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Crypto winter highlights gold’s warming qualities

LONDON, Nov 25 (Reuters Breakingviews) – The crypto winter is bitterly cold. The frost set in earlier this year with the collapse of Terra, a digital token believed to be tied to the US dollar. The recent failure of Sam Bankman-Fried’s FTX exchange further lowered the temperature. The total market capitalization of cryptocurrencies has shrunk by more than $2 trillion, down about 70% from its peak, according to CoinMarketCap.com. As institutional investors run for the hills, financial regulators are stepping in. The inevitable question arises: do cryptocurrencies have a future? To which the answer is: not under anything resembling normal circumstances.

True believers have not lost faith. They point out that cryptocurrencies were originally intended to provide a decentralized alternative to government-issued fiat money, which did not require users to place their trust in intermediaries such as banks. Instead, transactions will be recorded on a distributed ledger. In fact, most cryptocurrency trading has ended up on centralized exchanges like FTX. The opacity, leverage, illiquidity and shady dealings in this new financial world seemed like the worst of Wall Street.

The believers argue that crypto needs to return to its roots. However, this is easier said than done. Holding bitcoin or competing tokens in offline digital wallets is fraught with risks. If the owner loses their encryption key or sends coins to the wrong address, they have no recourse. Furthermore, cryptocurrencies are too volatile to serve as money. This is why crypto pioneers developed stablecoins, which peg their market price to old-fashioned fiat currencies. But, as Terra’s collapse demonstrates, stablecoins have not lived up to their name.

Bankman-Fried seemed aware of the inherent flaws of crypto. The FTX founder agreed that digital tokens were impossible to value as they did not generate any cash flow. He also pointed to the impractically slow speed of transactions over the Ethereum network. In this respect, bitcoin is little better. There is another problem. Most cryptocurrencies require a so-called “proof of stake” where major holders verify transactions. But it is theoretically possible for these “whales”, as they are known, to take control of a coin, depriving the plankton of their importance.

Bitcoin has a different design, based on “proof of work” to verify transactions. But this process consumes large amounts of energy, which is problematic at a time of high oil and gas prices. As Hyun Song Shin of the Bank for International Settlements points out, the rewards for verifying transactions rise and fall with market turnover. “Crypto only really works when coin prices rise and there is an influx of new buyers,” he concludes. In other words, the entire crypto world has the mechanics of a Ponzi scheme.

Then there is the regulatory backlash. Public officials complain that the only practical use for cryptocurrencies is to launder money or to demand ransom payments. In August, the US Treasury approved Tornado Cash, a firm whose software provided anonymity for crypto users. This could be a bigger deal than potential regulations spurred by the collapse of FTX. Calderwood Capital’s Dylan Grice suggests that crypto’s fundamental dream is dead: “Crypto is now de facto authorized, highly centralized and lacking in privacy,” he writes.

To curb all this, central bankers are responding to the threat that crypto poses to their monetary monopoly. China is testing a digital yuan. More than 50 million Brazilians use the low-cost Pix payment system, which is run by the country’s central bank.

However, it is conceivable that central bank digital currencies (CBDCs) will prove to be crypto’s salvation. If money is, as Fyodor Dostoevsky said, “freedom created”, then CBDCs have the potential to create a digital panopticon where the central authorities watch every transaction. In the wrong hands, a CBDC can be used to sanction recalcitrant individuals, determine what transactions are permissible or freeze financial assets without due process. No totalitarian has ever exercised such absolute power.

In such a nightmare scenario, access to a decentralized, anonymous type of digital money could be indispensable. This is the message of “The Network State”, a recent book by entrepreneur Balaji Srinivasan. He envisions a world in which the United States erupts into civil war and China’s digital yuan is used to track people worldwide. In this world, bitcoin serves as the lifeboat for civilization, providing protection against both anarchy and the surveillance state.

Readers must judge for themselves whether this dystopian vision is believable. The Covid-19 pandemic has taught us how quickly long-established societal norms can be upended. In China, fintech apps have been adapted to ease lockdowns and issue individuals with stay-at-home orders. In the West, PayPal ( PYPL.O ) recently froze accounts of those deemed to have violated the online payments firm’s “acceptable use policy.” After Russia’s invasion of Ukraine, Western governments froze President Vladimir Putin’s access to the country’s foreign exchange reserves and restricted Russian access to the SWIFT global payments system.

Under less dramatic scenarios, it’s hard to see a future for cryptocurrencies, except perhaps as tokens for the online gaming community. In recent years, their main function has been to provide access to a large online casino. Near-zero interest rates and quantitative easing have sparked crypto enthusiasm. The digital signs provided the most hyperreal form of wealth—what the French philosopher Jean Baudrillard called a simulacrum, defined as something that merely has the form or appearance of a thing, without possessing its substance or proper properties.

Back on planet Earth, investors need a stock of wealth that provides protection against inflation and economic disaster. They are best off rejecting “digital gold”, as bitcoin is sometimes dubbed, and embracing the real thing. Like bitcoin, gold is energy intensive to produce and limited in supply. Like bitcoin, it is quite difficult to value. According to information, an ounce of gold should buy about 15 barrels of oil or 350 loaves of bread. The gold-oil price ratio is in line with its long-term average. A 650-gram loaf of sourdough bread at British supermarket Waitrose costs 4.11 pounds ($4.98). Multiplied 350 times, this is also close to gold’s current market price of about $1,750 per ounce.

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Edward Chancellor is the author of “The Price of Time: The Real Story of Interest”.

Editing by Peter Thal Larsen, Streisand Neto and Oliver Taslic

Our Standards: The Thomson Reuters Trust Principles.

Opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed under the Trust Principles to integrity, independence and freedom from bias.

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