It’s been a rocky month for cryptoassets with Bitcoin falling below $4,000 in early December.
November saw the firms Paragon and Airfox settle cases with SEC on the failure to register their ICOs as security offerings, in line with the Howey Test. Any promise of token price appreciation is now a ground for the blockchain platforms to fall under the preview of securities regulation.
On a positive note for cryptoasset enthusiasts, SEC Chairman Jay Clayton has now called for a laddered approach to regulating ICO/IPOs indicating publicly traded companies and start-ups should be regulated differently depending on their market size. Watch this space.
In the first in a series of articles on cryptoassets with Navoop Sahdev, economist and fellow at MIT Connection Science, we explored the role of crytpocurrencies in future societies. In this second article, we explore why cryptocurrency prices are plummeting and attempt to put cryptocurrencies in a clearer context with fiat currencies.
Lawrence Wintermeyer: Why are cryptocurrency prices rapidly declining? Is this market correction of some sort or is the crypto bubble finally bursting?
Navoop Sahdev: I think there are two dynamics at play here. First of all, the development, and hence adoption, of the technology is turning out to be far slower than what many of the ICO investors anticipated. There is always a time element to adoption and hence investor returns, not meeting which, can easily result in a bearish market sentiment. We know that sentiment spreads like wildfire (also called information cascades) particularly in markets where investors can switch positions quickly.
Second, there is evidence around crypto markets responding to regulatory moves as regulatory bodies (like the SEC in the United States) issues subpoenas and brings more and more blockchain startups under the purview of securities regulation. There is empirical evidence on crypto markets reacting to regulatory action, as reported by the recent Bank of International Settlements report.
Wintermeyer: What, then, is the consumer use case for cryptocurrencies? Why would consumers use a cryptocurrency over a fiat digital currency?
Sahdev: The consumer use cases for crypto assets (which is broader than cryptocurrencies) continue to expand. The innovation taking place in the space is probably unprecedented and the ecosystem is just exploding with ideas and projects, clearly marking the growth of a new asset class. Two key features serve as the common denominator of all of these use cases: redemption from central control and restoration of trust. Most of the major players in all major industries are experimenting with blockchain.
Now, I do want to differentiate between real innovation (new products and services and/or new efficiencies that are gained by using blockchain technology) and the market sentiment in crypto markets (many of these are by no means a ‘currency’; I think it’s a huge fallacy to call them as such).
Prices (determined by market demand and supply) should not be confused with (identified and potential) innovation value of blockchain technology. While capital is necessary to help fund the build-out, we are past that stage. Now is the time to actually build the technology infrastructure with the ultimate test of the success of the technology being mass adoption.
While the speculation around the price of crypto assets may continue over the next months and years, my advice to blockchain companies is always to focus on the innovation and not the market valuation. Consumer adoption is the name of the game.
That said, I don’t think cryptocurrencies would replace fiat money anytime soon. As we covered the functions of money in the previous article on The Role of Cryptocurrencies in Future Society, cryptocurrencies can act as a stable store of value in the future. While this is one of the functions of money, it’s not the only function of money. I, hence, prefer to look at these tokens as crypto assets, rather than cryptocurrencies. A lot of comparisons have been drawn out with between cryptocurrencies and money.
While these are healthy debates from a theoretical perspective (Can crypto replace fiat? Will crypto replace fiat? Etc.), many of these are doing more harm than good by confusing money’s role in the society with crypto as a new asset class. There is also widespread confusion (example here) around how network adoption (and the overused – Metcalfe’s Law) drives higher valuation when the whole point of being a medium of exchange is to act as a reliable indicator of value.
In short, if your goal to maximize token price, no, you’re not going to replace fiat. Currency has to serve as a reliable medium of exchange; so while there is some secular inflation in the economy over the long term, there is a reason why central banks exist – to make sure that inflation does not go beyond a threshold.
Wintermeyer: When I speak to central bankers, many are focused on digital currencies and not cryptocurrencies, what is the difference? Will people be more likely to trust cryptocurrencies if they are created (or issued) by central banks?
Sahdev: Digital currencies issued by central banks usually represent fiat. Virtual currencies on the other hand, are not issued by central banks or credit unions. They are widely considered as unregulated digital money. Cryptocurrencies are a subset of virtual currencies – currencies that are secured through cryptography, usually based on a decentralized trustless network (and hence the use of cryptography to ensure security in transactions).
There is usually no one central controller that issues or controls cryptocurrency. Hence, central banks issue digital currencies (centralized currency representing fiat money) and not cryptocurrencies (which are usually issued by a group of developers and accepted as an alternative to money and an accepted representation of value by a virtual community).
I think cryptography certainly has benefits to offer in terms of higher security regardless of the actor deploying it. Here’s what central banks around the world are saying about cryptocurrencies. The important thing to understand is the difference between centralized and decentralized money. Centralized money is backed by the government – that’s responsible for upholding the statutory promise of providing the goods and services against a currency note – physical or digital. Decentralized money doesn’t have a central trust-lending authority to provide that promise. Hence, the community relies on cryptography as a way to securely transact value across the network. In other words, central banks don’t need cryptocurrencies.
In a centralized money world, cryptocurrencies would remain on the sidelines. In a decentralized world though, where central banks are one of the stakeholders in the regulation of money (rather than being the only one), they would be forced to adopt cryptocurrencies. This can happen if the peer to peer economy around the world grows large enough that governments can no longer ignore it and/or they actively promote peer to peer value transfer with friendly regulation. And if it is the demand for redemption from central control and a trust crisis we are talking about, I’m gonna place my bets on the future being decentralized.