The problems of cryptocurrencies

Cryptocurrencies have been popular in recent years, and people have flocked to cryptocurrencies for a variety of reasons. The idea of accountless digital money is hardly new, dating back at least as far as 1982 with David Chaum’s paper on blind signatures (Chaum, 1983), a technology he later used to create DigiCash Inc. that took shape in Pitt (1999). Other attempts to develop accountless electronic payment systems, such as E-Gold (Meek, 2007) and Liberty Reserve (BBC, 2013), were designed with privacy in mind and eventually ran into the authorities when criminals used these systems for nefarious purposes.

By the time Bitcoin emerged in early 2009 (Nakamoto, 2009), the financial crisis had triggered aggressive reactions from central banks around the world, and it was certainly no coincidence that the message of circumventing inflationary monetary policy attracted the attention of potential buyers. However, given the history of privacy as the primary motivation for digital money adoption, we believe that many of those who use cryptocurrency (other than speculators) are primarily seeking privacy, either to circumvent capital controls or simply to avoid the “pastoral gaze” of government or corporate oversight (Sotirakopoulos, 2017). Some important developments in recent years support this view, notably attempts to develop a “stable coin”: a cryptocurrency that avoids cryptocurrency price volatility by establishing a market-based peg, such as a fixed currency (Buterin, 2014). The best known example of a stable coin is Tether, a cryptocurrency created to maintain a single peg to the U.S. dollar (Popper, 2017; Williams-Grut, 2018). For this reason, stable coins can be expressed in units of fiat currency. However, stable coins have important limitations, including valid concerns about unilateral exchange rate pegs in general (Rogoff and Meltzer, 1998). As a substitute for “legitimate” currencies, guaranteed by the full faith and credit of sovereign governments, cryptocurrencies are far from perfect. There are structural reasons for this, including:

1. Lack of financial services. There is a notable lack of reliable institutions offering routine financial services such as lending, and more importantly, there is a lack of regulatory support for cryptocurrencies. In addition, unlike transactions made through global messaging systems such as SWIFT (Society for Worldwide Interbank Financial Telecommunications, 2018), there is usually no way to correct or undo erroneous transactions made using impermissible cryptocurrencies, which is a critical limitation in operation. In order for cryptocurrencies to be a real substitute for government-issued currencies, they must support a range of trading platforms and financial products.
2. Lack of regulated trading venues. History tells us that unregulated markets for financial products can be harmful to ordinary citizens and businesses; Consider, for example, the misbehavior of brokers and marketers that led to the creation of the U.S. Securities and Exchange Commission ( Durr and Kinnane, 2018 ) . Cryptocurrency markets lack such controls and mechanisms to ensure accountability, and uncontrolled market manipulation is commonplace.
3. Lack of legal context. There is no generally accepted mechanism for resolving disputes arising from transactions that are executed in cryptocurrency. When automatically-executable contracts such as those that formed the basis of the “Decentralized Autonomous Organization” that rocked the Etherium community in 2016 are exploited , there is little legal recourse for unfortunate victims. While “some operational provisions in legal contracts” can be automated to positive effect, it may seem that the maximalist concept of the “code is law” principle may not be possible without a suitable legal framework.

In addition, cryptocurrencies often fail to deliver on their key promises. For example, they are often not as private as is commonly believed. Analysis of Bitcoin transactions can de-anonymize them, and researchers have shown that it is extremely possible to identify meaningful patterns among transactions (Meiklejohn et al., 2013; Tasca et al., 2016). The problem persists not only as a result of common web trackers and the reuse of aliases associated with Bitcoin wallets (Goldfeder et al., 2017), but also because incoming transactions to a Bitcoin address can be largely associated with outgoing transactions from that address (Al Jawaheri et al., 2018). Indeed, it has even been argued that the explicit traceability of transactions in the Bitcoin ledger, combined with the simple approach of flagging suspicious transactions (Anderson et al., 2018), make it even less closed than traditional payment mechanisms. Even cryptocurrencies such as Monero, which are designed for privacy, have been shown to have important drawbacks (Kappos et al., 2018; Möser et al., 2018). Another, perhaps equally important disadvantage of cryptocurrencies is that they are not as decentralized as is commonly believed. Although decentralization is often advertised as the raison d’être of cryptocurrencies (Buterin, 2017), in practice the governance, “mining” services and infrastructures associated with cryptocurrencies remain centralized for a variety of reasons (Chepurnoy, 2017). The problem of decentralization is closely related to the more basic problem of governance, which is how to ensure that the system serves the interests of its users. Without institutional support, there is little to ensure that it stays that way.

The problem of governance is of particular importance for stable coins. It is important to note that if a stable coin is not backed and controlled by a central bank, its users will have to worry about who ultimately provides the assurance that it will retain its value.