World of cryptocurrencies standing on unstable ground

Last week Terrausd, a stablecoin — a system that was supposed to perform a lot like a conventional bank account but was backed only by a cryptocurrency called Luna — collapsed. Luna lost 97% of its value over the course of 24 hours, apparently destroying some investors’ life savings.

The event shook the crypto world in general, but the truth is that this world was looking pretty shaky even before the Terra disaster. Bitcoin, the original cryptocurrency, peaked in November and has since declined by more than 50%.

Here is one way to think about that decline. The Consumer Price Index has gone up about 4% over the past six months. But the cost of the same representive basket of goods and services in bitcoin has risen around 120%, which means inflation at an annualized rate of about 380%.

And other cryptocurrencies have performed worse. Two cities — Miami and New York — have introduced their own cryptocurrencies, with enthusiastic support from their mayors. Miamicoin is down more than 90% from its peak, and

Newyorkcitycoin is down more than 80%.

But what are cryptocurrencies? Many people — including, I fear, many people who have invested in them — probably still don’t fully understand them. Saying that they are digital assets doesn’t really get at it.

What is distinctive about cryptocurrencies is how ownership is established. I own the money in my bank account because the law says I do, and the bank enforces that by requiring I prove who that I am. Ownership of a crypto asset is established through what is known as the blockchain, an encrypted digital record of all previous transfers of ownership that supposedly obviates the need for an external party, such as a bank, to validate a claim.

What is the point of this kind of decentralized finance, and what purpose does it serve? Well, I’ll get to that.

Though cryptocurrencies are currently way down, boosters will reassure you that this has happened before. Bitcoin has always bounced back from previous dips, and investors who HODLED (held on for dear life to their coins, despite falling prices) have ended up with huge capital gains. But there are reasons to believe now may be different.

In the past, cryptocurrencies kept going up by attracting investors. Crypto was once held by a small cult-like clique, motivated in part by a combination of libertarian ideology and fascination with the clever use of technology. Over time, rising crypto prices drew in large numbers of additional investors and some big Wall Street money.

Crypto marketing has also gone mainstream, with endorsements from celebrities — including Matt Damon and Kim Kardashian — to political figures like Mayor Eric Adams of New York and the (unsuccessful) Republican Senate candidate Josh Mandel, who declared his intention to make Ohio “pro-god, pro-family, pro-bitcoin.”

One disturbing aspect of this marketing push is that those who bought cryptocurrencies relatively recently — and have lost a lot of money — probably consist disproportionately of the kind of people most likely to be influenced by celebrity endorsements. That is, they are probably poorer and less sophisticated than the average investor and badly positioned to handle losses.

In any case, as we look forward, the value of cryptocurrencies will have to rest on their underlying economic uses, which are …

Well, that’s the thing. I have heard many discussions in which crypto supporters have been asked exactly what economic role crypto can play that isn’t more easily and cheaply achieved through other means such as debit cards. Other than illegal transactions, in which crypto may sometimes offer anonymity, I have yet to hear a coherent answer.

Cryptocurrencies play almost no role in economic transactions other than speculation in crypto markets. And if your answer is “give it time,” bitcoin has been around since 2009, which makes it ancient by tech standards. If crypto was going to replace conventional money, surely we should have seen some signs by now.

But can crypto really have become such a big deal with just pure speculation? Can it really be just a bubble inflated by fear of missing out? Those who question crypto’s purpose are constantly confronted with the argument that the scale of the industry — at their peak, crypto assets were worth almost $3 trillion — and the amount of money true believers have made along the way proves the skeptics wrong. Can we, the public, really be that foolish and gullible?

Yes, we can.