What’s it take to get a little respect? In a Congressional Financial Services subcommittee hearing last week, congressmen expressed “deep skepticism” about cryptocurrencies, echoing critics’ claims that cryptocurrencies are nothing but a pyramid scheme updated for the electronic age. Rep. Brad Sherman (D-Calif.) stated emphatically, “Cryptocurrencies are a crock.” And last week, bitcoin — the best known of the cryptocurrencies — slipped to a new low under $8,000 after peaking around $18,000 in late 2017.
But maybe bitcoin and its cryptocurrency relations are more than that. Maybe they are a sign of the times.
Cryptocurrencies, including bitcoin, are built on a bit of sensible digital innovation known as distributed ledger technology, made possible by the expanding electronic universe. Remember the term “distributed ledger”; like “email” and “social media,” it will become a big part of your life.
A distributed ledger is the electronic record of actions, such as financial transactions, changes in inventory or legal records, that are recorded nearly simultaneously at different nodes or locations on the internet through an algorithmic validation process. Through the magic of programming, distributed ledgers have the attractive quality of being difficult to falsify and have advantages of scale, accessibility and transparency over non-electronic ledgers.
The best known use of distributed ledger technology is blockchain. Blockchain is distributed ledger technology that is purpose-built to record a series of related actions. The possibilities are endless. For example, blockchain is being used to validate the provenance of diamonds and the business conglomerate Louis Dreyfus recently carried out the first blockchain agricultural trade. The phenomenal range of blockchain uses is evident from prowling trade publications and specialty blog feeds, where stories of new business processes using blockchain are everywhere.
But the best-known use of blockchain is cryptocurrency.
Cryptocurrencies are blockchain programs that mimic real-world money. They are rising in popularity because they have attractive qualities made possible by blockchain. They are “portable,” in the sense you can access them anywhere. They are durable since there is a permanent record. They have, at least in theory, a limited supply fixed by blockchain coding, and a value that is market-driven. In short, cryptocurrencies have all the desirable attributes of money.
And, if not entirely anonymous (authorities can track cryptocurrency transactions), cryptocurrencies are relatively autonomous from state regulation and oversight and can be harder to hack than bank accounts and credit cards. Even cryptocurrencies’ limitations are appealing. Limits set by programming and large energy requirements to produce cryptocurrencies have contributed to huge valuation increases.
In a world of distrust of state and financial institutions and of economic insecurity, techies have happened on a technique that, conceptually, frees one from the existing ecosystem of regulatory control, legal accountability and bad guys who want your money.
And, it is not just dark money seeking safe havens and avenues for money laundering that account for cryptocurrencies’ popularity. It is also reputable institutional investors and wealth managers seeking greater returns and novel hedges against market risk.
Still, cryptocurrencies are to blockchain a little like a church deacon with a meth lab in the basement. Blockchain is good because it makes business more efficient and cost effective, but cryptocurrencies are bad because they involve risky behavior since they seem to have no real economic or financial anchor to ensure intrinsic value.
However, we have been here before. Cryptocurrencies are reminiscent of U.S. “free banking” in the mid-1800s before 1863 when a U.S. national currency was established. Prior to 1863, the need to supply liquidity to an expanding American economic space extending to the Pacific was filled by countless local banks — often known as “wildcat” banks — that issued their own script. Many of these bank scripts were based on little more than hopes and promises. Some were under-capitalized or backed by dubious assets. Some were frauds.
Shaky as it was, the system worked for a time because of (oft-misplaced) faith in the security of the underlying assets and in the good faith of the local banks to honor their obligations. Still, many went bust before the “normalization” of monetary policy through the establishment of a national currency backed by the full faith of the federal government, as well as federal bonds and capital requirements and tighter federal and state regulation. Sound familiar?
A prescient 1996 paper by the Federal Reserve Bank of Atlanta anticipated the similarity between free bank notes and “electronic money”:
“Electronic money is likely to consist of uninsured liabilities of private individuals or companies. If so, perhaps the most immediate lessons from free banking are that (1) consumers are not sheep waiting to be sheared (2) attention must be paid to the importance of the assets into which the electronic money is convertible and to the issuer’s reputation for making the conversion as promised.”
The bottom line is, with so much personal and business activity moving to the expanding digital universe, that universe needs a digital means to record and store value, just as the American economy in the mid-1800s needed liquidity to finance growth. Digital innovators are making that possible.
As in 1863, early adoption requires normalization. Blockchain is proving itself by expanding its uses, and experiments in cryptocurrency are becoming more credible and mainstream. Even countries with reputations for sobriety, such as Switzerland and Sweden, are considering the idea of national cryptocurrencies; and yes, Venezuela — although, in this case, it is a matter of necessity being the mother of desperate invention.
Will bitcoin collapse? Who knows. But will cryptocurrencies fade and wither like hula hoops and the tulip bulb mania? Don’t bet on it. Even governments know that it is no longer a question of extinguishing but of reining in the wildcats.
You’ll be using cryptocurrencies in the future, just as you will live in smart homes and use driverless cars.
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