The crypto winter, with the prices of most crypto assets falling in recent months, has shed light on the fragility of Bitcoin and other crypto assets as stores of value. Gone is the idea that, unlike other risky assets, they will be immune to changes in interest rates or serve as a hedge against inflation. Stocks have certainly taken a beating recently, but the drop in cryptocurrencies has been even more drastic. Bitcoin’s price has fallen by about two-thirds since its peak in November 2021 and the total market value of all cryptocurrencies has plummeted from around $3 trillion to less than $1 trillion. Even stablecoins — cryptocurrencies that are ostensibly backed by reserves of dollars and other financial assets that should help keep their value stable — have proven fragile amid the recession.
Does this herald the beginning of the end of the crypto revolution? Probably not. In fact, the cryptocurrency shakeup could benefit the sector by curbing some of the rampant speculative aspects and helping to focus on the beneficial elements of the technology. Could government regulators, who were already influencing the crypto industry and will no doubt redouble their efforts in light of recent events, stifle innovation? If properly designed, regulatory oversight could actually be beneficial to this sector by giving it greater stability and legitimacy.
The cryptocurrency revolution promised to democratize finance by reducing the power of big banks and other traditional financial institutions while expanding access to basic financial products and services so that less wealthy households can benefit from them. The reality, however, is that many of these benefits remain unrealized.
New technologies have created products that could not have been imagined before, including digital toys that often have little practical value, such as non-fungible tokens and meme cryptocurrencies. But there are also some useful ones such as smart contracts that allow you to buy and sell financial assets directly without the intervention of traditional intermediaries. This should, at a minimum, reduce costs and improve efficiency by creating competition for entrenched institutions.
There are downsides to the cryptocurrency revolution that have become apparent in recent months. The lure of easy money that comes from investing in cryptocurrencies was seductive to many investors. Ownership of many crypto assets quickly became concentrated among wealthy investors, threatening to widen already massive disparities in wealth. The fall in crypto asset prices has, as usual, affected not so much the wealthy and sophisticated investors who can handle the volatility, but rather the unsophisticated retail investors who might have been fooled by the hype of new and eye-catching digital products. and did not understand or ignored the risks.
Even the disruption of finances is far from assured. Big banks and other traditional institutions are co-opting new technologies in ways that could entrench their influence. For example, a consortium of large banks is using blockchain technology to handle transactions between them more efficiently, which could even hurt smaller banks, not to mention limit new competition.
What is the future of cryptocurrencies?
First, we will see much more regulation focused on investor protection, transparency and limits on risk taking. Financial education remains a great challenge. While retail investors should be free to invest their hard-earned savings in any way they choose, they should at least go in with their eyes open. Cryptocurrency promoters and their famous accomplices, who often hide their own financial interests in the products they promote, should be prevented from making inflated promises of high returns with little risk.
Second, as the technology matures and operates within regulatory barriers, it could begin to play a role in improving the functioning of the financial system. In particular, technology has the potential to make certain elements of finance, including payments, more efficient.
In developing countries, particularly those where the national currency is not highly trusted, customers and small businesses gain easy access to low-cost digital payment systems. International payments are getting cheaper and faster, helping exporters and importers and even economic migrants send remittances back to their home countries. Some of these changes were already happening through simple mobile phone payment apps, but are now being empowered through blockchain technologies and cryptocurrency access in countries where the national financial system does not meet the needs of consumers. and companies.
Better national regulation, as well as coordinated international regulation, will help ensure that these new payment channels deliver benefits to households and businesses and do not simply become conduits for financing illegal activities such as money laundering and drug trafficking. .
Regulation is also necessary to ensure that cryptocurrencies do not sow further financial instability. Even stablecoins, which were apparently only meant to make payments more efficient within and across national borders, have proven to be financially fragile. In effect, stablecoins have become similar to money market mutual funds or deposit-taking institutions, although they are not regulated like either. There are concerns about the amounts and quality of the collateral they hold, exposing them to the risk of collapse should they face a large number of redemption requests.
Regulatory clarity could actually benefit these innovative products by reducing the risks that they could lead to financial instability or facilitate illicit transactions. While innovations in payments and other aspects of finance should not be constrained by government intrusion, regulators have a legitimate role to play in preventing the misrepresentation of the security of what is touted as just payment tools but In fact, many users perceive them as financial assets.
The US government has an opportunity to take the lead, if it acts quickly, in setting standards for this industry and guiding international cooperation. It is also essential to promote digital and financial literacy that makes investors, who can get carried away by technology, more aware of the risks. The industry itself will need to recognize various kinds of risks rather than ignore them and engage with regulators rather than simply offer to police itself. For example, stablecoin issuers must agree to be regulated as issuers of financial products rather than just payment services, and must also require customer identification to limit illicit financial transactions. Indeed, regulatory oversight could help the technology gain legitimacy and allow it to truly disrupt the existing financial system by correcting its many inefficiencies.
For an industry that was meant to sidestep the government, a well-crafted dose of Big Brother might be just the right tonic.
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