The Bank of International Settlements is Bearish on Cryptos and So am I
The organization that is the Central Bank of Central Banks just published another update on its views on cryptocurrencies that can be read here. I took the following quote out of the report as a starting point for my analysis:
“The essence of good money has always been trust in the stability of its value.”
In order for money to facilitate this main objective, it needs to efficiently scale with the economy. To accomplish this, the decentralized trust that is thought to be the main benefit, is also an inherent limitation. The current iteration of these cryptocurrencies cannot scale with transaction demand due to the poor efficiency and vast amount of energy use.
According to this estimate of energy usage, the crypto universe uses more than 0.5% of world energy demand. And this is at a point where such a tiny fraction of people in the world actually use the technology. One argument for rapid price appreciation of cryptos in the future is that it is not widely adopted yet and the more people that ultimately use them the more price will rise. The argument of course is true of all Ponzi schemes until the last buyer has bought! At current energy rate estimate (5 cents per KWh), the mathematics of energy consumption alone should tell you that the current iteration of the technology is not sustainable. And while many refute estimates, even the conservative estimates when compared to the cost of a Visa transaction for example shows about 500,000 visa transactions equals 1 bitcoin transaction.
One hope for changing this is a change in technology in how Bitcoin is created. Bitcoin transactions are verified in what is called proof-of-work consensus algorithm. More energy efficient algorithms, like proof-of-stake, have been in development over recent years. In proof-of-stake coin owners create blocks rather than miners, thus not requiring power hungry machines that produce as many hashes per second as possible. If the miners disappear, so too will much of the hype I would bet. Because of this, the energy consumption of proof-of-stake is negligible compared to proof-of-work and would obviously be part of a longer-term solution. Bitcoin could potentially switch to such a consensus algorithm, which would significantly improve sustainability. The only downside is that there are many different versions of proof-of-stake, and none of these have fully proven themselves yet and are years away. Nevertheless, the work on these algorithms offers good hope for the future.
Based on the current price of Bitcoin, it is estimated that breakeven in terms of estimated cost of mining may be around $2,000-3,000 today. You can bet these “breakeven levels will be tested before long.
The history and future of money demands a few key elements. I do not see these things ever changing, but maybe.
- a unit of account – a yardstick that eases comparison of prices across the things we buy, as well as the value of promises we make;
- a medium of exchange: a seller accepts it as a means of payment, in the expectation that somebody else will do the same; and
- a store of value, enabling users to transfer purchasing power over time.
To the gold bugs out there, we are never going back to using a commodity type money like gold. We need fiat currency to create commerce and grow the economy. That said, the biggest concern I see in the decades ahead is the complete failure of governments to control the money supply and more importantly the level of debt outstanding. It’s likely to have a material negative impact of growth in the future. The interest on the debt needs to be paid. Cash in hand, pays no interest. Think about that for a minute. Governments will have an incentive to issue as much cash as possible to avoid the payment of interest. Or worse negative interest rates which promotes the velocity of money changing hands because keeping it safely will even further erode its value like inflation. The next global economic downturn will most likely see negative interest rates globally. This history of money has always seen a debasement, negative rates are a significant form of inflation. The hope of independent crypto is to avoid debasement. Though more importantly, it has facilitated far too much crime, and that is another major reason why it probably does not work in the long run.
Governments are essentially broke given the massive debt that has been accumulated. The US Social Security Trust Fund basically has $3 trillion worth of IOUs in it. One of the most attractive parts of electronic transactions is that it limits the grey economy and tax evasion schemes. Imagine a world with no cash. Barter will come back in a big way to avoid taxes, but tax avoidance will be mitigated. No more hiding income and wealth because every transaction will have to be captured. For this reason, governments will likely always control the money supply and I doubt very much independent currencies can exist on a mass scale. IMHO, I can’t see any other long-term outcome and we can expect governments to move to an electronic money system over time to improve tax collection and to pay as little interest as possible without formal debasement.