CTIC Academic Fellow Giovanna Massarotto outlines the possible routes of cryptocurrency’s future.
With cryptocurrency companies increasingly filing for bankruptcy following FTX’s path or significantly reducing their size and investments, the future of crypto is uncertain.
Stories like FTX are quite predictable. Mt. Gox bitcoin exchange bankruptcy dates back to 2014, and still, there are around 23,000 cryptocurrencies in circulation today. Simply put, crypto is unlikely to end, and there are several possible routes this story can take.
Although Bitcoin was developed in response to the 2008 financial crisis and conceived as a decentralized private money, cryptocurrencies have evolved in a centralized fashion. Many think crypto simply needs to revive its decentralization.
At the time of FTX collapse, “[s]ome 99% of crypto transactions [were] facilitated by centralized exchanges” like FTX. Centralized exchanges control your cryptocurrency because they hold custody of cryptographic keys. “Not your keys, Not your crypto,” it is said. A company and typically a person behind, such as Sam Bankman-Fried (SBF) and Changpeng Zhao (CZ), govern centralized exchanges and billions of clients’ money.
Thus, is decentralized finance (DeFi) the antidote for crypto’s survival? Not exactly.
As opposed to centralized exchanges, you do not ask a decentralized exchange to hold custody of your cryptographic keys. So if you own “your crypto,” you accept the risk that if you lose your key, your cryptocurrency is typically gone. There is no way to recover it because there is no central authority to ask or someone that you can count responsible.
DeFi protocols are also target of hackers, who often succeed in stealing money. Moreover, DeFi might not be as decentralized as the name suggests. Bitcoin decentralization relies on the Proof of Work (PoW) mechanism. Although anyone with a computer can “mine” bitcoins thanks to PoW, the reality is that it has become basically impossible for a single computer to successfully compete with mining farms and pools in the bitcoin mining business. In other words, bitcoin is becoming increasingly centralized.
Moreover, several countries, including China, banned crypto mining activities. Europe considered banning the PoW mechanism as well, because of the energy consumption related to mining. Several important mining companies have filed for bankruptcy in light of the present legal issues and uncertainty of the situation. On the other hand, governments are increasingly investing in central bank digital currencies (CBDCs), reversing the rules of the game.
CBDC can be seen as a fiat currency like the dollar or euro, which would replace cash making any payment increasingly traceable.
As a result, CBDC would empower rather than depower the government and the banking system, which bitcoin aimed to bypass. Unsurprisingly, China is “at the forefront.” On January 11, 2023, China’s Digital Yuan has been included in cash circulation data and central bank’s reserves.
Many countries – especially in Asia – are sharing similar enthusiasm by investing and testing CBDC projects. Thus, a “Big Brother” scenario is more likely than more decentralization.
A third possible solution for crypto is somewhere in the middle of these two paths. After the FTX collapse, cryptocurrencies are in the crosshairs of legislators and law enforcers all over the world.
The SEC recently settled a case against Kraken that prevents the crypto company from continuing the unregistered offer and sale of crypto asset-staking in the effort to clarify what is legal and illegal in the crypto space.
Across the pond, Europe is setting the tone for a new regulatory framework for cryptocurrencies. MICA and the sandbox initiative announced on February 15, 2023 have the potential to be in the cryptospace what the GDPR has become with respect to data protection regulation worldwide.
So where does this knowledge leave us?
No matter what route crypto eventually takes, if something goes wrong, we can always blame the crypto community for selling unlikely decentralized private money and the government for finding new ways to increase its power or for enacting too many rules that would stifle innovation and economic growth. Most importantly, we can always blame Sam Bankman-Fried!
Advances in technology like cryptocurrencies are welcomed and should be encouraged. But technologies are a means to an end, not the end itself. Please do not blame a cryptocurrency protocol for what comes next. We all have a role to play, just as we have always had in setting the tone for the future of technological progress.