Crypto is like digging holes and filling them so that the labour and material that is used in the process produces nothing tangible at the end of the process.
Cryptos promise freedom from big government, democratization and decentralization. Bitcoins, the best known crypto, are based on a paper released on October 31, 2008 by the mysterious Satoshi Nakamoto. It listed the potential advantages of his proposed digital currency as a) it would be fully peer-to-peer (P2P) and b) does not require a trusted third party for transactions. Bitcoin when it started in 2009 had a value of zero. Laszlo Hanyecz on May 22, 2009 reported the first transaction using a crypto when he got a pizza for 10,000 Bitcoins.
The Herd Mentality
The initiators of cryptos have designed it so that its price would rise yielding big capital gains to attract investors. This has indeed occurred and become self-perpetuating. The early investors and initiators of Bitcoins have reaped a fortune since the price has risen by factors of thousands and millions in the last one decade. Since no other asset class has appreciated so much it has rapidly attracted investment even though most investors do not understand cryptos.
But, would those investing now make such huge gains. The price has been fluctuating wildly depending on the news. For instance, the price rose when Mr. Elon Musk announced that he would accept Bitcoins for purchase of Tesla cars. The price fell when China banned cryptos. To attract more investors, promoters of cryptos point to the gains in the past decade and predict that this trend would persist. The future is uncertain but a lure has been created, especially in the present difficult times when many are desperate due to the pandemic induced loss of incomes and employment. The young have been attracted to cryptos and not just from the Metros.
Libertarians argue against big government. They welcome cryptos because of its promise of whittling down the power of government. In their framework, society’s problems stem from big government and its interventions in the economy. They believe in laissez-faire capitalism. They argue that excess printing of currency by the Central Banks leads to its losing value and to inflation. They point to the massive liquidity infusion during the Global Financial Crisis of 2007-08 for the world economy’s problems after 2009. Central banks had globally released trillions of dollars by buying bonds so as to keep interest rates low and prevent business failures. Simultaneously, governments created massive budget deficits to boost demand so as to prevent the world slipping into a depression, like in the late 1920s.
Cryptos hold the promise of preventing such interventions by creating a currency which would not be in the control of Central Banks. Bitcoins have an upper limit of 21 million. In contrast, Central banks have printed trillions of dollars during the current pandemic.
Cryptos also promise to remove the big intermediaries like, banks and card companies from transactions between parties. Peer to peer transactions can securely occur directly using cryptos without the need of an intermediary which ensured trust between transacting parties and for which substantial fees are currently paid for each transaction. Cryptos promise to save this cost to the transacting parties.
Ideals and Practice Diverge
Cryptos like, Bitcoin, can only be obtained with the use of massive computer power and energy. It is estimated that upward of 3% of the world’s electricity is being used to obtain cryptos. Bitcoins and similar cryptos are based on 'Proof of work’ security algorithm so that everyone on the network can approve the creation of Bitcoins (called mining) or their use for transactions. Hence, only the big institutions can mine them and transactions are difficult. To simplify, a 'Proof of stake’ algorithm is used. This requires one to declare one’s holding of cryptos and the one who has more is able to dominate the process. Though theoretically the cryptos are decentralized, in reality they are controlled by the moneyed and the big institutions.
Proponents of cryptos project them to be decentralized since all in the network have a say. That is why they are touted as democratic. But, since getting the cryptos directly or doing transactions using them are difficult, small investors use exchanges to buy and transact. This introduces an intermediary. The costs are also considerable with transaction fees, card company charges, etc. There is also a possibility of fraud with fake exchanges and fake cryptos emerging. This adds to the cost of using cryptos.
So, one way or the other cryptos with the domination of big money and big institutions, the small investor may have little say in the network and decentralization remains on paper while costs can be high.
Those promoting cryptos are doing so in their own narrow interest since they moved in first. The more the money pumped into cryptos the more the value of their holdings will rise and give the early movers big gains. It is like a Ponzi where those joining late may ultimately lose.
Socioeconomic Impact of Cryptos
Cryptos are a virtual product with no connection with any real good or a service that can provide use value for a citizen. It is like digging holes and filling them so that the labour and material that is used in the process produces nothing tangible at the end of the process. Yes, crypto production uses energy and computers along with people’s time. But at the end of it there is nothing tangible as a use value. Even if cryptos were easy to use for transactions like cash is, there would be some value to it. But they are not easy to use except when the product itself is a virtual one like, NFTs. For the purchase of products and services, cryptos have to be converted to cash to pay.
So, investment in crypto is predominantly for capital gains they promise. Since an artificial shortage is created, by limiting its amounts, it is projected to continue to rise in price. Even the cost of mining is rising since it requires more and more expenditure in energy and computer power. Thus, structurally capital gains are assured and one way speculation is feasible.
Two possibilities follow. First, people lured by capital gains switch from economic activities and investment into cryptos. Second, those holding cryptos have to liquidate some of them to buy necessities of life.
In the first case, fewer goods and services will be produced leading to inflation. As more people switch to cryptos and capital gains rise, more will be attracted to them further slowing economic activity. Investments in other activities would slow down since they may only yield 10% annual return whereas cryptos may yield a few hundred per cent annual return. Investors would switch from equity, mutual funds and real estate and their prices would fall. Banks would find their deposits declining. Companies trying to raise capital from the market would face difficulties. Their owners would also sell their assets and move into cryptos leading to further decline in production. The bubble would grow rapidly.
But life has to carry on and that requires consumption of real life goods and services. They would have to be purchased using cryptos directly but since that is difficult, they would have to be converted into real cash. So, cryptos would have to be liquidated. If for this reason more and more people start to liquidate their holdings, the price of cryptos will start declining and this could signal a move to sell and the bubble can burst. The first movers will make a profit while the late entrants will lose substantially, like in a Ponzi scheme.
The poor will be the real losers. They have little savings or access to computers or assured electricity and will be locked out of cryptos. They will not benefit from the cryptos while having to face unemployment as economic activity declines and as availability of goods and services declines. Governments may be forced to cut back on provision of public goods, like education and health which will aggravate poverty.
Laissez Faire Capitalism: Agenda to Perpetuate Inequalities
If cryptos help move toward laissez faire capitalism will that resolve the problems that currently plague the world – jobs, incomes and inequality. Actually, these problems are likely to aggravate.
With government regulation on the decline, monopolists and big capital will dominate society like never before. Their substantial control over politics will further increase. The big tech companies and financial institutions already have substantial control over policies and that would increase. Their influence over elections and who gets to power would increase, thereby further weakening democracy.
Undoubtedly big government serves the interest of big capital (like the military industrial complex) which is the biggest vested interest in society. How does the libertarian agenda counter it? Their agenda is not egalitarian and serves the interest of the rich in a very unequal society. They do not recognize market failure or its power which marginalizes the poor. For them inequalities don’t matter. They harp on failures of big government to push their agenda. Curbing government will give the rich greater choice and cryptos promise that. But that is not the same as greater decentralization and strengthening democracy; cryptos are not about that.
Prof Arun Kumar is Malcolm Adiseshiah Chair Professor, Institute of Social Sciences and Author of Indian Economy’s Greatest Crisis: Impact of the Coronavirus and the Road Ahead, 2020. Penguin Random House.
(Views expressed are personal)