Digital currencies: If you cant beat them, join them?

Cryptocurrencies are not for the fainthearted. Bitcoin lost more than 50 percent from its April high of $64,870. Volatility was always a hallmark of cryptocurrencies. Some of them may in the long run fare better than others. Ether has a special position because its underlying blockchain drives a multitude of other applications, like the non-fungible tokens in the art market.

Elon Musk’s tweets and comments sparked losses earlier in the year. Most recently, actions of the Chinese government put more systemic obstacles in the way of cryptocurrencies.

This is nothing new. In 2017, exchanges in China were told to stop trading in cryptocurrencies, and initial coin offerings were forbidden. Already the government was skeptical for financial institutions and fintech companies to be involved in crypto trades, which extended to opening bank accounts for bitcoin traders.

Last week, the Chinese government tightened the noose further. The province of Sichuan, and the city of Ya’an in particular, vowed to root out all bitcoin and ether mining operations within the year. This follows an earlier crackdown in Inner Mongolia and other provinces.

Bitcoin mining was hitherto big business in China. As per April 2020, 65 percent of all bitcoin mining happened in China, followed by the US, which accounted for 7 percent according to Cambridge University.

The mining of cryptocurrencies in China uses up more energy than the Netherlands consumes annually. No wonder then that the government started to crack down, as carbon neutrality by 2020 is a stated goal. Bitcoin miners also sparked the use of illicit coal.

The infringements on mining were but the first step. On Monday, the Chinese government reminded the Industrial and Commercial Bank, the Agricultural Bank of China and Alipay of the ban on engaging in crypto-related transactions. This action was about control because cryptocurrencies are one way to funnel money out of the country and, more importantly, because the Chinese government has for some time been at pains to eliminate risks from the financial markets.

The above is not good for business, and it means that cryptocurrencies are way off from acting as reliable stores of value. Still, cryptocurrencies are risk assets sought after by some. According to a survey of 100 hedge funds by Intertrust, respondents said they hold an average of 7.2 percent of their assets in cryptocurrencies. Hedge funds are all about risks and how to manage them. However, riskier assets may lose attractiveness the more hawkish central bank policies become.

This brings us to the “safe money,” like pension funds. Blackrock Chairman Larry Fink told Bloomberg that for him cryptocurrencies will, for the time being, offer only negligible investment opportunities, which makes sense since two-thirds of the money manager’s investor base are pension funds.

Several central banks are looking into issuing their own digital currencies. The People’s Bank of China is quite advanced in this endeavor. Other central banks are working on similar projects. In democracies, the hurdles are greater as data protection and privacy concerns are taken very seriously. The Bank for International Settlement has nonetheless opined that central bank digital currencies (CBDCs) were necessary to modernize the financial system, voicing concerns about the alternative of Big Tech moving into that space, as we have seen with Facebook’s Libra. Expect central bankers to aspire to keep up with the Joneses once the first CBDC is issued, wherever that may be.

Larry Fink had a point when he said that the significant change to the financial system would come from CBDCs, in the short to medium term at least. As the world moves toward digital solutions, currencies will do the same. Countries will not want to give up sovereignty over their currencies too easily, nor will they want them to become obsolete. The old adage “If you can’t beat them, join them” will hold true in the medium term at least. This does not mean that the crypto space will become obsolete; it will just remain speculative for the time being.

• Cornelia Meyer is a Ph.D.-level economist with 30 years of experience in investment banking and industry. She is chairperson and CEO of business consultancy Meyer Resources.

Twitter: @MeyerResources