Will crypto trigger the next financial meltdown? #CriptoNews

Back in 2022, around the time of the FTX meltdown, I wrote a column on the risks posed by cryptocurrency. The question I asked in that column was whether crypto had “any relation at all to the traditional role of the financial industry, which is the funnelling of productive savings into productive investment? Or is it mainly moving around existing assets (real or virtual) in a closed loop of financialisation which largely benefits a tiny handful of rich traders? And if it’s the latter, why do we continue to allow it? There seems to be little social use for it.”

More than two years on, with Elon Musk having just hobbled the Consumer Financial Protection Bureau (which was investigating several cryptocurrency companies and digital payment apps), crypto will probably make its way much deeper into the mainstream financial system. The CFPB was the primary regulator for non-bank digital payment systems, and between the gutting of that agency, and the departure of Securities and Exchange Commission head Gary Gensler (who had tried and largely failed to regulate the sector) I’m betting crypto and crypto-related fraud will proliferate.

That could pose problems for the real world. While crypto may have no inherent value, many experts — including Columbia University law professor Jeffrey Gordon — worry that as assets and liabilities are increasingly denominated in crypto, digital currencies will have a channel into the real economy.

“Stable coins can dive substantially below par,” Gordon said. “We’ve seen this movie before, with prime money market funds.” During the Great Financial Crisis, many of these seemingly safe funds “broke the buck,” returning less than their original worth to investors.

That could quite easily happen to stablecoins, but the effect would be compounded by the fact that if there is a liquidity crisis in crypto, there is no lender of last resort. You would just see a lot of imaginary value disappear, leaving real-world collateral calls and financing shortfalls. This is particularly worrisome given the fact that people who invest in crypto at a retail level tend to be younger and more financially vulnerable.

I know that many people see crypto as a kind of digital gold — a hedge against a world in which the dollar might be devalued thanks to America’s soaring debt and deficit situation, not to mention Trump’s erratic economic policies. If you buy into the idea that there is a finite amount of crypto available thanks to the efforts that it takes to mine and track digital currencies on the blockchain, then you can see its rise as a harbinger of a post-dollar world.

Certainly, the people who stand to gain the most from digital assets — like Elon Musk, Mark Zuckerberg, Jack Dorsey and other Silicon Valley bros — believe that digital currencies are better suited to a more multipolar world. They are largely unregulated and thus less subject to political forces (just look at how Trump is pressuring Fed chair Jay Powell). In the same way that large technology platforms demonstrate their power by removing users from social media on occasion, cryptocurrencies could conceivably float above the politics of any one nation state, which is (as we discussed in Swamp Notes last week) exactly the kind of post-governmental world that tech titans are looking for.

Richard, I have several questions for you. First, what’s your general take on crypto (and I realise that it probably depends on the coin). Secondly, do you see it taking hold in the real economy yet? Thirdly, do you have a sense of whether Musk could make digital currency a greater part of America’s financial plumbing, and what the ramifications of that might be?

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Richard Waters responds

I used to think of crypto as a massively interesting technology in search of significant uses (establishing a shared view of reality with no central authority is a powerful idea). But I think we found out what the killer app is, at least for now: Speculation.

Crypto has some utility (over and above money laundering and tax evasion), just not $3.2tn worth (the value of all outstanding coins, according to CoinMarketCap). Bitcoin is certainly seen by many holders as a form of digital gold, but who knows how lasting that will be — it’s a social construct with little history. Stable coins serve a theoretical use as a more predictable form of digital currency, though as you suggest, it’s impossible to tell how well they’re collaterised, which rather undermines the purpose. Meme coins and NFTs will always have value for some people as digital collectibles, particularly as cultural or political signifiers. With that said, the NFT bubble a couple of years ago was nuts, and it’s clearly nonsense to believe that Trump coins — essentially, trading cards with pictures of the president on them — are worth $3.8bn.

The areas where I thought crypto might start to influence the broader digital economy haven’t come to much. Decentralised finance is still just a way of getting around financial regulation, as far as I can tell.And the idea that digital tokens would support a new generation of decentralised apps, from games to social networks (what’s known as Web3), has completely fizzled.

As for Musk: Like Trump, I think he’s deeply intrigued, but I don’t think either man is a true believer. Musk loves the meme value and the disruptive potential — but after he parked some of Tesla’s spare cash in bitcoin a few years ago and the price fell, he quickly dumped three quarters of the holding. For Trump, it’s a magic money tree (those Trump coins) and a matter of political convenience (it helped boost his standing with young men, and crypto money has become a serious source of political donations).

So I think Trump will do his best to be crypto-friendly without doing too much to rock the boat. As you say, the SEC is likely to back off some actions (hence the fivefold rise in Ripple since the election). But I wouldn’t expect it to retreat entirely — securities law is still going to be an important weapon against the most egregious scams. Trump may even follow through on the promise to park a small part of US financial reserves in bitcoin, no doubt fuelling another bump in the price.

This feels like a recipe for more speculation and, no doubt, more fraud. It would only get truly worrying if it took on systemic significance — for instance, if crypto became entwined with the banking system — but I think (hope) we’re a long way from that. And as for whether the bitcoin price will be lower when Trump leaves office than when he started — who the heck knows.