Crypto Credibility

Jan 18, 2019·Alasdair Macleod

Last Monday, there was a striking headline in the Daily Telegraph: “Russia looks to bitcoin to soften effects of US Sanctions”. The immediate impact on bitcoin’s price was minimal, though it did rise 4.2% later in the day, after Zerohedge picked up the story.[i]

The Telegraph’s source seemed credible. Vladislav Ginko is an economist at the Russian Presidential Academy of National Economy and Public Administration, which is the training ground for Russia’s political and administrative elite, a Russian equivalent of France’s École Nationale d’Adminstration. Professor Ginko appears to be a firm believer in bitcoin and its technology, and he seems well-connected. But it is not a brand-new story. Earlier this month he tweeted the following:

Tweet 1

However, Professor Ginko perhaps should not be taken too seriously, being either a conspiracy theorist or perhaps a joker, as the following more recent tweet reveals:

tweet 2

Putting this bizarre allegation to one side, he has reminded us that President Putin has expressed an interest in cryptocurrencies and blockchain technology. The point missed in Professor Ginko’s tweets is that one way to destabilise the dollar would be to encourage a new bull market in cryptocurrencies, which could be the strategic logic behind a Russian move. It is not, as implied by Professor Ginko, that bitcoin is about to take its place alongside Western currencies in Russia’s currency reserves. Furthermore, the idea that Russia is seriously considering adding $10bn of bitcoin to reserves does not ring true, given it would be more likely to quietly accumulate them first instead of boasting about an intention and paying higher prices.

It may be just coincidence, but bitcoin’s vicious bear market broadly coincided with the US dollar’s recovery, which commenced only a month after bitcoin’s peak in December 2017. Recently, the dollar has shown signs of entering a new bear phase, in which case a negative correlation suggests bitcoin might begin to recover, and with other credible cryptocurrencies become to be seen as an alternative to the king of fiat.

Cryptocurrencies have disappeared from most people’s radar screens. While public attention has drifted elsewhere, it is clear that professionals are still working on solutions to identify and control risks at a time of market quietness. These are the generic market conditions usually identified with the prospect of a renewed bull phase.

Crypto criminal cleansing continues

For the moment, it might too early to expect cryptocurrencies to be ready for a lasting revival. The 2017 bull market blow-off exposed excessive greed, signalling the start of a probable multi-year bear market, or even the end of the entire phenomenon. Over a thousand cryptocurrencies were in existence by early 2018, issued mostly by wannabe Satoshis. Today it is estimated there are over 1,600.

In recent years exchanges and other service providers have been closed amid accusations of fraud and money-laundering. Freedom from national boundaries and the laws that go with them have undoubtedly contributed to criminal activity both real and imagined. On Monday this week, SlowMist, a Chinese-based blockchain security firm, reported suspected money-laundering in ethereum classic (ETC), in its newsfeed  reproduced below:

ETC Network Is Abnormal, Large Transactions Suspected of Money Laundering 0735

Monitored by China-based blockchain security firm SlowMist, there was a large amount of abnormal miners' rewards on the ETC public chain in the early morning of Jan 14 (UTC+8). Further analysis revealed that the abnormal rewards resulted from the address starting with 0xb71ee622 that holds approximately 72,383 ETC. The address paid a huge transaction fee for a large number of transactions, and the large amount of high fees were taken by the miner's address starting with 0x00473. The miner transferred out the mining revenue in real time, which is suspected of money laundering.

The previous week, SlowMist got to the bottom of a rollback attack on ETC. Hackers deploy a rollback attack by resetting protocols to an earlier point in time, so they can alter a blockchain’s transaction history to clone cryptocurrency. SlowMist identified the exchanges involved and all of them have now returned the extra ETC, as declared in the following tweet on Wednesday, 16 January:

Tweet 3

It is worth noting that the detectives in this story are China-based, which illustrates how markets left to their own devices lead to responsible cooperative behaviour, irrespective of nationality and national boundaries. You won’t hear this from governments, for whom this invisible hand of market forces is inexplicable and not to be trusted.

As well as rollbacks, there are other attack categories against which service providers have to be vigilant. And even though they continue, developers and service providers are getting better at recognising and preventing them. Clearly, it is a process that still has some way to go, but it appears that the cryptocurrency community is beginning to regulate itself effectively.

Consequently, there is likely to be growing institutional confidence in both cryptocurrency technology and in the leading cryptocurrencies themselves. We can therefore expect renewed attempts to package cryptocurrencies into regulated investment vehicles, pressure regulators will find increasingly difficult to resist, so that investing institutions can invest.

Defining cryptocurrencies and their role as currency

There is a continuing debate about whether cryptocurrencies are a form of money, so it is important to put them in their financial context and establish their function.

Money and the currency which represents it are mediums of payment that allow a business and people to turn their production output into the goods and services they need and desire. A common money or form of currency has to be accepted by everyone with whom the individual is likely to transact directly and indirectly. It must be stable in value, so that decisions on prices paid and received are confined to changes from the goods and services side of a transaction. In other words, money must have a common objective value which goes unquestioned between transacting parties, so that all else in a price is subjective.

The choice of currency is down to transacting individuals, whether it be crypto or fiat. Fiat currencies are accepted by us in our relevant jurisdictions because we are commanded to use it by our governments. We comply because of the convenience a state currency offers, but ultimately the decision to use it and the exchange value we put on it is a collective choice. Cryptocurrencies share this theoretical standing as fiat currencies, except that they do not have government backing and are not normally used to settle transactions in goods and services. It is on these two points that many dismiss the status of cryptocurrencies as a representation of money, as well as being too volatile to have that important objective value. But before dismissing it on these grounds we should note that there can be as much volatility in fiat, as users of Turkish rials, Indonesian rupiahs and others will attest; it just happens the volatility in fiat tends to be in a negative direction.

These considerations apply only to settling transactions in goods and services. A different case is the use of fiat currency as a counterpart to financial investment, where the objective is not to use it to facilitate consumption, but to convert the investment back to the original currency at a later date. This has led some investors to argue that cash should be regarded as a portfolio asset, having strategic value just like any investment allocation. In this respect, we can see both crypto and fiat can be regarded as ranking assets for investment purposes. All that is required for this to materialise is a loss of confidence in fiat relative to crypto for investors to accept crypto as a money-substitute for fiat.

We can take the comparison of cryptocurrencies with the status of fiat currency even further. As investors, we look at foreign-issued fiat money as a potential investment. Selling dollars for Swiss francs is with a profit in mind, a transaction to be valued in dollars and reversed at a later date, unless you intend to go to Switzerland to spend your francs. For the purpose of currency speculation, in this context a cryptocurrency is obviously an alternative that ranks with fiat.

The limitations on the future issue of a cryptocurrency that requires to be mined contrasts with the open-ended expansion of fiat currencies, and so purely on the difference in their individual rates of expansion they have the potential to drive cryptocurrencies priced in fiat relatively higher over time. The caveat which must not be neglected is that it assumes there is no change in relative confidence, because both state-issued currencies and cryptocurrencies are backed by nothing else.

Lastly, the rapid increase in the number of cryptocurrencies might at first sight constitute supply. This has not turned out to be the case, because confidence in future values has been restricted to those with an established history. There can be ten thousand different cryptocurrencies, but public acceptability will remain confined to very few.

Fundamentally, there is much in common between fiat and crypto, and to the extent that the central bankers issuing fiat currency understand it, they should be alarmed at the potential consequences. So far, most central banks have ducked this issue. The only governments that are interested in crypto are either ones that have destroyed their own monetary credibility, such as Venezuela, or those who might consider strategic benefits, such as Russia. And this is why Professor Ginko’s tweets are thought-provoking.

Could it be that President Putin thinks he has found a way to destroy the dollar? If so, he must be taking an iconoclastic view, because it will also need a systemic crisis to undermine faith in the dollar in order to trigger a widespread flight out it into cryptocurrencies.

Gold makes more sense for Russia

President Putin seems unlikely to indulge in cryptocurrency fairy tales. Instead, through Russia’s central bank he is building gold reserves in partnership with a number of important Asian governments. The geopolitical sense in this strategy is that Russia wants to replace the dollar and the currencies tied to it and instead accept hard, incorruptible money for its energy exports. Gold has been suppressed by the US Government’s long-standing denials that it is money, preferring to promote their fiat dollar instead. Gold priced in dollars is therefore cheap and an opportunity for Russia.

Gold’s durability as a medium of exchange establishes it as true money, whereas crypto and fiat are mere currency, that is to say they only pretend to be true money. Early cryptocurrency enthusiasts claimed that bitcoin and others were a modern replacement for gold, based on similar supply characteristics and the requirement to be “mined”. What they omitted to tell us was that without demand for cryptocurrencies, they are valueless, whereas if gold for the first time in the history of money became universally rejected as money, it still retains value for other uses.

It is those other uses, coupled with its incorruptible characteristics that marks out gold from all forms of ethereal currency. But in this confusing world of what constitutes money and currencies, few Westerners seem to understand that gold is the money. Instead, they regard it as an investment, offering protection in uncertain times.

This is a mistake. The purpose of an investment is profit. Investment is undertaken in anticipation of final values and their realisation in the underlying units of account. That is what a buyer of shares in gold mines and gold derivatives does. A buyer of physical gold buys it because he or she is disposing of inferior currency as a store of value.

This is why gold has remained the true money for millennia. Fiat currencies are probably on the path that ends in their final oblivion, a journey that has lasted only a century. Cryptocurrencies in the context of time are ephemera which will enjoy only a brief existence before oblivion.

For those of us that have taken the trouble to understand money, we can see that cryptocurrencies have the potential to evolve into the biggest bubble of all time and on a global scale, fuelled by the excesses of fiat issuance, past and future. Only time will tell if it happens, but if a cryptocurrency bubble really gets going, it could accelerate a move out of fiat currencies, undermining the public’s relative preferences that give fiat its credibility. Logically, cryptocurrencies have the alarming potential to kill fiat currencies stone dead.

Does President Putin understand this, and does he have a plan to demolish the dollar by triggering a cryptocurrency bubble? Clever though he is, probably not.

[i] See

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