Will Cryptocurrency Ever Deliver on Its Grand Vision?

In our world today, which seems to be defined by technological advancements, cryptocurrency is one phenomenon that has captured the imagination of tech enthusiasts, financial experts, and laymen alike. Proponents of digital currency have either claimed that it will revolutionize finance.

Picture this: a world where financial transactions are conducted seamlessly and often anonymously, beyond the limitations of traditional banking systems and fiat currency. That’s the grand vision of cryptocurrency.

Needless to say, the technology behind cryptocurrencies has great potential, but will the concept of a digital currency that enacts a decentralized, borderless financial system truly ever be? While it has certainly gained popularity and disrupted traditional financial systems to some extent, there are still concerns, especially about their long-term stability and security.

A deeper dive into the guarantee of a borderless financial system

The fundamental tenet of cryptocurrencies is to replace trust with technological mechanisms. This promotes the idea that the principle of "code is law" can create a self-regulating framework that is free of human bias and error. Therefore, the first assurance is the elimination of trusted intermediaries. At least, that was the central idea presented in the original Bitcoin white paper - a cryptographic solution that enables transactions to be conducted directly between parties without the need for any financial institution or third-party intermediary to be involved.

However, is the cryptocurrency industry really eliminating traditional intermediaries or replacing them with new ones? Certain experts already contend that a crypto-based financial system will exacerbate many of the issues with conventional banking, and according to Kadan, the CTO of Komodo, this is already happening.

“Currently, the average crypto user’s experience is closer to traditional finance. For example, many rely upon trust-based centralized crypto exchanges for holding and trading crypto. Centralized crypto exchanges operate similarly to banks but with significantly more risks for their users.”

- Kadan Stadelmann, CTO at Komodo

Initially, the concept of cryptocurrency was aimed at establishing a decentralized payment infrastructure built on blockchain technology. While some argue that this objective is attainable, the intricate challenges associated with implementing such a system make it appear nearly impossible to accomplish.

According to the CEO of O'Reilly Media, Tim O'Reilly, the much-acclaimed Web3 which is touted as the next evolution of the internet, represents just one of several endeavors to establish a decentralized system within the technology domain. Comparable to its predecessors, Bitcoin underwent a rapid centralization process, presently dependent on a restricted group of software developers and mining pools to sustain its operations. In his words,

“Blockchain turned out to be the most rapid recentralization of a decentralized technology that I've seen in my lifetime. It took a decade to recentralize in the case of the PC. It took a decade in the case of the web. But it took only a couple years with bitcoin before the majority of the value was held by a very small group of people.”

- Tim O’Reilly, CEO of O’Reilly Media, Inc.

According to a report from the International Monetary Fund (IMF), written by Hilary Allen, it is observed that voting rights in decentralized autonomous organizations (DAOs) and wealth accumulation in the crypto space tend to be even more concentrated than in traditional financial systems. Furthermore, the decentralized blockchain technology faces challenges in efficiently handling large transaction volumes and lacks mechanisms for transaction reversals, leading to the emergence of intermediaries seeking to streamline the cumbersome decentralized services for users, often with the motivation of generating profits.

The economists at the Bank for International Settlements (BIS) have asserted that there exists a "decentralization illusion" in the crypto space, primarily due to the unavoidable need for centralized governance and the tendency of blockchain consensus mechanisms to concentrate power. This statement raises questions about the extent of true decentralization achieved in the cryptocurrency ecosystem.

It is worth noting that while some crypto businesses claim to embody decentralization, many have not upheld this principle in practice. Centralized exchanges, wallet providers, stablecoin issuers, and various other intermediaries play pivotal roles within the crypto ecosystem. Some of these intermediaries operate without regulatory oversight, presenting concerns about consumer protection and financial stability, mirroring similar challenges faced in traditional finance.

Cryptocurrency Failures

CoinKickoff's graphics provide a breakdown of the failed crypto coins based on the years they ceased to exist and the years they were initially launched. The data spans a decade of crypto coin busts, covering the period from 2013 to 2022.

Sadly, many of these project failures revealed a disheartening truth—the presence of intermediaries who held considerable influence and control over these supposedly decentralized ventures.  This revelation shattered the notion of true decentralization and raised questions about the genuineness of their claims.

According to Visual Capitalist's report, 2018 witnessed the highest number of crypto coin casualties, with a total of 751 coins becoming defunct. Among these, 390 coins failed primarily due to insufficient trade volume, while 237 coins faced demise as a result of fraudulent issues. In subsequent years, we saw a rise in cases of regulatory evasion, inadequate risk management, and lack of transparency exposing the fragility of the crypto ecosystem.

Inarguably, this sort of centralization which mimics the one found in traditional finance is also followed by market failures, negative externalities, and vulnerabilities similar to those found in traditional financial systems. In 2022 alone, some of the biggest names in cryptocurrency which most people thought would never fail have either crumbled or filed for bankruptcy as per Reuters reports. Some of the companies in the list include:

• Celsius Network
• Genesis Global Capital
• Voyager Digital
• Three Arrows Capital
• Core Scientific
• Ftx
• Blockfi

What’s The True Cost of a Digital Currency?

One major concern is the significant negative impacts of crypto, including ransomware attacks and excessive energy consumption. The crypto industry lacks adequate regulation and consumer protection, leaving users vulnerable to hacks and scams, and the proof-of-work validation mechanism used by Bitcoin and others consumes enormous amounts of energy, raising environmental concerns.

Earthjustice reports that in the year leading up to July 2022, the energy consumption of Bitcoin reached an alarming 36 billion kilowatt-hours (kWh) of electricity. To put this staggering figure into perspective, it equals the combined electricity consumption of four states—Maine, New Hampshire, Vermont, and Rhode Island—during the same period.

Such explosive growth in the cryptocurrency sector is placing tremendous strain on energy grids, resulting in increased retail electricity rates, and contributing to a rise in both total carbon emissions and local air pollution. These consequences raise important environmental and social concerns, warranting a closer examination of the industry's practices and their impact on the broader energy landscape. As stakeholders grapple with finding a balance between technological innovation and sustainable energy use, addressing these issues has become paramount for a more sustainable future.

Additionally, the complexity of the crypto ecosystem and the potential for manipulations makes it prone to destabilizing booms and busts. One of the most notable examples is the Bitcoin price surge in 2017, where the value of Bitcoin reached an all-time high of nearly $20,000, followed by a significant crash in 2018, leading to a steep decline in value. Similar boom and bust cycles have been observed in other cryptocurrencies as well. These price fluctuations can create instability in the market and lead to potential losses for investors who bought at the peak of the market.

The speculative nature of cryptocurrencies also makes things worse. Many investors and traders buy cryptocurrencies with the hope of making quick profits as prices rise. This can lead to overvaluation and bubbles in the market. When the hype subsides or negative news impacts the market sentiment, prices can collapse, causing losses to investors who entered the market during the hype phase.

In many cases, profits in the crypto market may depend on finding new investors to buy at higher prices than the initial investors paid. This is often referred to as the "greater fool" theory, where investors believe they can always sell their assets to someone else at a higher price. However, when the flow of new investors slows down, prices can stagnate or decline, leading to potential losses for those who bought at higher prices.

So, Will Cryptocurrency Deliver On Its Grand Vision?

While crypto proponents often present the narrative that digital currencies have the potential to foster financial inclusion, the World Economic Forum has expressed a different perspective on the relationship between financial inclusion and cryptocurrency. While acknowledging that financial inclusion is an important issue, the forum contends that cryptocurrency might not be the ultimate solution to address the fundamental political and technological challenges associated with it. The organization points out that digital currencies as they are currently implemented may not offer significant new advantages for financial inclusion beyond what traditional financial options already provide.

According to Hilary Allen, professor at American University’s Washington College of Law,  whose research centers on the effects of new financial technologies on financial stability,

"Cryptocurrency fails to fulfill its promises of decentralization, and its volatile cycles of growth and decline could result in significant economic ramifications if it becomes integrated into the conventional financial system, potentially disrupting the flow of capital to the real economy."

-Hilary Allen, professor at American University’s Washington College of Law

I believe the realization for us should be that cryptocurrency is not a magical solution to all our economic challenges. While it does offer potential benefits, it is crucial to understand that cryptocurrencies alone cannot swiftly resolve the complexities of the financial market.

As we explore the future of digital currencies, it is essential to approach them with a balanced perspective. Only with a pragmatic approach can we hope to cultivate the true potential of cryptocurrencies while navigating the dynamic landscape of the financial world.