Some say to never kick a cryptocurrency when its down. But I will.
The recent Bitcoin crash has brought the question to light of the long-term viability of cryptocurrencies. Will they come back, or won’t they? I don’t know.
What I do know is that cryptocurrencies have some serious structural challenges. These challenges will hamper cryptocurrency’s ability to become mainstream.
Cryptocurrency has Limited Use Cases
Whenever I evaluate a new technology, I like to look at the problems it solves. What problems do Bitcoin, Ethereum and other cryptocurrencies solve? That’s a good question, and the answer reveals a lot about how much of this “crypto hype” is well-founded.
Black Market Transactions
The first and most obvious use of crypto currency is for black market transactions.
When anyone is a victim of ransomware, how do they pay? Usually in Bitcoin. Many ransomware attacks involve criminals extorting money from targets in the form of crypto coins of one kind of another.
Then there’s the black market. If you check out the dark web, there are many drug sites that sell their products for cryptocurrency.
So, cryptocurrency definitely solves a problem. It allows for semi-anonymous transactions on the web. Not quite as anonymous as cash, but much better than ACH transfer or PayPal!
It is “convenient” but hardly anyone would scream that this use case is going to make cryptocurrency mainstream.
But wait, there’s more!
Cryptocurrency Tax Fraud
Bitcoin and other cryptocurrency options can facilitate a whole other range of illegal activity: shielding money from the government!
According to the MotleyFool, a third of Bitcoin investors plan to commit tax fraud. Now there is a point to be made about whether these investors are going in thinking they’ll keep money back from Uncle Sam, or whether many of them just didn’t do their due diligence and understand their tax responsibilities. But it’s all too easy to cheat – especially with the decentralized nature of these transactions. This is probably more likely to prevent cryptocurrency’s rise, as governments have an incentive to stop cryptocurrency instead of encouraging it. Experts contend that “managing economies” will act to limit crypto sectors for the sake of both stability and fraud prevention, although if you look closer, whether nations will embrace decentralized digital currencies has a lot to do with the nation’s place on the world stage.
For example, take a look at authoritarian regimes like Venezuela, a country that’s in the process of launching its own cryptocurrency, the “Petro.” What are the chances that the Petro will end up being used in dark web activities or to evade sanctions? The same goes for Iran, where it’s almost certain that a national coin is a move to make an end run around U.S. sanctions. Reports of high-end Iranian hotels accepting Bitcoin is just part of the recent press around how crypto is helping to shield regimes from the global consequences of their actions.
So crypto has the potential to cause foreign policy problems– but let’s take it back to the domestic front for a moment. There’s a whole different issue related to anonymous transactions and parties that people want to shield financial transactions from.
What about our spouse?! You might not check your spouse’s Bitcoin account like you would a shared credit card or checking account.
So maybe you can use Bitcoin to buy him/her a surprise birthday present? Or maybe something that is legal, but not exactly something you want her to know about. “Gray market” activities are perfect for Bitcoin; some strip clubs now accept it as part of the discretion that caters to a married clientele.
Now your wife won’t see a strip club on your credit card statement.
Another “customer base” for cryptocurrency includes people who don’t have access to banking, or who live in countries that have very volatile currency. A report in CCN cites huge “informal sectors” in African countries where crypto currency use can thrive. Although financial systems are catching up to some of the problems that make cryptocurrency attractive, wherever there’s less than full functionality in an economy, cryptocurrency use is going to surface. Here’s another example: If you are someone living in an authoritarian regime, cryptocurrency is a great way to get your money out. Exchange your currency for Bitcoin. Put it on a USB drive. Escape the country – and you have money!
Want another cryptocurrency use case? Interplanetary travel! – if there isn’t a way to get reliable access to a network – how do you clear transactions? Imagine a Mars colonist 24 light minutes away from Earth trying to make financial transactions. They cannot rely on checking if there is money in their account on Earth. Cryptocurrency could actually solve the problem. In the shorter term, the folks in the international space station may be able to finally buy snacks from vending machines!
To sum up, the cryptocurrency use cases are:
- Black market
- Gray market
- Don’t have access to banking/volatile currency
- Escaping an authoritarian regime
- Buying your spouse a “surprise birthday present”
- Interplanetary travel
While useful, none of these use cases will push cryptocurrencies into the mainstream at least until we have colonies on faraway planets.
Governments Will Impede Cryptocurrency Development
Because of the threats to tax bases, governments won’t help solve problems that cryptocurrency faces right now.
If someone makes a fraudulent transaction in the U.S., the bank must refund the victim their money. That’s because banks are centralized – so the move to decentralize to crypto currency means losing those protections.
Banks have a financial incentive to help prevent fraud. They also are backstopping the transactions with the bank’s money to give consumers confidence.
There is no such thing with crypto currency. If a thief steals crypto coins, then they are gone! Hackers are making the rounds trying desperately to grab coins from digital wallets or defraud exchanges, because they know that enforcement isn’t the same in the cryptocurrency world.
Cryptocurrencies also suffer from unfavorable tax treatment. Governments treat cryptocurrency trading like capital gains, and not like currency exchanges. But, some classical economists would argue, part of the reason that they do that is to prevent cryptocurrency use from flooding a market – not just to keep a lid on fraud and crime, but to make sure that an economy stays stable.
Because of the threat to their tax bases, governments will continue to keeping cryptocurrencies in a regulatory gray area. You’ll see, for example, that the U.S. SEC is slow to open up cryptocurrency ETFs – partly due to fears about – you guessed it! – stability. Even China has quite a few rules on crypto. The Middle Kingdom is a place where you might think crypto currency would thrive – but recent Chinese moves include banning digital asset exchanges and ICOs, blocking online access to foreign trading platforms, and cutting off power to Bitcoin miners.
Cryptocurrency Technology Has Some Really Unattractive Aspects
Now, let’s talk about some of the issues with cryptocurrency.
Popular cryptocurrencies like Bitcoin have a scalability problem – there’s a maximum on transactions per second, and as soon as actual use bumps against that, transactions get messed up.
Part of the problem is that every time you make a new Bitcoin or crypto block, you bring the whole history of the currency with you! The current Bitcoin ledger is almost 200 GB and growing. If Bitcoin were to reach broad market adoption, the size of the ledger would be an impediment.
Then there’s the “proof of work” burden.
Much is made of the idea that new proof of work, proof of stake and proof of ownership algorithms accomplish that decentralized verification that’s so much a part of the crypto value proposition. But on the other hand, these algorithms and their practical application (especially proof of work) use up enormous amounts of resources! The environmental impact and the processing cost are two key issues with broader cryptocurrency implementation.
Could these and other technical problems be overcome with a future cryptocurrency technology? Yes. However, as it stands, all of these are real barriers to wider adoption.
For the reasons we have outlined above, there are strong indications that cryptocurrency as a transactional system is “not ready for prime time.” There’s the type of demand that exists – and there are those other nagging problems with logistics. Think about this when you ponder the future of the cryptocurrency world.
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