Issue 109

The crypto carnage

Delivered on 20 April 2021 by Justin Pyvis. About a 4 min read.

There was a bit of a perfect storm for Bitcoin (and almost all cryptocurrencies) over the weekend, culminating in rapid double-digit price declines. Bitcoin fell almost 15% in 24 hours, Ethereum fell 17% and Litecoin was down some 24%. All have since paired some of those losses but as of Monday, the bitcoin price was still ~10% lower.

Bitcoin's crash.

The major carnage stemmed from a rumour that the US Treasury will soon "tackle financial institutions for money laundering carried out through digital assets". That's a big deal – one reason for Bitcoin's meteoric rise over the past year has been its growing legitimacy, with Mastercard bringing crypto to its network, crypto exchange Coinbase going public last week, growing talk of bitcoin exchange traded funds (ETFs), and then who could forget Elon Musk's $US1.5 billion bitcoin purchase.

Any moves by the US Treasury to undermine that new-found legitimacy will have a detrimental effect, at least in the short-term, on crypto prices. Let's not forget that Turkey last week banned crypto payments entirely, albeit for different reasons (crypto is a threat to the Turkish lira – Turkey's President, Erdoğan, believes that high interest rates cause inflation and has sacked multiple central bank chiefs who have tried to rein in the country's rampant inflation).

Finally there are the ongoing attacks on crypto – Bitcoin in particular – claiming it's nothing more than an "open Ponzi scheme", most recently by Nassim Taleb (of Black Swan/Antifragile fame). We summarised the argument in yesterday's Brekky Wrap (if you haven't signed up, you should – it's free), which boils down to a misunderstanding of what Bitcoin is: a store of value, not a currency.

Taleb's criticism of Bitcoin.
Taleb's criticism of Bitcoin.

Bitcoin "doesn't do anything economic" in the same way that the vast majority of the world's gold "doesn't do anything economic". It's a hedge against people like Erdoğan and is a lot easier to store than physical gold. If you're looking for a blockchain that does a lot of "economic" things (smart contracts, non-fungible tokens, etc), that's most likely going to be Ethereum.

But just because Bitcoin doesn't 'do' anything economic (although there are 'layer 2' developments that might eventually change that) doesn't mean it's "economically equivalent to an open Ponzi scheme".

Regulating the competition away

The big Australian banks – CBA, NAB, Westpac and ANZ – are growing increasingly frustrated at financial innovation that threatens to undermine their monopoly rents:

Last week’s Coinbase float put bitcoin on the radar of the parliamentary committee overseeing the major banks for the first time and National Australia Bank CEO Ross McEwan responded on Friday by urging policy makers to set out a plan to protect investors who trade digital assets.

"We need to think, as a country, [about] what is crypto, how could it be used, and do you trade it – if it is something that should be traded – safely, and so we make it safe. Those are the issues we need to think about – and quite quickly – because people are making a livelihood out of trading cryptocurrencies."

Australian banks are protected but also handcuffed by the implicit backing of the federal government and central bank and many layers of costly regulation. That limits their ability to take risks and innovate, which is why they're only now talking crypto some 12 years after it was invented. They also recently woke up to a more imminent threat – the popularity of buy now, pay later:

"I acknowledge the work and innovation [Afterpay has] undertaken to build such large and successful company – and avoiding all of that regulation is quite a feat," Mr Comyn [CBA CEO] said.
"I would suggest the line around innovation in this area is skewed to a complete absence and lack of regulation in a number of areas," he said.

"The government does and should have a posture towards new players to facilitate and encourage innovation, but my point is based on size and scale – they are beyond the point where the legislation framework that applies to that sector needs to be comprehensively reviewed."

Buy now, pay later is eroding banks' interest margins and non-interest income from credit cards, which is basically a heavily regulated version of the former. Buy now, pay later is not so much an 'innovation' in the truest sense of the word – it's an innovation in regulatory arbitrage, or an ability to exploit a loophole the banks didn't see until it was too late.

I suspect it won't be long until regulators come down hard on buy now, pay later. The banks have too much influence in Canberra and there's too much at stake in terms of perceived financial stability:

"We see roughly buy now, pay later users having twice as much credit on their credit facilities, and typically on their credit cards [and] they have more credit products," Mr Comyn [CBA CEO] said. "That is what we can see. But a number of buy now, pay later providers don't contribute to 'comprehensive credit reporting'."

The knives are out and if regulators decide to burden the likes of Afterpay with even a fraction of the existing banking regulation it will hurt their profitability (added costs) and growth potential (less differentiation from traditional credit cards). Tread carefully.

Issue 109: The crypto carnage was compiled by Justin Pyvis and delivered on 20 April 2021.