Cryptocurrencies Achilles heel: trust

I seem to enjoy beating up on cryptocurrencies, despite owning a bit of it.

Volatility seems to be part of owning them as virtually all these currencies are way down from their most recent highs, more so than markets in general. To deal with all the volatility though, many of these currencies have offshoots called stablecoins. The idea of a stablecoin in that it should retain its value in relation to some other store, typically the U.S. dollar. This is supposed to allow easier trade of these currencies without the downside of its implicit volatility.

That’s the theory anyhow. Most of these so-called stablecoins are sort of living up to the promise, with some losing five percent or so compared to the U.S. dollar, but generally only for short periods of time. Some of these so-called coins put money in assets like gold, which I guess they figure is more stable than dollars, or at least more inflation resistant. The price of gold though tends to be pretty volatile, up in risky times, down in more secure times. Others “invest” in other cryptocurrencies, sort of like a crypto index fund. They hope that if one of these goes down some others will go up and counterbalance things. These assets though are mostly loaned out, which is how these coin creators make money. It needs to make sure there are enough real assets in cash to handle a run on the coin. It appears that many of them do this poorly. Anyhow, for sure they are not being monitored by the FDIC.

Then there is TerraUSD, which recently and spectacularly wiped out about $45B in investor assets. One dollar of TerraUSD is now worth about $.07, but it’s hard to unload it if you have it because its trading has largely been suspended. Since May 9, 2022 its value is no longer pegged to the U.S. dollar. Lots of people rushed in to own TerraUSD because it was guaranteeing a 20% return.

TerraUSD succeeded in maintaining its value for so long mainly by purchasing more of its non-stablecoin Luna whenever TerraUSD’s value slipped a bit, and pegging its value to that. It was a stablecoin by algorithm, which if investors knew about this, should by itself have been a red flag. Anyhow, they’ve been pretty much wiped out. The coin’s founder Do Kwan though doesn’t seem too upset and is working to create a new Terra stablecoin fork that isn’t pegged to the US dollar. Presumably his current investors won’t be stupid enough to trust this man again.

It’s hard to find a sure fire bet against inflation these days. The closest version though won’t be a stablecoin, but a U.S. Treasury I Bond. You can get a 9.63% return on an investment up to $10,000 a year, or $15,000 if you invest up to $5000 of your tax refund in this bond. That won’t hedge much of most people’s portfolio, but at least it’s guaranteed by the U.S. government.

TerraUSD’s value was guaranteed by nothing. It is essentially a Ponzi scheme. Anyhow, Do Kwon is being investigated by South Korean authorities. I’m betting most of his investors assets went into his pocket. I’m also betting not much of it is ultimately recovered and returned to investors.

Crypto investors are slowly discovering that crypto is mostly a lot of smoke and mirrors. The smarter ones have left the market altogether, but certainly there are diehards in for the long haul. What crypto really needs is regulation. Unfortunately, regulation means tracking, less privacy and likely less return on these “investments”.

Crypto was invented to make the transfer of money seamless, private and quick. Regulation won’t make it seamless. It also won’t keep things private. And it’s likely to slow things down too, as if things weren’t already pretty slow trading these “investments”. Also, it costs money to trade crypto, either directly or indirectly. When I write someone a check, its full value is exchanged. You just have to wait a few days for the funds to clear.

So crypto needs to be tamed to work, but does it really work at all if it doesn’t achieve its goals? A cryptocurrency whose only value is some correlation between the cost in energy it took to produce it doesn’t seem valuable. As best I can tell, no one first buys, say, $100M in gold assets and then creates 100 million digital coins tied to this asset, and sells them at $1 each. But if someone did, is this really a cryptocurrency? It sounds like a share of an index fund whose ownership can be documented in a public blockchain server somewhere instead of a ledger in a brokerage house.

The U.S. dollar is backed up by the full faith and credit of the U.S. government. You have to assume the country will not be going away and that its money supply will be at least reasonably well managed, but that’s a pretty safe bet. And since it’s a government in charge you can assume it has smart people, like the members of the Federal Reserve, continuously monitoring the financial world and taking steps (like it is doing now raising interest rates) when things go awry.

Who do you trust more, the U.S. government, despite its not stellar record on retaining the value of the dollar? Or Do Kwon? In some ways, inflation appears to be the cost of keeping money transfer moving at all.

Our banking system, despite its imperfections and the slowness by which is transfer assets, at least ensures accountability and, at least in theory, legitimacy of these transactions if they adhere to international banking laws. It sounds like a much safer way to transfer money than to trust in people like Do Kwon.