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2018-02-11 23:02:41 UTC
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The implications of crypto currencies

Robert Henderson

Cryptocurrencies are fiat currencies without the reassurance which a stable and well run advanced country can bring. A fiat currency is one in which the money is not based on something valuable like gold or silver but something of little or no intrinsic value such as paper money which is inconvertible. It is made legal tender by law. Its market worth is based on confidence, both domestic and international. hat confidence is a reflection both of how the currency actually performs, the regulatory regime which governs the currency and general standing of the issuing authority which is normally a nation state. Cryptocurrencies have no national or supranational body (such as the EU’s ECB) which can be held to account if things go wrong because they are created by private individuals or corporations and as yet largely unregulated by governments.

Crypto- currencies are created in various ways. The most famous BitCoin is supposedly based on a limit of 21 million BitCoins which can either be “mined” using complicated software, IT expertise and serious energy usage or bought from exchanges with real-world currencies such as the Pound Sterling or the US Dollar. Other cryptocurrencies currencies such as XRP which is owned by Ripple creates a set number of coins and then sells them. Fractions of currency units such as BitCoin can be purchased.

But however a cryptocurrency is created it has the obvious disadvantage that only those who initiated the currency truly know how it is being run or will be run in the future . They may claim that only a certain number of currency units are being created or are available to be mined but no one knows if that is so now or will be in the future.

To these potential drawbacks can be added huge volatility. From $20,000 high in December it is now at less than $8,000. It might be argued that for example gold is also volatile but the difference is that gold always has an intrinsic value . There is no chance that gold would ever become worthless or seriously cheap and consequently even if it has its ups and downs holding it can never be an unequivocal disaster. Cryptocurrencies could all too easily become worthless.

The volatility is primarily driven by “bubble mania” but another component is surely the number of cryptocurrencies which are appearing. Investors climb into the cryptocurrency which looks the best prospect for growth at any moment.

Cryptocurrencies are also vulnerable to fraud and theft throughhacking. The most recent admitted example affected the Japanese exchange CoinCheck.
More banal disadvantages are the high transaction fees, long wait times and lengthy identity checks. There have also be practices which have shut out would be buyers and sellers especially at times when serious volatility occurs.

No one to make restitution if things go wrong

Potentially the greatest problem with cryptocurrencies is there is no person or institution which can be held responsible if things go wrong . They have largely operated without state interference although that is beginning to change. The head of the Bank for International Settlements, Agustín Carstens recently warned “If authorities do not act pre-emptively, cryptocurrencies could become more interconnected with the main financial system and become a threat to financial stability…” He also described Bitcoin as “little more than a ponzi scheme".

This type of concern has led governments to begin taking the first faltering steps to regulate crypto currencies and banks have begun to stop the purchase of cryptocurrencies using credit cards to purchase them.

Governments are also moving to investigate the possibilities for running their own cryptocurrencies which

Governments could also act to destroy large holdings of cryptocurrencies by destroying their value. For example China is reputedly ideally placed to undermine Bitcoin because much of the computing power required to sustain BitCoin is within China.

More broadly there are some important questions which remain to be answered. These are

1. What will be the relationship between real life currencies and cryptocurrencies? The danger is that if cryptocurrencies become a competitor to real life currencies they could undermine real life currencies.

2. How can cryptocurrencies be put under state control other than by banning it? The answer is surely that it could not be done for two reasons. First, even if the size of the issued currency is restricted, for example, the maximum number of Bitcoins, there could be no restriction on what the value of, for example, a Bitcoin could reach. Second, cryptocurrencies are designed to be universal. Whatever a government might want to do a successful cryptocurrency will still be available because the blocking of websites relating to them is never going to be perfect. For this reason a cryptocurrency owned by a state would also be problematic.

3. How would cryptocurrencies affect international finance or trade? there is obviously potential for huge amounts of money to be redirected. Suppose those using the Pound to buy cryptocurrencies where do the Pounds go? Potentially anywhere in the world. Because probably that it will be hoarded and decrease the velocity of circulation. That would hinder economies.

4. Could a country be left with a severe deficit in real life currencies which could actually be used to settle debts or pay for public services?

5. How will cryptocurrencies fit in with fractional reserve banking? This is the normal practice of banks (at least in the West) reserves equal to only a fraction of its deposit liabilities. The idea is based on the assumption that the reserves will be sufficient to meet any likely demands from depositors wishing to withdraw money because only a fraction of deposits will ever be requested over a short period of time. If the demand for cryptocurrencies continues in its seemingly insatiable way the reserves which are now deemed sufficient could easily prove to be grossly inadequate.

The head of the Bank for International Settlements, Agustín Carstens was not far wrong when he likened Bitcoin to a Ponzi scheme. It is not a Ponzi scheme as such, but the fact that Bitcoin is still largely unregulated and there is no nation state or supranational agency behind it means that it and the increasing number of cryptocurrency competitors means that it is essentially resting on the same utterly insubstantial foundations that eventually always catch up with the Ponzi scheme, the need to keep generating confidence to lure in more and more suckers.