Crypto’s Choice: Join the Financial System or Fight It

Crypto’s Choice: Join the Financial System or Fight It

Frances Coppola

This has been an extraordinary year. Not for a century has there been a pandemic on this scale. And although far fewer people have so far died from COVID-19 than perished in the 1918-19 “Spanish flu,” the economic damage is probably far worse. Governments shut down large parts of their economies to try to prevent the virus from spreading, and borrowed heavily to support businesses that could not trade and people who couldn’t work. Central banks cut interest rates to the bone and poured money into financial markets to ward off a deflationary collapse. Now, as 2020 draws to a close, returns on investment are nowhere to be found, and there are rising fears of inflation. It’s no surprise, therefore, that 2020 is ending with a cryptocurrency boom. 

During 2020, the fortunes of cryptocurrencies have been determined mainly by central banks. When financial markets crashed in March, cryptocurrencies suffered an even worse fall than traditional asset classes. Bitcoiners would like us to believe that the halvening in May helped price to recover, but the fact is cryptocurrencies recovered . Continued infusions of fiat money caused the prices of all assets to rise, and cryptocurrencies proved to be no exception. 

Fiat money injections by central banks have particularly fuelled the rise and rise of stablecoins, the ties that bind the crypto ecosystem ever more tightly to the existing financial system. All that fiat money has had to go somewhere, and thanks to central banks’ zero and negative interest rate policies, yield on conventional assets is all but non-existent. So why not have a flutter on the crypto markets, while holding an option to exit back into fiat quickly if it all goes wrong? Stablecoins may be more than a real safety net, but they seem to be giving growing numbers of people the confidence to trade cryptocurrencies. 

The March crash also revealed that, contrary to what bitcoiners had hoped, institutional investors don’t regard bitcoin as a “safe asset.” They dumped bitcoin and poured their money into traditional safe havens – dollar, yen and Swiss franc. And bitcoin’s recovery since then has pretty much tracked the rise of stocks and corporate bonds, though with somewhat greater volatility. So it seems that despite all that central bank money printing, investors don’t see inflation as their principal risk, or if they do, they don’t regard bitcoin as a good inflation hedge. They buy bitcoin and other established cryptocurrencies as high-risk assets to spice up their yield-starved portfolios. 

But in the crypto world, bitcoin is now firmly established as the principal “safe asset” for DeFi collateralized lending, along with and certain stablecoins. So depending on your point of view, bitcoin and ether are either high-risk, high-yield assets in their  own right, or safe collateral for high-risk, high-yield borrowing and lending. 

This bifurcation reflects the chasm between those for whom the crypto world is “home” and those for whom it is . Even seasoned crypto investors : it’s hardly surprising that traditional investors are as yet reluctant to do more than dip in their toes. 

But that doesn’t mean traditional finance isn’t interested in cryptocurrencies. On the contrary, cryptocurrencies are becoming high-yield assets of choice for many institutional investors. And as cryptocurrencies become increasingly easy to acquire, hold and trade, more and more ordinary people are investing in them, too. 

In fact, the ease with which retail investors can buy cryptocurrency with credit cards is a matter of some concern: credit cards are debt, and cryptocurrency trading is by any standards a high-risk activity. In the past, every time there has been a debt-fuelled cryptocurrency bubble, people have been broken. And as I write, cryptocurrency is bubbling again.

When crypto bubbles, regulators wake up. This extraordinary year draws to a close with the news that the Financial Crimes Enforcement Network (FinCEN) . The idea seems to be to bring crypto in line with traditional banking.

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