Cryptocurrency Has Yet to Make the World a Better Place

A truly consequential innovation is one that makes possible entirely new business models that touch the lives of millions. The car enabled motels and shopping malls, the internet enabled e-commerce, and smartphones and GPS enabled ride-sharing.

What business model that touches the lives of millions have cryptocurrencies such as bitcoin made possible? American motorists now know: ransomware. In such attacks, hackers encrypt and sometimes steal the victim’s data, demanding a ransom to decrypt and not release the data. Crypto is how Colonial Pipeline Ltd. paid hackers who earlier this month forced offline a conduit that supplies 45% of the East Coast’s fuel.

A few days after the Colonial attack,

Tesla Inc.

announced it would no longer accept bitcoin as payment for cars because of the carbon emissions generated by the computer processing necessary to mint new coins.

The two events underline how an innovation that was supposed to displace the dollar as a medium of exchange has proved largely useless for buying legal things yet frighteningly effective at facilitating extortion.

China’s recent warning on cryptocurrency sent the market in a tailspin. WSJ’s Aaron Back explains why the recent shake-ups in the value of bitcoin, dogecoin, ether and other cryptocurrencies may point to obstacles in mainstream acceptance. Photo: Dado Ruvic/Reuters

We usually think of innovation as unambiguously good. Human welfare advances through the continuous recombination of materials and muscle in new and creative ways. Every innovation has its dark side, but even with car accidents and internet scams we’re clearly better off with cars and the internet.

There is, though, a small list of innovations whose net contribution to society is negative: asbestos, now widely banned. Cigarettes, still with us. Fentanyl: In legal usage, it’s a potent, easy-to-make synthetic opioid for severe pain, but those same qualities are how bootleg versions are wreaking untold destruction through overdoses, addiction and crime.

Will bitcoin join this list? True, legitimate business does get transacted with cryptocurrency. But not much; the vast majority of turnover in crypto is trading and speculation. Chainalysis, a crypto security company, estimates merchants received $2.8 billion in crypto payments last year, less than in 2017, though payments this year are ahead of the pace in 2017.

By contrast, it estimates illicit entities received 75% more: $4.9 billion last year, though that’s down substantially from 2019. The fastest-growing category is ransomware: Payments quadrupled to $348 million last year from 2019. That’s almost certainly an undercount since many ransoms aren’t reported. Actual costs are far greater once you include data recovery, disrupted operations and reputational damage when hackers publicly release stolen data. Countless Americans paid more and waited longer for fuel because of the Colonial attack.

Unlike most computer crime, ransomware is largely a product of cryptocurrency. Coveware, a firm that assists ransomware victims, attributes the rise of the ransomware economy to a large pool of underemployed tech workers in the former Soviet Union; easy access to the necessary software tools, such as malware to break into computer systems; and crypto. “These three elements (labor, currency, and raw materials) form the fundamental ingredients that fuel the cyber extortion industry,” it wrote in a blog post last year. Coveware Chief Executive Bill Siegel said 100% of ransoms are demanded in crypto, and it’s usually the victim’s first crypto transaction.

Despite this, some analysts are still bullish on cryptocurrency’s potential, including Mr. Siegel: “Any project with the ambition and scale of replacing fiat currency is going to be challenged, and evolution is never without pain.”

While crypto hasn’t proved useful as a medium of exchange for the law-abiding, blockchain, the distributed ledger technology that underlies crypto, is more promising. For example, the current payment system is comparatively slow, costly and often controlled by big banks and credit and debit card processors. Access can be monitored or severed by governments pursuing criminals, terrorists or political opponents. Blockchain could be a faster and cheaper alternative, especially for those dealing with countries whose financial system is rickety, untrustworthy, racked by inflation or under U.S. sanctions. International payments are one of the big selling points for stablecoins, which are much less volatile than other cryptocurrencies because they are backed by hard assets such as Treasury bills.

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Still, such applications are far from achieving a scale that matters to consumers. The most popular stablecoin, tether, is mostly used to trade other cryptocurrencies and its issuer this year settled New York state charges that a sister company raided its reserves.

Facebook’s

stablecoin project Diem (formerly Libra) has been slow to launch amid regulatory skepticism. Meanwhile, regular currency-based systems are addressing their flaws: China’s Alipay and

WeChat

Pay are fast and cheap because they bypass banks and card companies, and its central bank has just launched a digital version of the yuan.

Blockchain is slowly finding its way into other applications from land registries to the “nonfungible tokens” now flooding the collectibles market. Yet this simply shows that we can get the benefits of blockchain without crypto.

Defenders argue that even if crypto never succeeds as a medium of exchange, it has succeeded as a store of value, much like gold without the hassle of storing physical metal. Cryptocurrencies’ collective value topped $2 trillion earlier this month, more than all dollars in circulation. This might be a bubble, but aren’t bubbles the hallmark of every financial innovation?

But most financial innovations finance something. England achieved global economic dominance because London’s financiers would lend to ventures when no one else would. The dot-com bubble financed internet startups. Subprime mortgages financed houses. For the most part cryptocurrencies don’t finance tangible investments.

Cryptocurrencies are supposed to be a hedge against inflation because issuance is usually restricted. But that’s only true of an individual currency. As an asset class, cryptocurrency inflation is rampant: There are now more than 5,000 coins. Gold never faced competition from dozens of new precious metals hitting the market each month.

Gold became a store of value because through most of history it was also a medium of exchange: Coins were once minted from it, and paper money was long backed by it. If crypto never finds acceptance as a medium of exchange, its usefulness as a store of value is also in doubt.

Write to Greg Ip at [email protected]

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