CryptoCrash! The scent of Musk is everywhere as cryptocurrencies face their own Bloody Wednesday

Profile picture for user cmiddleton By Chris Middleton May 20, 2021
Summary:
The sound of markets tumbling or just a blip? Everything's up in the air in the fast-changing state of play in alternative finance as digital coin valuations crash.

crypto

It has been a torrid month for cryptocurrencies, digital coins, and online exchanges, with 19 May described by some traders as 'Bloody Wednesday' for crypto.

Valuations of Bitcoin and other digital currencies tumbled this week, after a perfect storm of bad news for the sector, including environmental fears, Chinese regulatory moves, and money laundering investigations. Plus, the tweets of a megastar investor who has positioned himself as champion of the crypto world, in every sense of that word.

So much has changed so quickly, which is a real problem with this sector. Just a month ago, Coinbase’s IPO and the stellar valuations of some coins showed that confidence was high in alternative finance, with trust growing from more traditional quarters too. That confidence has been shaken by events this week.

But is it just a blip – a shakedown and market correction? Probably, but the important issues are the problems revealed by these events.

As ever, the highest-profile story has been Bitcoin. The cryptocurrency’s valuation fell below the $40,000 mark on 19 May, after hitting more than $63,000 at the beginning of the month – which was roughly triple its value in autumn 2020.

The valuations of some other major tokens – Ethereum, BNB, cardano, and Dogecoin – also fell by double-digit percentages this week, wiping roughly $700 billion dollars off the value of the crypto market.

Critics of Bitcoin and rival tokens say that such rollercoaster valuations mitigate against the viability of some coins as money – as a trusted medium of exchange for goods or services with a known, (relatively) stable value. More, they encourage the coins’ use in high-risk, unregulated speculation, not to mention criminal activity.

Musk - an ox in the China shop

Bitcoin’s collapse this week was partly due to recent tweets from Tesla and SpaceX supremo Elon Musk. He said that Tesla was no longer accepting payments in the currency, citing environmental concerns over the amount of energy that mining for it uses.

As reported on diginomica last week, the Centre for Alternative Finance at Cambridge University calculated that global Bitcoin mining – the process of running the cryptographic and consensus processes needed to produce a coin – was using more energy than all of Malaysia or Sweden, and nearly as much as Egypt or Poland.

To recap, that was the median estimate. The Centre’s upper estimates of Bitcoin’s energy consumption (the worst-case scenario) were four times higher than that, putting it almost on a par with the total energy generated worldwide from biofuels and waste. On the face of it, that does not suggest a sustainable solution for the future, whichever figure is correct.

Musk – aka the first doge in space, aka the world’s second richest man, and surely the wealthiest human-in-waiting - who would bet against him becoming the first trillionaire? – said his company wouldn’t be selling its Bitcoin stocks. Instead, it would hold onto them until the network could be moved onto a more sustainable footing.

However, it is far from clear if the Proof-of-Work (PoW) blockchain that the currency is based on can be improved significantly without invalidating the blockchain itself.

Proof-of-Stake (PoS) blockchains use far less energy – some estimates claim up to 10,000 times less. However, Bitcoin’s proponents say that PoS models lack the consensus, authentication, and transparency controls of PoW, and thus replicate the problems of traditional finance by focusing on traders’ existing stakes rather than on their rigs’ ability to mine or process transactions.

However, in light of a multi-billionaire tweeting Bitcoin into a digital crash – reminiscent of one of his less successful rocket landings, in fact – those criticisms now ring hollow. How is this new financial system any better than the old one?

Alas, the scent of Musk was everywhere this week, to the dismay of some traders who complained that cryptocurrencies don’t need a self-appointed saviour. The multi-billionaire tweeted that he is currently working with Dogecoin’s developers to improve the efficiency and speed of that coin’s supporting infrastructure.

For months beforehand, Musk had been tweeting the coin onto many traders’ radar, driving up the value of his own holdings.

While there is nothing illegal about a billionaire technologist with a good track record in financial services working with developers to improve a computer system, Musk’s stake in the currency, and his ability to influence markets simply by tweeting, might well potentially be something for lawmakers and financial regulators to contemplate in future.

This, then, is a critical point: there is little regulation that has any meaning or use in this new world. Some see that as a good thing, of course - it’s a new frontier, it’s the Wild West (or rather the Wild East, as we explore below). That makes this space exciting, and the law is not even close to catching up.

Meanwhile, social influence can be deployed by smart, connected, and already wealthy individuals, such as Musk, as a form of legalised insider trading on an unprecedented scale. Again, it is hard to see how any of this solves problems such as greed, market manipulation, and currency speculation that are found in traditional financial markets.

Not only that, but the disruption is happening just as those traditional markets – imperfect, rigged, and politically compromised though they are – are at least attempting to grapple with issues such as money-laundering and terrorist financing, with new models such as Open Banking and FinTech regulation, and with Know Your Customer (KYC) rules, in the long tail of the 2008-09 financial crisis.

Good or bad energy, man?

But back to Bitcoin. Its proponents claim that critics’ focus on excessive energy use is misconceived and misleading. That’s because many miners – notably those in large pools in China – use energy from renewable sources, or energy that would otherwise go to waste. A fair point that is explored in this report on Bitcoin and so-called ‘stranded’ or ‘non-rival’ energy

It’s true, of course, that the amount of energy used by any activity is less significant than its source – if that source is sustainable or would otherwise be wasted – though the inefficient design of PoW blockchains remains a massive problem. Meanwhile, the carbon footprint of the traditional finance sector needs consideration too, linked as it is to the petrodollar, not to mention to vast cloud data centers.

Mining is also designed to be resource-expensive, forcing traders to use low-cost energy and/or resources that would otherwise be wasted to keep their profits high. But for exactly the same reasons, this also encourages crime – such as cryptojacking, the use of other people’s processors and energy to mine for coins.

After all, criminals think, why pay for electricity if you can make someone else do it for you? Arguably, a lot of legitimate blockchain initiatives also succeed by offloading energy costs onto members or consumers.

At the core of the Bitcoin and cryptocurrency debate, therefore, is the question of whether claims about collective action for mutual benefit – of digital tokens being a better, fairer financial system for the planet (with the absence of traditional power structures, politics, and central banks) – are sincere. Or are they a cover for networked greed and naked self-interest by groups of technology-obsessed gamblers? Looking at the market today, that’s not an easy question to answer.

The impression that some miners are just playing a giant, unregulated slot machine – a slow, resource-intensive, planet-boiling one – is hard to avoid. Not that gambling is inherently wrong; it’s a centuries-old human activity. Crypto’s proponents would argue that, if everyone owns the house, it doesn’t matter if the house always wins. And in the old financial system most people don’t own the house (or any house, for that matter).

Yet the creation of a decentralised, egalitarian ‘people’s financial system’ that also attracts unfettered criminality, money laundering, and currency speculation – while being vulnerable to the whims of billionaires – would seem to be replicating the worst excesses of the old financial system.

Particularly as many in the old system have the resources to play the new, unregulated one to their advantage too. And are doing so.

China crisis

There have been other problems for Bitcoin and the crypto market in recent weeks.

First, China has announced that it is cracking down on Bitcoin, cryptocurrencies, and the widespread speculation that still characterises the space. Earlier this week, Beijing instructed banks not to facilitate crypto transactions.

This is significant, as the Cambridge research into Bitcoin energy usage found that roughly two-thirds of its miners (65%) are based in China, according to their IP addresses and hash rates. Overall, roughly 85% of miners are in Asia and Eastern Europe, including Iran (which is responsible for almost as much mining as the US) and Russia.

Second, blockchain ecosystem/digital asset exchange Binance suspended trading in Ethereum / ERC20 tokens for a period on 19 May, citing “network congestion”. This led to a tweetstorm that saw #Binance trending worldwide.

The move coincided with tumbling valuations of the top five digital currencies, leading some traders to describe the date as “Bloody Wednesday” for crypto. Again, this was oddly reminiscent of the boom/bust/traders-losing-their-shirt problems of traditional finance that the shiny new system was supposedly designed to solve.

In April this year, Bloomberg reported that Cayman-Islands incorporated (!) Binance Holdings was being investigated by the US Justice Department and the Internal Revenue Service (IRS) as part of wider moves against money laundering, organised crime, and terrorist financing.

According to that report, forensic blockchain analysis firm Chainalysis Inc, whose clients apparently include US federal agencies, found that more funds tied to criminal activities flowed through Binance than through any other crypto exchange.

So where does all this leave us?

My take

As a largely unregulated financial system with hotspots that appear wherever processors are cheap, fast, and numerous, energy is cheap and abundant, and large groups of people can collaborate in pools or network nodes, it stands to reason that the crypto space is rife with money laundering and organised crime. Why wouldn’t it be?

But the same can be said for traditional finance, where market rigging, fraud, mis-selling, sub-prime credit scandals, and/or laundering illicit Russian cash has damaged the reputations of countless high street and Wall Street names in recent years. That’s a given.

No one would claim traditional finance is free of corruption, or that no one suffered from the 2008-09 crash and the decade of austerity that followed. Millions of people emphatically did suffer – and do so to this day as the gap between rich and poor becomes a gulf in many economies. Solutions are urgently needed, particularly as the pandemic may widen the divide, rather than close it.

With massive, unregulated profits available in the crypto world – at least until this week – it’s no surprise that gamblers are attracted to it too. And of course, a sudden dip in a coin’s value is an opportunity for someone to step in and make a killing. Some social media accounts accused Musk of doing exactly that – engineering a crash to buy on the dip – but, crucially, without presenting evidence to support the allegation.

Yet the fact that many believe this is what happened surely represents a problem for alternative finance. Why? Because it proves that there is a conceptual flaw and a structural weakness in the new system: a well-connected billionaire could, hypothetically, simply tweet the market up or down to suit his private investments. How is that progress?

Beyond some people’s desire to hero-worship charismatic CEOs, what good does that bring the world? What problems does it solve for the majority of humans living on a fast-warming planet in infinite space? Isn’t it just more high-stakes gambling and market rigging of the kind that crypto-fans are supposed to be against?

The systemic flaw in alternative finance can be expressed in another way: it turns out that social influence and social network connections are more powerful currencies than Bitcoin. The English expression ‘a token of my esteem’ is apt in 2021: today, esteem is the most powerful token in the world.

But there’s yet another problem for the West as it emerges from the pandemic and from the redrawing of old political maps. It stands to reason that – regardless of how distributed and decentralised a technology is – the centre of gravity in this new financial world will always be in China.

The reasons for this aren’t complicated: there are 1.4 billion people in that country; they are extraordinarily adept at collaborating efficiently to achieve shared aims (a strength of Chinese culture, underscored by a repressive, authoritarian government); energy is abundant there and often wasted – and is 58% generated from fossil fuels; and China controls the world bottleneck for fast, cheap computer processors.

Don’t forget, much American ICT hardware and most critical components are still manufactured in either China or Taiwan, despite the trade war that characterised Trump’s presidency.

Where else could crypto’s gravity-well form, in a world that is supposedly decentralized? This is the real China crisis for the West: the core of global finance is melting down and falling from Wall Street towards mining pools in rural Sichuan or Yunnan.

The figures prove that decentralization is a myth. Just follow the processors. Look again at the Cambridge figures: two-thirds of Bitcoin mining is in Chinese nodes or pools. Who can compete with that?

So, the crypto/digital token/blockchain ecosystem may technically be decentralised – and supposedly above and beyond outmoded geopolitics – but the balance of power in our digitized world looks stubbornly familiar.

China is still in the ascendant; billionaires can still play the system – just faster than they did before, while influencing (and sometimes even controlling) the means of production; money laundering and financial crime are still rife; boom-and-bust is still happening, only now at internet speed; and the new brokers are still sequestered in offshore tax havens, just like the old ones.

Meet the new boss: same as the old boss, but claiming to be a revolutionary.

But hey, you might get lucky, especially if you jumped on the bandwagon early. Pull the handle on the new global fruit machine for long enough and, who knows, maybe a Ferrari will fall into your lap while the world burns.