Unfortunately, some of these benefits have fallen by the wayside as cryptocurrencies gained in popularity and speculative forces in search of quick profits took hold. One major paradox of crypto is that there is now enormous centralization in this unregulated ecosystem. Apparently unwilling to put their full faith in a trustless technology, most users rely on cryptocurrency exchanges to hold their crypto assets and to trade them. The fraud perpetrated by Sam Bankman-Fried’s FTX, in which its executives treated investor funds like a personal piggy bank, highlights this vulnerability. And the government’s charges that Binance, the world’s largest cryptocurrency exchange, engaged in money laundering and other forms of malfeasance show how the problems of concentrated market power can pervert the noble aims of crypto visionaries.
Despite the problems illustrated by FTX and Binance, regulation is scant and centralization remains pervasive. The process by which transactions are validated and recorded on the Bitcoin digital ledgers is controlled by a handful of major consortiums that deploy their computing power to enable this process and reap the rewards. And in other parts of the crypto world, true democracy goes only so far. Large stakeholders have been accused of trying to manipulate rules, which are based on majority voting power, in ways that favor their interests over those of smaller players.
Moreover, it has become clear that risks could spill over from decentralized finance to traditional finance, as well as the other way around. Consider stablecoins, a highly popular type of cryptocurrency whose value is tied to the U.S. dollar, making them far more useful for payments than other, more volatile, digital currencies. Stablecoins are usually backed up by easily tradable securities such as U.S. Treasury bonds. A huge volume of redemption requests could lead a stablecoin issuer to liquidate a sizable volume of such securities, causing problems in those markets. On the flip side, the failure of Silicon Valley Bank last year caused problems for a major stablecoin issuer that had deposits in that bank.
Bitcoin, in particular, has essentially become a purely speculative financial asset, whose value seems to hinge solely on its scarcity rather than any useful purpose it serves. Its volatile value, which is evident in its wild price swings in the last few days, high transaction fees and slow processing times have rendered it ineffective as a means of payment, which was its original purpose .
But thanks to a loosening of restrictions by the Securities and Exchange Commission, retail investors, even nonprofessionals with modest savings, can now easily incorporate crypto into their portfolios via products that are offered by mainstream investment management firms. Endorsement by politicians further legitimizes crypto as an asset class. This only exposes such investors to risks they may not fully understand and that could hurt them financially.