Disclaimer: Opinions expressed below belong solely to the author and should not be treated as financial advice.
Crypto winter is upon us with coin valuations in free fall and several bankruptcies wiping out billions of dollars from the pockets of private investors.
But the question is — if blockchain was supposed to be a much better alternative to traditional finance, why is it doing so badly right now?
After all, shouldn’t a global economic crisis, coupled with crippling sanctions on certain countries, be a boon for blockchain-powered DeFi that gives the middle finger to the financial establishment? Shouldn’t it be the perfect opportunity for innovation to show its advantages?
Central banks are still calling the shots
Even though regulation of crypto is patchy and limited, and many countries don’t even recognise it as a financial service per se, it is still just another market, subject to the very same fundamental laws of supply and demand.
This is because, for most people, entry into the cryptoverse still leads through fiat. They spend their dollars and euros to purchase digital coins.
And because of this link to fiat, traditional central banking wields just as much influence over crypto as over everything else.
Fundamentally, there is no difference between buying carrots, cars or condos and buying Bitcoin or Ether. In each case, it’s just a bilateral transaction using a common medium of exchange: currency.
This is why, when global inflation began gaining steam last year and central banks started cutting off generous money supply and raising interest rates, cash started running for cover.
Stock market valuations collapsed and cryptocurrencies followed, as investors decided it’s more useful, safer and valuable to hold dollars than BTC or ETH (not to mention a zillion meme coins).
So much for “decentralisation”.
When money is accessible and cheap, it can flow to risky investments (including borderline gambling). But when its price goes up (by way of higher interest rates set by central banks), it leaves for safer shores, starving those who relied on it for existence.
“It’s only when the tide goes out that you learn who has been swimming naked.”– Warren Buffett
Once fiat was made more expensive, investors stopped feeling like risking their money on crypto.
Despite the fact that it was meant to challenge and, ultimately, depose the ruling class of central bankers, the reality is that a mere fine-tuning of interest rates revealed that the entire industry is no alternative (yet, at least) and that it is as dependent on the whims of national monetary authorities as every other.
Is decoupling possible?
For crypto to succeed as a decentralised solution, retaining stability amid changing external conditions, it would have to be able to completely decouple from existing financial systems.
The problem is, of course, that people still need to buy access to the cryptoverse using existing currencies (while mining is only in the hands of the very determined few). There’s really no way to change that because you have to be able to enter the market somehow, and that means exchanging something for the digital coins, and you can’t stop people from offering their dollars or euros in exchange.
So, since decoupling is impossible, is there another way for crypto to supersede the stale status quo? Or is it going to be forever swayed by the influence of the old elites?
If cryptocurrencies cannot avoid being traded for fiat (what opens them up to interference from central banks and their monetary policies), the only other path to upend existing systems is by functional superiority.
In other words, crypto will only be on the path to replace traditional finance when people will flock to it (particularly in a crisis), because it offers functional benefits that fiat does not.
So far, cryptocurrencies have been traded like baseball cards. You hold onto them in the hope of future appreciation denominated in dollars, euros, yen etc.
There is no functional reason to own most of the coins in existence, including the most popular Bitcoin — which, by the way, has clearly failed in its role of “digital gold”.
Despite many design flaws, many have lauded BTC as a possible digital equivalent to gold, which is typically used as a safe store of value.
Well, given just how much of it it has lost in the past year, we can safely say it isn’t even close.
And while gold itself is currently feeling pressure from conventional currencies, given high interest rates that guarantee a safe return, it remains near its historical highs, providing a relatively secure store of value during tough times.
Ethereum seems to have always had a better strategy, being more functional by design, enabling existence of multiple digital services on top of its blockchain, providing benefits that are not matched by any competitor.
But it too is far from what we could call developed, as this year it has kept recording a staggering 1+ million failed transactions each month.
FUN FACT: According to Blockchair, 1,228,131 #Ethereum transactions failed in May.— Watcher.Guru (@WatcherGuru) June 1, 2022
Reasons for failures may vary, but they incur gas fees which are not returned. In extreme cases, it may involve thousands of dollars — five transactions in May cost 3ETH each, or about US$6,000 at the time.
It doesn’t seem to be an advantage over paying by wire or credit card and certainly not something that inspires trust.
How long may the crypto winter last? How low may cryptocurrencies fall?
As for the latter, it’s anybody’s guess, as there are very few fundamentals on which to base your opinion. Unlike with stocks which represent a stake in companies that have a financial performance you can review, cryptocurrencies are not moneymakers and their current price is pretty much entirely dependent on whatever market participants are willing to pay.
As for how long this unfavorable situation may last, however, we can make a few educated guesses, given that the collapse has largely been triggered by the global economic situation.
It seems unlikely that the market will meaningfully rebound as long as inflation is high and money supply restricted by central banks of the largest economies. Such a state may last for at least a year or two, what CZ of Binance also observed lately.
It could change earlier, provided that someone is able to deliver a cracking new innovation that will meaningfully compete with traditional services, but to achieve that substantial funding would also be needed and that’s bound to be restricted for as long as money supply is being tightened).
So, barring an unexpected functional breakthrough, the next bounce-back is likely to only happen when central banks become generous again. Thus, ironically, proving once more just how dependent the entire cryptoverse is on them.
Featured Image Credit: rafapress / depositphotos