functions with smart contracts, like ethereum and its related cryptos – are likely to prove more durable. Non-fungible tokens, unique digital assets marketed as providing an income source for artists, are one application of the smart contract technology currently attracting press attention. In a leaked report, Goldman Sachs forecasts that the cryptocurrency ethereum will soon overtake bitcoin as the dominant cryptocurrency in circulation because of its more sophisticated possible uses. One plausible future role for cryptocurrency technology is here, acting as something different to more conventional forms of money rather than as a direct replacement.
But cryptocurrencies’ relationship to fiat money also extends into the wider financial system. Increasingly, those speculating on cryptocurrencies – betting on their value going up or down – are doing so by borrowing fiat currencies. This so-called “leverage” is making the market more volatile, as small swings in crypto prices are magnified by those needing to cover leveraged positions. And, as we know from the 2008 crash, the more leverage is used, and the more complicated the forms of leverage become – packaging and repackaging different kinds of debt – the bigger the systemic risk grows. In 2008, highly leveraged mortgage products collapsed when US house prices dropped and brought down the global financial system. In theory, decentralised cryptocurrencies should be less prone to the same problem of tangled risks. There is no big crypto bank that can become “too big to fail”. But in practice, since cryptos are mostly traded on specific exchanges, and since financing for leverage comes from other financial institutions, systemic risks have started to develop – hence why the UK has already banned leveraged crypto trades.
In just the past 24 hours, the notoriously unpredictable Elon Musk has had yet another change of heart on cryptos, now deciding that perhaps they can be environmentally sustainable after all. But the incentives for global governments to edge out crypto remain. And at a time of growing state involvement in economies, of governments and businesses drawing more closely together, to bet in favour of bitcoin in the long term seems a high-risk strategy. If it comes down to Elon Musk vs the People’s Bank of China, it should be obvious who to bet on. If it’s Elon Musk vs the People’s Bank of China and the US Federal Reserve, you may as well sell up now.
James Meadway is an economist and Novara Media columnist.