Ashok Dhillon
Feb 27, 202111 min
Disclaimer: This commentary is for general information purposes only, and not a guidance on the cryptocurrencies, their strengths, or weaknesses.
After the global financial crisis of 2008, the World became familiar with the term ‘Quantitative Easing’(or ‘QE’) as the US Federal Reserve in concert with other major Central Banks around the World, embarked upon an unprecedented direct intervention in the financial markets to try and save the American and the global financial system from complete collapse. That intervention was in the forms of drastically slashing interest rates to ‘near-zero’, and by printing hundreds-of-Billions of dollars worth of their own currencies and pumping them into their financial markets to restore confidence, and to provide liquidity to the collapsing and fear-frozen markets.
These unprecedented actions by governments and their central banks, to rescue and ‘support’ the financial markets and the economies, were labelled ‘Quantitative Easing’ – and were enacted repeatedly until some form of stability returned to both the financial markets and the economies, but even then, were continued in some form or the other by most major central banks. This was all done by the central banks even as their various governments launched relief and rescue packages (bailouts) of banks, businesses, and individuals to try and stave off economic collapse from what was later labelled the ‘Great Recession’ of 2008.
Since the end of 2008 (at the start of the financial crisis), QE in one form or another has been on-going, as the global financial markets and economies exhibited lingering weakness going-forward, a decade or more later. In fact, QE was never quite retired, and the ‘Balance Sheets’ of governments and central banks were never reduced, as QE was maintained in varying forms around the World, giving artificially induced buoyancy to all asset markets and economies.
As economies and financial markets in particular, became dependent upon endless QE, the Federal Reserve and the central banks found it impossible to retract it entirely as markets reacted swiftly and negatively to their full-blown addiction to it.
During and following the years of the Great Recession of 2008, hundreds-of-Billions of dollars of debt were added to the balance sheet of every major government and its central bank, and in the case of major economies like the US, additional Trillions were added in total debt.
Collectively, the global debt has risen by tens of Trillions of dollars till now it is estimated to be over $280 Trillion; and the US debt is now over $20 Trillion, greater than its annual GDP.
Upon the debut of the Corona Virus global pandemic on the world stage, the Federal Reserve and the central banks had to turn-on the printing presses once again for renewed rounds of hyper-QE to deal with the ‘Great Economic Stall’ of early 2020.
This time the amount of money required to ‘save’ crashing markets and stalled economies dwarfed the amounts required in late 2008. As the debt on the balance sheets of countries and their central banks have grown by additional hundreds of Billions, or Trillions, the fear that the US dollar and the other world currencies are losing value through massive dilution in this new economic era of hyper-QE supported economies and financial markets, has given rise to the search for new ‘storehouses of value’ beyond the traditional go-to(s): precious metals, real estate, gemstones, art, etc.
In other words, investors deprived of meaningful returns for their savings in a ‘zero bound’ interest rate world, combined with the steady erosion of value of their money during the time of massive printing of fiat currencies, turn to hard assets such as gold, silver, real estate, tested storehouses of value that may hold their value in times of worrying devaluation of their money.
This search for ‘value retention’ is the foundational idea behind the creation of Bitcoin, and the expanding universe of other cryptocurrencies, even though they are not ‘hard assets’ in the traditional sense but are rather ethereal, being digital, with no three-dimensional form to them.
Lately cryptocurrencies have been very prominent in the news. Of them all, Bitcoin is the original crypto-coin, and thus the most prominent, credible, and most widely accepted. Though Bitcoin was created years ago (2008), as a fringe idea of the hardcore denizens of the edgy digital world, today big names of the tech and business world like Elon Musk, and old-school giants of the financial world like BlackRock (the World’s largest Private Equity Firm), and Ray Dalio, the founder of Bridgewater Associates (the World’s largest Hedge Fund), and Paul Tudor Jones (a legendary Hedge Fund Manager), are starting to take the idea of cryptocurrencies, and particularly Bitcoin, more seriously; as are major central banks and their governments.
This public recognition of Bitcoin from some of the most successful and respected people, and institutions in the financial world, are giving increasing credibility and invest-ability boost to the current high-flying prices of Bitcoin, and other cryptos such as Ethereum.
The primary credence for Bitcoin, and other cryptos, is their claim to be an alternate and un-dilutable storehouse of value, akin to gold and silver, at a time and in a world where the debasement of all fiat-currencies is taking place at an alarming rate, even as the Federal Reserve and the other central banks ‘print’ endless money to ‘support’ their financial and economic systems, and thereby, increasingly dilute the value of their ‘paper money’ through seemingly endless QE.
So are cryptocurrencies, and Bitcoin in particular, good storehouses of value as the value of fiat currencies fade? The answer is complicated, and subject to personal assessment of its qualities and risks vis-a-vis the other more traditional and accepted storehouses of value.
While algorithmic formulas responsible for the ‘mining’ of the cryptocurrencies purport to prevent mass dilution of the cryptos, the retention of ‘value’ over time is still untested (to say the least) as these ‘currencies’ are only a few years old (Bitcoin being the oldest), unlike their traditional counterparts in the real ‘three dimensional’ world.
Precious metals like gold and silver, gems, real estate, or art for that matter, have been around for thousands of years and have been tested time and again through the ages, in all kinds of human disasters, and have held their value through time (albeit their values do fluctuate).
Bitcoin and other cryptocurrencies are still too new and have yet to prove themselves.
The recognition that this is the ‘digital age’ and life has changed dramatically from earlier times, may lend less credence to the comparison of cryptos to ‘older’ storehouses of value in times of mass currency devaluation or disasters, but nevertheless, it is a question that vexes, and will continue to until it has been answered by time. Can cryptocurrencies hold their value over time?
However, there are some strengths of Bitcoin and cryptocurrencies that are forwarded by the believers in comparison to precious metals, and other valuables such as gems, real estate etc. that merit examination.
The major strengths of cryptocurrencies put forward by their proponents, which seem to be increasing by the day, are their ease of acquire-ability, transportability to anywhere one is, divisibility into smaller units for daily transactions, storability and security with enhanced encrypted codes, and block chain traceability from point of origin etc. All of the above can be done with one’s personal smart phone or computer, online, from wherever one is.
Certainly, the traditional storehouses of value cannot meet most of the above criterion, easily. For instance, it is not easy to acquire, get delivery of, store safely, transport, divide or transact with, most of the precious metals such as gold and silver, real estate, art, and others that are considered the traditional hedges against the devaluation of fiat currencies in inflationary or economically stressed times. A lot of these storehouses of value are difficult if not impossible to transport, and divide to use in daily transactions, like real estate, art and others, and even gold.
There is also the oft cited virtue attributed to Bitcoin and other cryptos - the privacy of the owner, and if they want, the secrecy of the transaction. This aspect of the cryptocurrency was exploited earlier-on in the short life of Bitcoin by the more unsavoury elements of our global societies - and to a degree it always will be.
To be fair however, so are fiat currencies, precious metals, gems and just about everything else, including barrels of oil, have often been used for under the table, and illegal transactions and operations across the world. The criminal elements of humanity will always misuse assets, people and systems, and everything else they can to bypass societies rules and legalities to gain undue advantage, and they always will.
Those elements of illegal transactions, in the use of Bitcoins and other cryptos are reportedly on the decline as cryptocurrencies gain greater acceptance and usage, and now reportedly form a very small portion of all Bitcoin and cryptocurrency global transactions.
The other argument forwarded for holding Bitcoin and cryptocurrencies is the small market cap of these currencies in comparison to their primary comparative storehouse of value – gold. The gold market capitalization is estimated to be about $9 Trillion, while Bitcoin hit the $1 Trillion mark just recently. The point being made is that as a comparative hedge against fiat currency devaluation, the discrepancy between the ‘gold market’ and the ‘Bitcoin market’ is very significant, with a lot of potential room to grow for the Bitcoin market, with the resulting increase in value of each Bitcoin. This element of the Bitcoin market was on full display lately.
This argument for Bitcoin is a little harder to accept, as the actual material usage of gold is myriad, as in ornamentation, jewelry, or use in electronics and industry, along with the proven test-of-time favouring of gold, while the primary use of cryptocurrencies is as an alternative to fiat currencies alone, with a number of other cryptocurrencies being developed at lightning speed; while there is no replicating gold.
The latest price action of Bitcoin is certainly attempting to fill the gap between the two ‘assets’ as far as ‘market cap’ goes. The 400% plus price rise of Bitcoin, over the past year or so, certainly helped to dramatically increase its market capitalization in a short period of time, and thus get a bit closer to the ‘gold market cap’, but only time will tell if Bitcoin can breach the gap.
At this time, it would seem Bitcoin and the idea of cryptocurrencies is certainly here to stay, in general, as interest in them by larger players grows by the day, including governments, and therein may lie the greatest risks, among others, to the current day cryptos including Bitcoin.
Apart from the many ‘strengths’ of Bitcoin vis-a-vis gold etc. (the ones mentioned above such as ease of access, divisibility, storability, transportability, security etc.), the greatest strength touted by its most ardent believers, is its un-dilute-ability.
In very general terms – Bitcoin’s ‘mining’ algorithm confines its total number available at any time, as the total maximum minable Bitcoins is set at 21 million, of which reportedly 18.5 million have already been mined.
The ‘reward’ for mining Bitcoin to its ‘miners’ is cut in half every four years to limit its inflationary rate, and unlike every fiat currency and other hard assets (except land of course, to an extent) it is near impossible to manufacture additional amounts, and is tightly controlled, and thus near impossible to dilute, or so it is at this time. The other cryptocurrencies are mined along the same lines, more or less. But, apparently, things might change in the future.
Bitcoin (and other cryptos) are designed to be very difficult, if not impossible to mine or produce in their original form, and nigh impossible to reproduce and dilute meaningfully. And that, along with their other strengths cited above, are the rationales for them being considered as modern-day preferred store houses of value, in these possibly very inflationary times.
So, to summarize, these are Bitcoin’s (cryptocurrencies) strengths: un-dilute-ability, and therefore (hopefully) retention of value and hedge against inflation, ease of purchase-ability, access, storage, transportability, ease of divisibility, therefore ease of use in daily transactions, privacy, and lastly but most importantly, they are uncontrolled by governments and central banks, and therefore are not regulated (currently), manufactured, printed, manipulated or otherwise controlled by governments or financial institutions such as banks, and central banks. This last but not least of Bitcoin and cryptocurrency strength is also perhaps its greatest weakness. As Bitcoin (in particular), over the years grew in wider acceptance, profile, and in value and price, governments and central banks started to take notice, and some started to study it, and to study the concept of cryptocurrencies in general.
More recently, as Bitcoin and others started to gain real favour among the powerful and respected individuals, businesses and institutions, governments and central banks really started to examine the concept and phenomenon of Bitcoin, and cryptocurrencies, worldwide. And therein lies the great risk, among other more pedestrian risks.
Now, many of the major governments and their central banks are actively looking into and starting to move in the direction of having their own cryptocurrencies. China is perhaps the most advanced in that endeavour, but others are actively pursuing the idea. Needless to say, if governments decide to produce their own cryptos, they will definitely go to the next step and regulate the cryptocurrency market, at least in their own countries. If some governments do that, then more will follow, and the crypto world will go from an uncontrolled, unregulated one, to a controlled and regulated one, thereby losing its most important and appealing trait to its current believers.
There are also other risks that need to be made note of. Cryptocurrencies are difficult to mine, but to a degree, easy to lose to hackers. Being entirely digital and always ‘stored’ on some computer or system, individual ‘wallet’ or trade exchange, they are susceptible to hacking. Suffice it to say, already, hundreds of Millions of Bitcoins have been lost to hackers (theft) over the years.
To prevent hacking theft, the owner is advised to use complicated (theoretically un-hackable) passwords, ‘private keys’ to access their accounts, and the exchanges themselves use all the security measures available to them through the most advanced current security technologies.
These security measures sometimes pose a risk in of off themselves. People have forgotten or lost their passwords (‘private key’), and there is no way to recover or re-gig it. Apparently, individuals have lost Millions of dollars in Bitcoins because they ‘lost’ or forgot their personal password or private key to their crypto account(s).
Crypto exchanges have been hacked through some inherent weakness, or mistake made by the exchange, an employee or even a client, and have lost in some instances hundreds of Millions of dollars’ worth of Bitcoins.
Japan-based Mt. Gox (established in 2010), was the world’s largest exchange, reportedly handling over 70% of all Bitcoin transactions worldwide. It was hacked twice, once in 2011, and the second time in 2014. The second time the hack, which was in fact a theft, was massive, where reportedly, approximately $450 Million of Bitcoins were hacked or stolen, forcing Mt. Gox to file for bankruptcy and close forever, losing all its clients’ money, as no refunds were ever made.
Considering the instances of theft that have already taken place, and reported, apparently no system, code, password, is entirely safe. [Greater details of crypto thefts are on the internet].
As Bitcoin and the other cryptocurrencies are not government or big bank controlled or managed (their sole purpose for existence), they are also not guaranteed or recoverable like regular money when stolen from the bank, or from the client’s account. It is only up to the crypto exchanges whether they can, or will, replace the stolen or lost cryptos.
The other question that is vexing is that if numerous cryptocurrencies are being developed, and mined, and being used, then isn’t that already a form of dilution? Even if individual cryptocurrency is limited in its mine-ability, or restricted in its final number of distributions, but if there are many, the overall effect is certainly dilution of a sorts. Like the many currencies of today. So, while Bitcoin maybe todays equivalent of the US dollar as the most dominant cryptocurrency, as the dollar is among the other currencies, yet that dominance may be challenged by another cryptocurrency because of some more advanced features that perhaps Bitcoin does not possess in its original makeup? Therefore, the uncertainty of the developing cryptos market is itself a risk.
The greatest uncertainties regarding Bitcoin and the developing cryptocurrency market are the more than likely future interventions of governments and central banks in the distribution and use of cryptocurrencies in their countries, and the development of their own cryptocurrencies.
With greater government and central bank interest will come the likelihood of new regulations. In this, the very success of Bitcoin and the other cryptocurrencies may bring on their greatest and most transformative risks, because the more widely accepted they become the greater likelihood of government(s) interventions.
The other major and growing risk is the amount of electricity it takes to ‘mine’ a bitcoin or another cryptocurrency. It is estimated that annual consumption of power in mining cryptocurrencies, including Bitcoin is equivalent to the entire consumption of electricity of a small country, like Denmark! As the crypto market grows rapidly so will the electricity consumption grow exponentially, so much so that the gargantuan consumption of electricity in mining cryptocurrencies could possibly rise to the equivalence of the consumption of a medium sized country, and that may create its very own Achilles heel in this time of heightened concerns about the environment, and the very real dangers being posed by Climate Change. But for now the cryptos are the rage.