Cryptos are a benediction for bad actors. Rogue states and international pariahs use Cryptos to flout international sanctions. Do we want to help the North Korea’s government?

• Even the dark web has a regulator
• Even CBDCs may have malevolent intentions

Anonymity also hides bad actors and hinders enforcement authorities.

It is naïve to think that there’s only a few bad apples.

• There are a lot of ransomware transactions.
• Cryptos are used for money laundering.

Ransomware actors commit enormous damage.

• The Colonial Pipeline ransom cost $90 million.
• Ransomware will cost $265 bn annually in 2031.

The whataboutism of saying that there are much more fraud in fiat currencies may be true, but probably not after adjustment by the sizes of the two monetary masses or transaction volumes. Anyway fraud is fraud, and it should not be facilitated. 

That’s an enormous amount.

• 20% of all bitcoins have been lost already.

This would never happen at a regulated institutions, which would always be able to return your money to you.

We don’t know who owns the majority of cryptos. 

Natoshi Nakamoto, the creator of BTC, owns probably 1 million BTC, worth dozens of $ billions at the current level. Natoshi Nakamoto is a pseudonym.

• We don’t know who he (they) is (are) or what his (their) intentions are.

Contrarily to stated democratization objectives, 80% of cryptos are currently held by only 20 wallets (exchanges). DeFi has created its own new giants.

What power would these individuals and private entities hold on all of us if we convert, say, 20% of the world’s economy to crypto?

They are not full-proof.

They also consumes an enormous amount of resources.

The day a quantum computer breaks the code, a miner can hack the blockchain. BTC will be worth nothing after that. It will happen in the next decade.

• Mining is not safe from quantum computing.

Cryptocurrencies have a large negative environmental impact.

• Mining already consumes 0.5% of the world’s energy.

A lot of transactions could be moved to virtually instantaneous settlement.

An exchange or a repository of crypto like Coinbase IS a third party. You are still exposed to third party risk with cryptocurrencies.

If anything, your counterparty risk is actually much higher than in the regulated world.

• There has been numerous thefts by exchanges (aka exchange managers fleeing with investors’ money).
• Exchanges can be hacked too.
• Exchanges have recurring operational issues, like power outages.
• Exchanges have poor compliance, permitting manipulations and  insider traders.

Needless to say, regulated providers have a much better resilience. More on this in the exchange section below.

Free/very cheap transactions

The fee structure is actually opaque, and certainly not free.

• Fee structures are complicated, involving fixed fees, AUM-based fees and transaction fees.

Worse, transaction fee is only one element of transaction costs. The other are:

• Transaction spreads: the most liquid cryptos have spreads typically of 5-25 bps, while BTC has a spread of 1.5-20 bps, which are in line with the major currencies. But most crypto currencies are way less liquid.
• And liquidity: the slippage in BTC is a few bps for $100k$. It is orders of magnitude higher than for major currencies (you could trade dozens of millions of EUR/USD without impacting the pair’s price).
• The rumor is that some platforms (advertising free trades), have a tendency to move their spreads when you come for trading… It’s another cost.

Yes, governments can issue new dollars.

But cryptos are structurally inflationist – their number is limited and the cost of mining them increases over time.

The recent exponential growth price of BTC matches the rhetoric that it can ‘only go up’.

• The number of bitcoin is limited, and mining efficiency decreases every 4 years automatically (and the computational cost increases inversely).
• If you think the crypto is not inflationary, then at least it is deflationary, since the price of any asset, expressed in BTC, will go down.
• You may not create more of a given crypto currency, but you can endlessly create different crypto currencies.
• There is an estimated 6,000 cryptocurrencies at this stage. Most of these currencies will never have any value.

Which is the most stable and reliable? A fiat currency like the dollar in existence for centuries and backed by the power of taxation, or ‘something’ (see the regulatory question) that has no intrinsic value, is not a store of value, is not well defined and whose prices is highly volatile?

Not knowing what sustains the Thai baht currency, or the geopolitical complexity of the Turkish lira, is irrelevant to most individuals – they don’t use those currencies. It is the same for cryptocurrencies.

• Oil is in priced dollars; that will not change any time soon.
• There are only a few reserve currencies; sorry to hurt some people’s feelings, but BTC will never be part of this exclusive club.

As a result most people will never use such complex assets as a mean of payment, especially when they are evolving faster and faster.

Highly volatile in nature

A store of value must meet several criteria, like being durable, fungible, verifiable, storable, portable, and divisible.

Cryptocurrencies meet many of those. Where it becomes difficult is that a store of value must “retain purchasing power into the future“.

• Gold is perceived as such. Most fiat currencies are to some extent.
• Cryptocurrencies instead have no ‘intrinsic value”, and will never have any, to the exception of the mining cost (precious metals are worth at least their general extraction cost)
• Cryptocurrencies are generally not backed by anything of value (like the USD is backed by the full faith and power of the US government & its economy)
• They must also be perceived as such.
• Because of the lack of history and their high volatilities, it will take years / decades / generations before they could be accepted as such.

Also, a store of value should be usable for exchange. Just walk around town, your supermarket to start with, and it is pretty obvious. Most of the world’s assets cannot be purchased with Crypto currencies (at this stage).

• People buy cryptos for speculation, not for commerce.
• That is the main reason why economists believe that cryptocurrencies will eventually go back to zero.

This being said, cryptocurrencies offer other unique characteristics like

• being seizure resistant (for now). Who is looking for this again?

Not accepted everywhere

A few countries have accepted BTC as a national currency or borrowed in cryptos, but it is more to escape international sanctions than by structural benefit (see our previous note here)

• El Salvador’s attempt to avoid sanctions turned into a fiasco.
• Venezuela tried to create a Petro-currency pegged against its reserves, mostly to circumvent international sanctions. It also went nowhere.

So will cryptocurrencies ever be accepted as means of payment? Elon Musk thinks so, but

• Cryptos would have to be authorized by governments first.
• For that, Cryptos would have to become less volatile first.
• Government would consider that they would not hinder on their responsibilities and powers. You really have to be naïve to think that the US government will ever relinquish the international power and the responsibilities coming from being the world’s top reserve currency.
• And for what? To let commercial entities make profits? To support speculation? The Fed has prevented banks to issue their own currencies in the past.
• The Fed will support any form of economy and will likely let crypto exists, but never to the point of a challenge. Most central banks follow the same guideline. China just forbade them, as a preparation for their own CBDC.

Companies may use them, but it will be marginal. At this stage, crypto are not even secure and their legal nature not well defined.

There are many theft and scams.

Maybe just some official statics from the Federal Trade Commission.

These numbers are based on self-reporting and are way below reality.

You have no recourse against another participant.

More importantly, the regulatory environment is so weak, that there’s nothing you can do when your money is gone.

 See the regulatory section below.

It is a pandemic issue, according to fraud, compliance professionals and litigation attorneys.

The world’s computer infrastructure is limited. Energy resources are limited. The more energy you consume, the more you pollute. Simply said, the computational needs to handle cryptocurrencies are already unmanageable.

• BTC by itself already consumes more energy than small countries. It is equivalent to New Zealand’s economy.
• In 30 years, BTC alone will have raised the world’s temperature by 2 Celsius.

Or they can tax transactions. The IRS is actually the best positioned agency to regulate cryptocurrencies in the US.

• At this stage, cryptos are treated as property by the IRS.
• The profit you make on them is taxable like a stock or a house, aka capital, subject to short-term and long-term capital gain taxes.

• BTC and Ether are not, according to the Howey Test (the criteria confirmed by the Supreme Court to define what is an investment contract).
• But an Initial Coin Offering (ICO) is a sale to the public and the SEC considers it its responsibility.
• Also the SEC’s gods disagree, and they may simply change the rule at some point.
• Right now, the SEC is being finger-pointed for the lack of a clear policy, and for playing whac-a-mole on everything crypto (aka ruling by enforcements).
• Gary Gensler, the SEC’s new Chairman and an MIT professor on cryptocurrencies, has a clear intent to regulate cryptos.
• A minima, a lot of exchanges better be registered (since some cryptos are definitely securities), and sooner than later.

As a result, the SEC is limited in its rights & competencies to intervene in cryptocurrencies.

Cryptocurrencies are not commodities.

• Because Cryptocurrencies are not used to create other goods, they are not commodities.
• But futures are, and so the CFTC has oversight on a segment of the crytpo market – those having futures.

So the CFTC is also limited in how they can intervene in cryptocurrencies

They are at best means of payments.

Which means the OCC (Office of the comptroller of the currency) has little jurisdiction.

• The IRS can determine how it will treat cryptocurrencies and how it will tax their transactions.
• It can also force individual to report transactions, even on foreign exchanges, as well as their transaction prices.
• The IRS considers cryptos as capital assets, whose profits are subject to capital gain taxes.
• You can tax what you don’t like and therefore the IRS could become the best regulator.

What is needed

It is Congress’s job to determine what a cryptocurrency is, and how cryptocurrencies should be handled by the United States.

• Although many bills are supposedly in progress, Congress has still not decided how it will define cryptos.
• with a bit of cynicism, the old men in DC may not be the most competent in the newest technologies, so don’t hope for anything soon.

Jurisdictional / accountability issues

The blockchains are located nowhere and everywhere. Any miner keeps a copy of it. as a reuslt,

• Which agency has jurisdiction to investigate an issue?
• Who do you sue when there is a loss?
• Which law from which jurisdiction apply to blockchain, so where do you sue? Most disagreements become cross-border.
• Worse, many explicit participants (exchanges) are located in far jurisdictions, for which no international treaty works or handles cryptocurrencies. Good luck collecting your crypto-monies from a Gibraltar-based exchange that refuses to pay you back or goes bust. Let’s not even mention mention that some exchanges have chosen to be country-less.

Cryptocurrencies promises anonymity to its account holders. Thieves could not hope for a better way to manage their finances.

But data also is stolen. When Ledger’s database was hacked, 1 million emails and the entire information from 9,500 customers were stolen. If you are one of those, you have no recourse against the company – there are no laws.

If someone hacks your bank account, banks are forced to cooperate with the police. There is no equivalent in cryptocurrency. Demonstrating that an individual committed a crime is much harder in an anonymous world.

Privacy issues

Anonymity is a problem for law enforcement. But it is not even guaranteed by the blockchain technology. The technology company Chainalysis can already identify the owners of multiple crypto currencies.

Also, blockchain’s distributed peer-to-peer technology may be infringing on confidentiality rules like HIPAA and CCPA.

Intellectual Property

Industries exposed to counterfeits are interested in the traceability of transactions. It raises concerns of ownerships, enforceability of smart contracts, as well as difficulties with licensing, distribution and exclusivity.

NFTs are a quagmire of issues of their own. See our previous piece.

Most interestingly, if your bank loses the money you have deposited in your account. You can trace it or force the bank to get your money back. There is absolutely no equivalent in a decentralized system. If a hacker depletes your wallet, you are alone.

Needless to say, wallet hacking is now a big business, notably through the ubiquitous smart phone – and apparently both common and relatively easy to do.