I have been watching, with keen interest, the outcome of the FTX fiasco. For those not watching the crypto space, FTX was an exchange that facilitated cryptocurrency transactions. And they filed for bankruptcy as the $32 billion in company value disappeared overnight. And with that, 30-year-old Sam Bankman-Fried’s empire has collapsed.
The details of the fiasco are still coming out, but we do know this: the management team including their young CFO had funneled client funds into their investment arm, Alameda Research. The investments made by Alameda collapsed made FTX insolvent, and the rest is history being written as you read this.
A Cautionary Crypto Tale
There are many things we can take away from this. First, it is quite obvious that the crypto complex, which is what I call all of the infrastructure needed to run cryptocurrencies including exchanges, nodes, wallets, etc. is far from a finished product.
There is still much to be figured out on how the business model will work, who is actively developing quality software and infrastructure, and exactly how value will be determined by the market. It is really no different than the dot-com bubble that burst a little over 20 years ago. Many attempts at leveraging Internet technologies collapsed, leading to the giants that we know today such as Amazon, Google, etc.
Meaning, while the technological innovation is nice, we are still a long way away from having a working business model for the crypto space. And we also lack clarity on which coins and which supporting services will stand the test of time. This will all be figured out as the years go by; which unfortunately does not soothe current investors who have lost their money in the various failed crypto projects.
Years ago, I wrote a piece on Seeking Alpha about the perils of Bitcoin and the crypto space. In it, I said:
“A recent Forbes Article, Eight Reasons To Be Skeptical About Blockchain, provides several reasons why these technologies haven’t been widely adopted as formal payment mechanisms.”
I went on to point out troubles with adoption as a legitimate currency (15% of transactions) versus speculative trading (85% of transactions). I also pointed out the issues with infrastructure and how any crypto at the time would have collapsed under the weight of true economic demand. Transaction volume has to be light unless many layers of ledgers are used in a federated fashion.
Further, I provided a critique on the power requirements for Bitcoin, which grow exponentially as the math gets harder to solve the closer we get to the last coin issued. This also creates a first-owner conundrum in that those that got in early have the incentive to pump the system in order to magnify their gains for founder Bitcoin purchased or mined at literally pennies on the dollar.
I also addressed the hacking threat to exchanges and to private wallets which still exists as a risk today. The more complex the software becomes in order to scale these systems into a fully-fledged currency regime, the more hackable they become.
In the cybersecurity space (which I worked in for many years), this is a known issue and demands security be purpose-built into the product. And while the blockchain itself has several security features, the software implementing it across the ecosystem does not; and as a consequence, is very vulnerable to criminals searching for easily stolen profits.
What’s Next
I believe what is coming next is a huge round of regulation from the government aimed at addressing the issues and concerns the market has developed with Bitcoin, other cryptocurrencies, and the industry infrastructure which is growing like a weed every single day.
As a former auditor, I DO NOT think additional regulation will solve all of the issues we see now in the space. Some of them are software development lifecycle maturity issues which will require innovation in development and security best practices in use today in other, more mature industries.
What regulation CAN DO is provide a framework for controls and reporting that forces entrepreneurs in the space to consider risk before they begin developing their platforms. It will slow down development, but there is a bigger risk for Bitcoin and the rest of the private crypto space in the meantime.
Central Bank Digital Currencies (CBDCs)
Governments and central banks have caught onto the idea of digital money and are eagerly developing their own centralized versions. In the US, it will be called the Digital Dollar and the NY Fed has announced they are actively developing it while working on interoperability with CDBCs from other countries.
Through the NY Fed’s Innovation Center (NYIC), the central bank has devised two stages of testing for international CDBC transactions dubbed Project Cedar. What is interesting about the NYIC is their work collaborating with other central banks that are developing their own CDBCs. In fact, the Atlantic Council, a research organization, has provided a nice handy roadmap for worldwide CDBC adoption.
It is clear to me that CDBCs will be the replacement for fiat currencies (the paper versions) such as the dollar, euro, pound, yuan, yen, peso, and many others. All the central banks need is a catalyst to replace paper money with the electronic version. A quote from the IMF:
“Monetary policy space remains constrained by the lower bound in many countries, limiting the policy options available to address future deflationary shocks. The existence of cash prevents central banks from cutting interest rates much below zero. In this paper, we consider the practical feasibility of recent proposals for decoupling cash from electronic money to achieve a negative yield on cash which would remove the lower bound constraint on monetary policy. We discuss how central banks could design and operate such a system, and raise some unanswered questions.”
That paper was from 2018, 4 years ago. However, there have been additional papers written as far back as 2015 that address how the central banks and government can get around the cash problem and move the public into electronic money in the banking system. CDBCs are not a new concept, though many have never heard of them.
Final Thoughts
FTX’s failure was probably predictable, in as much as the crypto space is still in its early ‘wild-west’ phase. The problems that FTX created for the crypto space will lead to more regulation and control, and the government moving the public away from private crypto options and into the waiting arms of the centralized digital currencies provided by each sovereign central bank.
While the CBDCs may solve the banker and government problems of too much debt and fiat money, I do not believe those experiments will last for long. It will become much too easy for the banking system to devalue your digital dollars because they will no longer have the anachronistic controls of debt ceilings and the printing press. Truly, computers had outmoded printed dollars decades ago. The public is just now becoming aware of this fact.
In the meantime, I see gold and silver bullion as the proven 5000-year alternative to what is a rocky start on the road to worldwide electronic money. I also suspect that they will become much more popular to the public as the CDBC era comes more into focus for the average person.
And to be sure, I see this as a catalyst for gold and silver prices in the meantime because as the fiat currency era dies, the people will be looking for value that has stood the test of time. And that sure as heck is not the cryptocurrencies. At least for a long, long while.
How the private crypto battle with the central banks and government evolves will determine their fate. That story has yet to be written. While the current financial regimes complete that novel, I opt for the safety and security that the precious metals provide me.
