Tech
The cryptocurrency industry should use innovation to regain lost trust
The spiraling fall of Sam Bankman-Fried, the disgraced founder of cryptocurrency exchange FTX who was recently convicted of fraud and money laundering in New York, has cast a harsh light on a largely unregulated market. For all the supposed wonders of the blockchain technology behind cryptocurrencies, events that have made headlines in recent years point to an industry in turmoil.
The spiraling fall of Sam Bankman-Fried, the disgraced founder of cryptocurrency exchange FTX who was recently convicted of fraud and money laundering in New York, has cast a harsh light on a largely unregulated market. For all the supposed wonders of the blockchain technology behind cryptocurrencies, events that have made headlines in recent years point to an industry in turmoil.
In addition to the criminal activity that led to FTX’s spectacular collapse in 2022 and Bankman-Fried’s guilty verdict in early November, US regulators have sued Binance, the world’s largest cryptocurrency exchange, for having allegedly operated a “network of deception”. A global reckoning looms. Will cryptocurrencies always be a magnet for fraud and wrongdoing, or will they ultimately transform and democratize finance?
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In addition to the criminal activity that led to FTX’s spectacular collapse in 2022 and Bankman-Fried’s guilty verdict in early November, US regulators have sued Binance, the world’s largest cryptocurrency exchange, for having allegedly operated a “network of deception”. A global reckoning looms. Will cryptocurrencies always be a magnet for fraud and wrongdoing, or will they ultimately transform and democratize finance?
An increasingly evident paradox has emerged. Satoshi Nakamoto, the pseudonymous creator of Bitcoin, proposed the idea of a purely peer-to-peer version of electronic cash in the wake of the 2008 global financial crisis, when trust in governments and central banks was at its lowest point . Soon after Bitcoin’s launch in 2009, Nakamoto wrote that “the main problem with conventional currency is all the trust needed to make it work.” Today, the system that was supposed to eliminate the need for trust between people and institutions in traditional financial systems is experiencing a crisis of trust.
Cryptocurrencies like Bitcoin and Ethereum are based on computer code and networks that are not controlled or managed by a central entity. Surprisingly, such decentralization works. Transactions can be completed securely, without relying on a bank, credit card company or other institution. In principle, this should make financial systems less vulnerable to fraud and manipulation.
Unfortunately, scammers and unscrupulous companies have exploited customers and investors enamored of the new technology and, in the process, obscured cryptocurrency’s most compelling innovation: blockchain-enabled tools that can improve transparency and strengthen the trustworthiness of the financial sector. Maintained on computers around the world and publicly accessible by anyone with an internet connection, blockchains are digital ledgers that contain an immutable record of all transactions in a system. Their reliance on algorithms, rather than human interaction, creates a robust money trail that traditional financial infrastructures lack.
So how did we end up with a cryptocurrency industry that often contradicts its founding ethos? One answer is that any innovation inevitably attracts speculative mania and cheating, especially in the early stages of its development. In the 19th century, banks deceived examiners by filling gold reserves with nails. More recently, the dot-com era gave us the likes of Enron, while the biotech boom brought us Elizabeth Holmes and Theranos.
Another problem is that the new industry’s new consumer-facing platforms have grafted old ways of doing business onto technology designed specifically to eliminate them. While FTX was an “exchange,” a gateway to blockchain-based cryptocurrencies, it did not make fundamental use of decentralized technologies. Most cryptocurrency holders today store their assets on exchanges that require high levels of trust and carry many of the risks of traditional financial institutions.
Behind the scenes, the cryptocurrency industry has begun using technology to shift the balance back towards innovation. One example is the development of proof of reserves, a mathematics-based method that allows institutions to verify their crypto assets. Such tools could help prevent debacles like FTX, where a lack of transparency allowed Bankman-Fried to hide financial fraud.
Importantly, proof of reserves and similar tools work best for cryptocurrencies, not for regular financial assets, including the US dollar. These technical advances then pushed traditional financial institutions, the very ones Bitcoin sought to replace, to embrace cryptocurrencies. JPMorgan, for example, plans to move trillions of dollars of value onto blockchain, while monetary authorities are exploring central bank digital currencies (CBDCs), which would involve using blockchain technology to issue digital versions of their fiat currencies .
To be sure, the cryptocurrency industry faces several daunting challenges: the enormous environmental impact of Bitcoin mining, its use for illicit transactions, privacy shortcomings, and more. But, as the evidence of reserves suggests, the crypto community is innovating new and powerful ways to leverage the inherent transparency and reliability of blockchain technology to create a more secure and flexible financial ecosystem.
As these innovations progress, governments around the world are exploring ways to safeguard consumers from the excesses of the cryptocurrency industry. They would do well to look beyond the headlines that often scream scandal and seek a balanced approach that allows this extraordinary technology to thrive. ©2023/project syndicate
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