Tech
Cryptocurrency is failing as money; Bitcoin and other cryptocurrencies need help
Cryptocurrency has so far failed to wipe out government-issued money, or bring about the broader revolution its most ardent supporters envision. But what if the underlying technology could be harnessed to transform traditional fiat currencies, for example by making them much easier and cheaper for more people around the world to use?
This goal could be achievable, with the help of governments that cryptocurrencies were supposed to overshadow.
Regular money leaves much to be desired. Most people keep it at big banks, which have sometimes used subterfuge and even outright fraud to tax their customers, and which have proven worryingly fragile in a crisis. Moving money can take days, especially if it has to make its way through the antiquated and hackable network of correspondent banks that handle international transfers. For those without bank accounts, including millions of Americans, disproportionately black and Latino, things are worse. Currency exchanges, ATMs, card issuers, and money transmitters all charge onerous fees.
Read also: Looking for a smartphone? To check the mobile device locator
Bitcoin, the original cryptocurrency, was designed to circumvent all that. Anyone with an internet connection can create a pseudonymous account, controlled with a private key. Users can send digital tokens anywhere, anytime, thanks to a voluntary network of computers that record transactions on a public ledger known as a blockchain. High-powered encryption and decentralization protect against abuse and disruption. The technology has inspired hope not just for fairer finance but for greater stability: The demise of one or more major global banks would cause far less harm if payments could proceed without them.
Bitcoin has spawned an entire movement, but so far it has failed as money. Pure cryptocurrencies are too volatile to be useful beyond speculation, illicit trade, and the occasional funding of activists in oppressive regimes. The processing power required for the Bitcoin blockchain makes it slow and expensive for smaller transactions, not to mention damaging the environment. People are afraid of losing the keys to their cryptocurrencies (an estimated one-fifth of all bitcoins have been lost this way), so they entrust them to wallet apps and other platforms that are frequently hacked. Most crypto “believers” engage in transactions through the same kinds of intermediaries (exchanges, PayPal, specialized ATMs, opaque trust companies) that the technology was intended to replace. Many of these businesses are less secure and more expensive than traditional banks. Their rapid growth threatens greater financial instability.
That said, all is not lost for cryptocurrencies.
Despite all this, cryptocurrency innovation could still lead to a better payment system.
Consider stablecoins. They manage volatility by tying their value to fiat currencies, implicitly acknowledging pure cryptocurrencies’ biggest flaw. They can run on blockchains that run more efficiently than Bitcoin and have a smaller carbon footprint. At the moment, they’re mostly used by cryptocurrency speculators to park funds while they decide what to bet on next, or to earn interest in unregulated lending pools. But as a unique form of electronic money, they have the potential to make transfers easy, instant, and cheap. The Facebook-initiated Diem Association, for example, wants to use them to enable payments on mobile apps like Facebook Messenger and WhatsApp. Ultimately, the infrastructure they use could even provide the rails on which government-issued digital currencies could ride.
Another initiative, known as Lightning, seeks to solve Bitcoin’s throughput and energy problems by establishing side channels through which multiple payments can be made, with only the final balance recorded on the blockchain. The system has enabled one application, Strike, to use Bitcoin as a utility for remittances between the United States and El Salvador. Users’ money can go in as dollars in one country and go out as dollars in the other, with virtually no time wasted on volatile cryptocurrencies.
Innovations like these are promising, but they also present risks that regulators must consider.
• They could spark runs. Stablecoins that are convertible into fiat at fixed rates and fiat balances in apps like Strike need to be securely backed. Often, they aren’t. A recent Bloomberg Businessweek exploration of Tether, the most popular stablecoin with about $70 billion in circulation, found a company “riddled with red flags.” A lack of clarity, or a lack of funding, could one day spook holders, precipitating a crash as everyone rushes for the exits.
Regulators should insist on backing in the form of high-quality assets, ideally fiat currency. In the US, this can be achieved by requiring payment apps and stablecoin issuers to invest only in bank deposits that are themselves held at the Federal Reserve, or by creating a narrowly defined banking license that allows them to open reserve accounts directly with the Fed.
• They could weaken traditional banks. If people could safely store their money in stablecoins and payment apps, they might stop putting it in banks, depriving them of the resources to lend. The resulting credit crunch could bring down the economy.
A recent Bank of England analysis suggests that such concerns are overblown. People will likely be slow to adopt new forms of digital money, its authors say, giving the system time to adapt. Still, regulators should err on the side of caution, banning stablecoins and payment apps from paying interest or reducing the interest they receive on their deposits at the Fed. Such restrictions could be eased later, once officials are able to assess any threats to the banking system and credit.
• They could crash or get hacked. It’s one thing for Facebook apps to go down for a day; it’s another thing if the company were running a global payment system. Newer protocols are still untested, as the recent Solana blockchain outage demonstrated. Lightning has known vulnerabilities.
Regulators should require sufficient equity capital to absorb unexpected losses and set standards for security and governance, such as testing for resilience and identifying who is responsible for managing emergencies. If a company cannot demonstrate that it is acting responsibly, it should not be allowed to operate a payment system. Systems should also be interoperable, so that a dollar in one can easily be converted into a dollar in another.
• They could facilitate crime. Crypto platforms typically identify users only with an alphanumeric address. This has made them useful to ransomware developers, tax evaders and other criminals, and raised concerns that they could undermine international sanctions and anti-money laundering laws.
Platforms and apps can and should require identification when necessary to enforce the law. If regulators required it, such as when balances or transactions exceeded certain thresholds, cryptocurrency-enabled payment systems could remain widely accessible and still be far more transparent than the current banking system. In most cases, transactions are already visible on public ledgers, which has helped both law enforcement and the cryptocurrency community track down and recover ill-gotten gains.
For many, the speculative frenzy surrounding cryptocurrencies won’t end well. Officials like U.S. Treasury Secretary Janet Yellen are right to call for urgent measures to address the growing risks. But they’re also right not to ban cryptocurrencies entirely, as China has attempted. Growing innovation is already driving competition, both private and public, to upgrade a financial system that can certainly stand some improvement. The result could benefit people everywhere, as long as regulators don’t fall further behind in guarding against the dangers.