Bitcoin was the first cryptocurrency to achieve mainstream success, but it took years for that to happen. Once Bitcoin demonstrated the advantages of cryptocurrencies, the entire cryptocurrency universe began to expand exponentially. Before long there were dozens, if not hundreds, of cryptocurrencies, each claiming to be the greatest thing since sliced bread.
The ecosystem of goods and services that served the cryptocurrency universe began to grow too, with wallet providers, apps, and exchanges propping up to serve consumer wants and needs. In a free flowing world free of regulation and driven purely by market behavior, it was possible for just about anyone to hang out a shingle and grow their business.
Despite the fact that Bitcoin was developed specifically to counteract the centralization that has proven to be so deleterious to fiat currencies, and despite the fact that Bitcoin was able to make every man into his own bank, exchanges and wallet providers grew to become massive centralized centers in the cryptocurrency world. And now we’re finding out exactly why that’s a problem.
The Problems of Centralization
Bitcoin was developed specifically to counteract the problems inherent in fiat currencies issued by central banks. Because central banks are a single issuing authority, they can make unilateral decisions about how much currency to create. If they create too much currency it may benefit the central bank and its monetary policy aims, but at the expense of the currency’s users.
Bitcoin’s solution to that was to decentralize currency issuance. There was no single authority issuing or creating currency, and there was no single node that, if targeted, could destroy Bitcoin or force changes to its protocol.
Human nature being what it is, however, users of Bitcoin and other cryptocurrencies didn’t always adopt this radical decentralization. Part of that was due to the fact that, while Bitcoin was developed as a currency, cryptocurrencies quickly became speculative assets, especially as the value of each bitcoin rose from thousandths of a penny to thousands of dollars.
Exchanges began to facilitate trades of cryptocurrencies among users and across borders. And many of these exchanges also held traders’ funds, making them centralized nodes that would be targeted by hackers and thieves. But the case of disgraced exchange FTX provides an example of another danger of centralization.
Rise and Fall
FTX rose from nothing just a few years ago to become one of the world’s largest cryptocurrency exchanges, at one point handling 10% of the world’s cryptocurrency trading volume. But the firm had one fatal flaw: it funneled billions of dollars of its customers’ funds to its trading arm, in contravention of its user agreement.
This isn’t a problem inherent to cryptocurrencies, it’s a problem that can occur in just about any industry. But most other industries have long enough histories that most actors who engage in that type of behavior have been driven out of the market. And those who do engage in outright fraud generally make sales pitches that sound too good to be true, providing some warning to potential customers or investors about the dangers they might face.
FTX appears to have siphoned $10 billion of customer money to its trading arm, which became a problem when customers began to lose confidence in the exchange and withdraw their funds. Suddenly the firm found itself needing billions of dollars in liquidity, which it didn’t have. And so FTX was forced to declare bankruptcy.
Cryptocurrency proponents have often been prone to braggadocio, claiming that cryptocurrencies are the new digital gold, and that cryptocurrency will supplant gold as a safe haven asset. Yet how many cryptocurrencies and cryptocurrency firms have fallen by the wayside as this infant industry remains in its growing phase? How many investors or speculators have seen their wealth disappear through hacking, theft, or fraud?
Compare cryptocurrency to gold, which has served as a safe haven asset for thousands of years. Gold markets are well established, reputable mints and depositories exist around the world, and even the possibility of a multi-billion dollar fraud seems laughable.
The only questionable aspect of gold markets surrounds exchange-traded funds, which claim to own gold, although no one knows exactly where that gold is or whether it is encumbered. But that’s why most gold investors resort to investing in physical gold, such as gold coins and bars.
The Advantages of Physical Gold
Owning physical gold can mean storing it in a depository, keeping it in a safe deposit box, or storing it at home. There is a risk of theft if you store gold at home, but when was the last time you heard of a gold depository having all its gold stolen? Or when have you ever heard of a depository that claimed to store gold but actually sold it and didn’t tell the owners?
Those types of incidents just don’t happen in precious metals markets, and fraud, theft, and deception generally happen on an individual scale when people try to make deals with unknown or disreputable individuals or businesses. If your gold is being stored in a gold depository, it’s going to be about as safe as Fort Knox.
As beneficial as cryptocurrency may end up being, there’s just no way that it’s going to replace gold as a safe haven asset or as a store of value during times of turmoil. We’re still too early in the history of cryptocurrency to know which crypto coins are going to survive over the long term, or even if any existing cryptocurrencies will still be around 10-20 years from now.
Not only has FTX’s collapse illustrated the challenge of trust that exists in the cryptocurrency sphere, it may also end up spurring governments to crack the regulatory whip when it comes to cryptocurrencies. With governments pushing their own central bank digital currencies (CBDCs), the case of FTX may be the nail in the coffin for private cryptocurrencies, as the push for CBDCs gains momentum.
One thing is for certain, though. Throughout gold’s long history it has outlasted currency after currency. Mesopotamian, Greek, Roman, and British empires have all seen their power and their currencies wax and wane. All that time gold has remained steady as a safe haven and store of value, and it will continue to do so after the last cryptocurrency is but an ancient memory.