Cryptocurrencies: The bad side

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BY PETER WANYONYI

In January and March of this year, this column discussed the emergence and growing acceptance of cryptocurrencies such as Bitcoin, as well as their underlying technologies such as Blockchain. The general view of cryptocurrencies is that they are a fresh new approach to money and its issuance and management, and the lack of a centralised authority controlling the issuance of such currencies makes them particularly attractive to those who want to remain anonymous while transacting online.

So far, so good. But every good thing has a not-so-good side, and cryptocurrencies are no different. The very reasons that make cryptocurrencies attractive to a certain class of people – especially libertarians, who seek to uphold individual liberties as a core principle and eschew state control – also make them vulnerable to various acts of manipulation by nefarious agents.

Ordinarily, a currency is backed by a State. The currency is, effectively, a claim against the economy of that state. The assets and revenues of the state back the value of the currency up, and the currency can be exchanged for goods or services of corresponding value in that state – or, in the case of a reserve currency like the US Dollar, in any open market worldwide. Cryptocurrencies do not have this sort of backing. As “citizen currencies” without any sort of state control or any acknowledged asset base against which they can claim value, they resemble giant pyramid (ponzi) schemes that can easily be manipulated and whose value can be lost to fraud or digital attacks.

Blockchain relies on distributed consensus to verify transactions. Distributed nodes – computers – each have a copy of the master “ledger” to which new transactions must be added and which are then subjected to a “vote”, with the transaction being accepted if at least half the nodes involved “agree” that the transaction is valid. This creates a problem of scalability – the more the transactions to record and verify, the slower the system becomes. If, theoretically, everyone used cryptocurrencies for their normal transactions, the world doesn’t have enough computing power to allow normal, real-time transactions to happen. The payments system would quickly become cumbersome, and the amount of energy used up by the computing nodes needed to verify and record transactions would increase exponentially, creating massive power shortages and ecological disasters as more and more power was generated to meet demand.

To maintain coherence and prevent data corruption, Blockchain systems include a “speed limit” on the number of transactions that can be recorded to the distributed master ledger within a given period. This speed limit is a function of the limitations imposed by the realities of computing physics: data cannot be transmitted faster than the speed of light, and recording transactions to even the fastest media still takes significant amounts of time. Add to that the need to then conduct a “vote” of participating nodes to verify a transaction, and it becomes clear that the more transactions you have in a Blockchain payments system, the slower it becomes. This in turn pushes up transaction costs, since time is money and the longer a transaction waits to be verified, the more it costs the buyer and the seller – even before the usual profit margins are applied to the transaction.

Transactions would have to remain in queues for long periods, negating the benefits of online commerce. In a world of finite computing power and expensive electricity alongside demands for real-time e-commerce, this quickly becomes economically and financially unsustainable. And what happens if a Bitcoin spent on one commodity in a transaction that’s pending verification, is then spent again by an unscrupulous buyer – before the first transaction has been verified and recorded? There would be a need for transaction rollbacks a few hours after the fact. But in a world with “Dark Web” buyers who pay for digital goods and services using cryptocurrencies, that would be too late.

Perhaps the biggest threat to cryptocurrencies, though, is the power and jealousy of nation-states. Control of a currency gives a nation-state enormous political power over the citizens of that state. States use that power to control spending, set and carry out policy, manage social conditions, and so on. The widespread acceptance of cryptocurrencies would remove these powers from the state – but would not vest them into any other central authority. Who then becomes the arbiter if there are disputes about transactions?

Today, people using cryptocurrencies have to trade through self-appointed third parties who issue “crypto-wallets” and provide “crypto-exchanges”. These third parties do not have the power to enforce any settlement, though, and many of them are vulnerable to theft and digital heists: there have been many cases of Bitcoin exchanges being hacked and the criminals making off with vast fortunes. In the complex world of digital currencies, such perpetrators include state agencies looking for easy money, as well as your usual run-of-the-mill digital bandit.

It’s thus little surprise that the enthusiasm for cryptocurrencies has waned. Bitcoin value peaked at a dizzying $19,187 in December 2017, only to crash back to a humbler $6,000 today. Like all moneys today, cryptocurrencies are fiat tools backed by nothing but the trust of those that use them. Unlike state-issued currencies, they do not constitute a claim against the revenue stream of a recognised nation-state, and so are inherently worthless. They will remain a preferred currency of some parties in the current and future economy, and could very well grow in value and popularity again. But, as with everything in the digital world, they should be adopted and used with caution.