Tether prices listed on the Kraken website.
LONG READ
BYSOHALE ANDRUS MORTAZAVI
JACOBIN
01.21.2022
Cryptocurrency is a scam.
All of it, full stop — not just the latest pump-and-dump “shitcoin” schemes, in which fraudsters hype a little-known cryptocurrency before dumping it in unison, or “rug pulls,” in which a new cryptocurrency’s developers abandon the project and run off with investor funds. All cryptocurrency and the industry as a whole are built atop market manipulation without which they could not exist at scale.
This should surprise no one who understands how cryptocurrency works. Blockchains are, at their core, simply append-only spreadsheets maintained across decentralized “peer-to-peer” networks, not unlike those used for torrenting pirated files. Just as torrents allow users to share files directly, cryptocurrency blockchains allow users to maintain a shared ledger of financial transactions without the need of a central server or managing authority. Users are thus able to make direct online transactions with one another as if they were trading cash.
This, we are told, is revolutionary. But making unmediated online transactions securely in a trustless environment in this way is not without costs. Cryptocurrency blockchains generally don’t allow previously verified transactions to be deleted or altered. The data is immutable. Updates are added by chaining a new “block” of transaction data to the chain of existing blocks.
But to ensure the integrity of the blockchain, the network needs a way to trust that new blocks are accurate. Popular cryptocurrencies like Bitcoin, Ethereum, and Dogecoin all employ a “proof of work” consensus method for verifying updates to the blockchain. Without getting overly technical, this mechanism allows blockchain users — known as “miners” in this context — to compete for the right to verify and add the next block by being the first to solve an incredibly complex math puzzle.
The point of this process is to make adding new blocks so difficult that meddling with the blockchain is prohibitively expensive. Though the correct answer to these puzzles can be easily verified by anyone on the network, actually being the first to find the answer requires an enormous amount of processing power — and thus electricity — and outcompeting the rest of the network is impractical.
For their troubles, miners collect a reward for being the first to verify the next block. The Bitcoin blockchain adds a new block every ten minutes, and the block reward is currently 6.25 newly minted bitcoins, worth nearly a half million dollars at Bitcoin’s last all-time high. Competition for block rewards has led to a computing power arms race as prices have risen. Mining bitcoins on a personal computer is no longer feasible. The majority of cryptocurrency mining is now conducted in commercial mining farms, essentially huge warehouses running thousands of high-powered computer processors day and night. The electricity expended mining Bitcoin and other cryptocurrencies is rapidly approaching 1 percent of global usage, which is famously greater than the total electricity consumption of many smaller developed nations.
Given that cryptocurrencies don’t produce anything of material value, this enormous waste of resources renders the whole enterprise a negative-sum game. Investors can only cash out by selling their coins to other investors — but only after the miners and various cryptocurrency service providers take the house’s rake. In other words, investors cannot — in the aggregate — cash out for even what they put in, as cryptocurrencies are inefficient by design.
This makes them a poor and costly form of currency and absolutely ludicrous as a long-term investment. We could dismiss them as a doomed experiment in the “greater fool” theory of investing, in which investors attempt to profit on overvalued or even worthless assets by selling them on to the next “greater fool” — think of it as gambling on a high-stakes game of musical chairs — if the rising price of Bitcoin and other cryptocurrencies were simply a function of demand.
This isn’t the case. Price manipulation plays as much or more of a role than demand in driving prices higher.
The Central Bank of Crypto
This isn’t some big secret. In a widely circulated 2017 paper, researchers attributed over half of the then-recent rise in Bitcoin’s price to purchases made by a single entity on Bitfinex, a cryptocurrency exchange headquartered in Hong Kong and registered in the Virgin Islands. These purchases were timed to buoy the price of Bitcoin during market downturns in a way that so strongly indicated market manipulation, the authors found it inconceivable that such trading patterns could occur by happenstance.
Critically, these purchases were not made with dollars, but with Tether, another type of cryptocurrency known as a “stablecoin” because its price is pegged to the dollar so that one tether is always worth one dollar. Many offshore cryptocurrency exchanges lack access to traditional banking, presumably because banks deem doing business with them too risky. Bitfinex, which shares a parent company and executive team with Tether Ltd (the issuer of its namesake cryptocurrency), struggled to find US banking partners after Wells Fargo abruptly stopped processing wire transfers between the exchange’s Taiwanese banks and their American customers in 2017 without giving reason.
This was a problem. Without traditional banking relationships for issuing wire transfers, exchanges cannot easily facilitate trades between buyers and sellers on their platforms — someone has to pass cash between buyers and sellers. Stablecoins solve this problem by standing in for actual real dollars. They allow cryptocurrency markets to maintain ample liquidity — the ease with which assets can be converted into cash — without actually having to have cash on hand.
Tether has become integral to the functioning of global crypto markets. The majority of Bitcoin trades are now conducted in Tether, 70 percent by volume. By comparison, only 8 percent of trade volume is conducted in real dollars, with the remainder being other crypto-to-crypto pairs. Many industry skeptics, and even proponents, see this as a systemic risk and ticking time bomb. The whole system relies on traders actually being able to exchange tethers for real cash or — far more commonly in practice — other traditional cryptocurrencies that can be sold for cash on banked exchanges like Coinbase or Gemini, both headquartered in the United States.
Should faith in Tether falter, we could see its peg to the dollar collapse in a flash. This would be a doomsday scenario for crypto markets, with investors holding or trading crypto assets on unbanked exchanges unable to “cash” out, since there was never any cash there to begin with, only stablecoins. This would almost certainly cause a liquidity crisis on banked exchanges as well, as investors rush to cash out their crypto anywhere possible amid cratering prices, and banked exchanges processing far less volume would almost certainly not be able to pick up the slack.
There is no reason to have any faith in Tether. Tether’s peg to the dollar was initially predicated on the claim that the digital currency was fully backed by actual cash reserves — a dollar held in reserve for every tether issued — though this was later shown to be a lie. The company has since continuously revised down claims about how much cash they keep in reserve. Their latest public attestation on the matter, from March of last year, claimed to be holding only 3 percent of their reserves in cash. The rest was held in “cash equivalents,” mostly commercial paper — essentially IOUs from corporations that may or may not exist, given that reputable actors trading in commercial paper don’t appear to be doing any business with Tether.
While even these modest claims about their reserves may be a lie, as Tether has never undergone an external audit, none of this really matters, since Tether’s own terms of service make it clear that they do not guarantee the redemption of their digital tokens for cash. Should the market suddenly lose faith in Tether and exchanges become unable or unwilling to exchange them one for one with dollars or the respective amount of cryptocurrency, Tether accepts no obligation to use whatever reserves they may or may not have to buy back tethers.
And in practice, Tether rarely buys back or “burns” their tokens (sending the tokens to a receive-only wallet so as to remove them from circulation and decrease the supply, in an attempt to raise the price), as one would expect if the purpose was simply to provide market liquidity as claimed. If that were the case, we would expect the overall supply of Tether to closely track daily crypto trading volumes. Exchanges would only keep enough Tether on hand to cover trading volume and presumably sell off or redeem excess Tethers for cash when fewer people are actively trading crypto.
Instead, the Tether supply has been growing exponentially for years, exploding during crypto market bull runs and continuing straight through years-long downturns. There are now over 78 billion tethers in circulation and rising, about 95 percent of which was issued since the latest cryptocurrency bull market started in early 2020.Cryptocurrency is not merely a bad investment or speculative bubble, but something more akin to a decentralized Ponzi scheme.
There is no conceivable universe in which cryptocurrency exchanges should need an exponentially expanding supply of stablecoins to facilitate daily trading. The explosion in stablecoins and the suspicious timing of market buys outlined in the 2017 paper suggest — as a 2019 class-action lawsuit alleges — that iFinex, the parent company of Tether and Bitfinex, is printing tethers from thin air and using them to buy up Bitcoin and other cryptocurrencies in order to create artificial scarcity and drive prices higher.
Tether has effectively become the central bank of crypto. Like central banks, they ensure liquidity in the market and even engage in quantitative easing — the practice of central banks buying up financial assets in order to stimulate the economy and stabilize financial markets. The difference is that central banks, at least in theory, operate in the public good and try to maintain healthy levels of inflation that encourage capital investment. By comparison, private companies issuing stablecoins are indiscriminately inflating cryptocurrency prices so that they can be dumped on unsuspecting investors.
This renders cryptocurrency not merely a bad investment or speculative bubble but something more akin to a decentralized Ponzi scheme. New investors are being lured in under the pretense that speculation is driving prices when market manipulation is doing the heavy lifting.
This can’t go on forever. Unbacked stablecoins can and are being used to inflate the “spot price” — the latest trading price — of cryptocurrencies to levels totally disconnected from reality. But the electricity costs of running and securing blockchains is very real. If cryptocurrency markets cannot keep luring in enough new money to cover the growing costs of mining, the scheme will become unworkable and financially insolvent.
No one knows exactly how this would shake out, but we know that investors will never be able to realize the gains they have made on paper. The cryptocurrency market’s oft-touted $2 trillion market cap, calculated by multiplying existing coins by the latest spot price, is a meaningless figure. Nowhere near that much has actually been invested into cryptocurrencies, and nowhere near that much will ever come out of them.
In fact, investors won’t — on average — be able to cash out for even as much as they put in. Much of that money went to cryptocurrency mining. Recent analysis shows that around $25 billion and growing has already gone to Bitcoin miners, who, by best estimates, are now spending $1 billion just on electricity every month, possibly more.
That money is gone forever, having been converted to carbon and released into the atmosphere — making cryptocurrencies even worse than traditional Ponzi schemes. Most of the money lost in Bernie Madoff’s infamous Ponzi was eventually clawed back and returned to investors. Much of the money put into cryptocurrency, even if courts could trace back tangled webs of semi-anonymous cryptocurrency transactions, can never be recuperated.
Regulatory Failure
Ponzi schemes of this scale typically target other financial firms, banks, elite institutions, and other wealthy investors. Cryptocurrency, by comparison, is the people’s Ponzi. Cryptocurrency exchanges with user-friendly interfaces, as well as financial services companies like Square and PayPal, allow retail investors with few assets and little financial literacy to buy cryptocurrency on their smartphones.
The minimum purchase on Coinbase is only $2. On Robinhood, it’s a buck. A recent Pew survey found that one in three adults under thirty have bought or used cryptocurrency. It is everyday working people who will suffer most when their savings inevitably evaporate overnight.
Regulators and policymakers have been slow to protect the public. Ponzi schemes can remain solvent for years while flying under the radar of law enforcement and regulators. Madoff ran his hedge fund as a Ponzi for at least seventeen years. While the Securities and Exchange Commission (SEC) failed to heed multiple warnings from an industry whistleblower for seven years, regulators acted quickly once Madoff was turned in by his own children. He was, after all, defrauding the wealthy, bankers, celebrities, and elites.Large Ponzi schemes typically target other financial firms, banks, elite institutions, and other wealthy investors. Cryptocurrency, by comparison, is the people’s Ponzi.
The cryptocurrency Ponzi scheme has its own whistleblowers, but they’re hardly necessary. Tether is built atop and hosted on other public blockchains, predominantly Ethereum and Tron at the moment. Every time Tether prints another round of stablecoins, now by the hundreds of millions or billions at a time (always in suspiciously round numbers), sometimes several times a week, literally anyone can see. There are Twitter bots analyzing cryptocurrency blockchains and posting large or suspicious transfers of new stablecoins that make this as easy as clicking follow. Tether is cooking the books right out in the open. Skeptics have been pointing this out for years, but regulators and policymakers did virtually nothing until cryptocurrency went mainstream and wildly overvalued cryptocurrency companies began posing a risk to traditional financial markets.
Their response is a case of too little too late. The SEC and US Commodity Futures Trading Commission subpoenaed Tether and Bitfinex in 2017. In 2018, the Justice Department launched a broad probe into cryptocurrency price manipulation and quickly homed in on Tether. Tether was ultimately fined $41 million for lying about their reserves, among other wrongdoings, and also settled a suit with the New York attorney general for $18.5 million for the same reason. But these actions are a slap on the wrist given the level of fraud and have not slowed down Tether’s money printer in the least.
Meanwhile, regulators haven’t even tried to stop cryptocurrency from infecting broader financial markets. The SEC let Coinbase go public in April, and several other US-based cryptocurrency exchanges, including Kraken and Gemini, are planning to do the same. The first cryptocurrency futures ETFs have debuted in recent months, giving traditional investors indirect exposure to cryptocurrency by investing in a range of cryptocurrency companies. Fidelity Investments also launched a spot cryptocurrency ETF in Canada that would actually hold cryptocurrencies, which would allow investors to make direct investments in cryptocurrency on the same platform where they manage retirement savings; Fidelity is seeking the green light from US regulators to allow Americans the same direct access.
While a few listed companies, most notably Tesla and MicroStrategy, have taken multibillion-dollar gambles on cryptocurrency with company money, most of these companies are simply offering custodial or transactional services rather than investing into cryptocurrencies themselves. They are operating parasitically, profiting off investments into the crypto Ponzi while rushing toward IPOs before the whole thing collapses.
These companies hold precious little cryptocurrency themselves and thus little risk. Even MicroStrategy, though initially spending $250 million in company money on Bitcoin in August 2020 while the CEO shilled crypto on Twitter, proceeded to raise billions more in repeated rounds of fundraising.
Policymakers have done little to curb any of this. Even those paying attention to problems with unregulated stablecoins seem hell-bent on trying to preserve the wider cryptocurrency industry. A recent report from the Biden administration assesses the risk of stablecoins without investigating their primary role in market manipulation. SEC chair Gary Gensler wants to regulate stablecoins as either securities or money market mutual funds accounts. The STABLE Act, a bill languishing in Congress since last year, would require stablecoins be fully backed and regulate issuers and anyone offering related services.
These efforts are as insufficient as they are misguided. Governments won’t be able to keep unregulated stablecoins from being traded on exchanges operating outside their jurisdiction. Tether is not the only stablecoin game in town. Tether has printed more than $8 billion in stablecoins since November. Meanwhile, South Korean crypto firm Terraform Labs, which few people have even heard of, minted another $8 billion of their own stablecoin (TerraUSD). There are others behaving similarly. Shut these operations down and there’s nothing to stop them or a copycat from setting up shop elsewhere.
The problem extends beyond unregulated exchanges and issuers. Coinbase also has its own stablecoin pegged to the dollar, USDC, managed by partner company Circle, which is also looking to go public with an SPAC deal that would exempt it from the scrutiny of a traditional IPO. There are now 45 billion USDC stablecoins in circulation, most of them issued since 2020, just like with Tether. Coinbase and Circle also lied about their stablecoin being fully backed by cash when in fact reserves are mostly composed of yet more mysterious commercial paper, which is less liquid and far riskier. As Amy Castor, who has long reported on cryptocurrencies, put it, “Despite efforts to distance itself from Tether, Circle is starting to look more and more like a similar scheme, only with a different critter on the wildcat banknotes.”
Ban Them All
Going after fly-by-night stablecoin issuers will devolve into a hopeless game of whack-a-mole. The only real solution is to ban the trade of private cryptocurrencies entirely. We cannot stop foreign actors from issuing unbacked stablecoins and manipulating crypto prices on unregulated exchanges. But we can make it illegal to sell cryptocurrencies on banked exchanges, such as Coinbase, operating entirely legally while they cash people out of the Ponzi scheme.
This would, of course, kill off cryptocurrency almost entirely, relegating it back to an oddity of the tech enthusiast. No one should shed a tear. Cryptocurrencies have virtually no legal use case. They’re great for facilitating ransomware, laundering money, distributing narcotics and child porn, running Ponzi schemes, and… not much else. They fail as currencies due to high transaction costs. They fail as “digital gold” or a “store of value” because they consume ludicrous amounts of energy to run what is essentially a glorified spreadsheet.
China already banned cryptocurrencies entirely, and India and Pakistan are poised to do the same. Other countries have also made moves to prohibit or constrain cryptocurrencies, but Western liberal democracies are notably permissive. This is in no small part due to aggressive industry lobbying, which includes hiring former financial regulators and compliance officers into the industry to influence policymakers.The only real solution is to ban the trade of private cryptocurrencies entirely.
Among their ranks is Brian Brooks, who was the chief legal officer at Coinbase before serving as acting Comptroller of the Currency in the Trump administration. Now CEO of blockchain mining company Bitfury, which is also purportedly looking to go public, Brooks joined other crypto CEOs to testify before the House in December. Predictably, they oppose meaningful stablecoin regulation, as they understand that it would kill the industry and render their companies worthless.
These people and everyone else in the cryptocurrency industry are complicit in the Ponzi scheme and actively misleading the public. They understand that fraud is the engine driving their industry and fueling their profits — and that is perhaps the most damning indictment of private cryptocurrencies and the industry surrounding them.
The 2008 financial crisis made clear why the financial sector must be brought under public control. Cryptocurrency and “decentralized finance” aren’t special — they’re just more of the same privatization and deregulation masquerading as high-tech “solutions” we’ve seen in other industries. Unregulated, privatized financial markets pose the same risks to the public whether or not they are “on the blockchain.”
In the case of cryptocurrency, regulation is an existential risk precisely because regulatory loopholes and fraud are the only reason the industry appears profitable despite being wholly unproductive and a waste of energy resources. The same applies to private cryptocurrencies as a whole. The longer governments take to ban them, the worse normal people will be hurt.
Sohale Andrus Mortazavi is a writer based in Chicago.
 |
 |
January 24, 2022 |
|
Why the appeal of cryptocurrencies and NFTs crosses borders of class and race |
By Tressie McMillan Cottom |
My family managed to get together for a small Thanksgiving dinner this year. It was our first gathering since April 2020. After a big meal, my cousin only wanted to talk about one thing: cryptocurrency. He is a middle-aged Black man from New York, just a few years older than I am, but those years make a huge difference in his job security. When he came of age, he got a blue-collar job working for the city. He has worked at that job since he was 17 years old, so he will be able to retire as a relatively young man. And since the job is unionized, my cousin will retire with a pension and health benefits — the kind of pathway to economic security that is becoming increasingly rare. |
These days, ours is an information economy that likes credentials, which involves going to some kind of postsecondary school. Even with high wages for skilled trades, like the one my cousin used to get that union job straight after high school, blue-collar trades are a hard sell to young workers. My cousin is not exactly a dinosaur, but he is not the kind of guy you imagine day-trading or actively managing an investment portfolio. |
Yet he is absolutely enthused about Bitcoin. While he is figuring out his second act, he views crypto as the way to build “generational wealth” and “freedom.” I put those words in quotes because you hear them a lot in conversations around financial-sector schemes, and I am not sure they mean anything in those contexts. This week, the New York mayor, Eric Adams, is living up to his campaign promise to get his first three paychecks converted to cryptocurrency. My blue-collar cousin has a lot in common with his mayor. The allure of the next American frontier crosses all kinds of lines, including class lines. I’ll get to that in a second. |
Bitcoin is the most well-known cryptocurrency, but there are many others, like Ethereum, Dogecoin, and Tether, which come up a lot among my peers. Some people talk about crypto as being revolutionary because it promises to democratize access to financial markets and give individual investors control of their destiny. In an adjacent space, nonfungible tokens — or NFTs — promise something similar. NFTs are like coupons that represent an underlying object, like a piece of artwork, although they could represent almost anything. |
For my part, the discussion over Thanksgiving leftovers brought home a data point about women’s and people of color’s interest in cryptocurrency. A 2021 survey found that the people who trade crypto are a far cry from the young, white, male image of a techbro: |
The average cryptocurrency trader is under 40 (mean age is 38) and does not have a college degree (55 percent). Two-fifths of crypto traders are not white (44 percent), and 41 percent are women. |
That survey captured a lot of people, like my cousin. |
What fascinates me is how widely crypto and NFT talk has diffused, and so quickly. It is not often that I hear the same branding from lower-income people of color that I also hear from high-earning white peers with advanced degrees. Depending on your consumer profile — biographical data like your age, race and gender, plus your purchasing habits — you probably hear about these financial instruments from online ads, social media groups, and peers who are early adopters. |
I hear about crypto from my educated, high-income academic and writing friends who also shop at Target a lot. I also hear about crypto from financial advisers and college classmates who share stories about making a lot of money mining crypto and trading NFTs. But because of my racial and geographic identities, I also hear about crypto from my working-class friends and family. They are getting messages about crypto from Facebook and Instagram and their friends who have moved on from candle-leggings-timeshare- |
All of the branded cryptos and NFTs were born out of the invention of the blockchain. I don’t think of blockchain as a technological innovation so much as it is a cultural iteration. Blockchain is about solidarity among strangers. That’s the kind of thing we have been striving for since the first mechanical age. On a purely technical level, blockchain is a ledger. That ledger is decentralized (although we will complicate that a bit in future discussions) and that decentralization makes it hard to manipulate. Now, the point of decentralization is that ideally no one who records information in the ledger has to trust anyone else when they exchange information based on that ledger. If I buy something, I can list my ownership in the ledger that assigns my ownership rights a unique identifier. If someone challenges my ownership, the ledger’s record is the god tier of ownership. I have something that no one can take away from me! You start to see why this idea would appeal to a lot of people, but especially to groups of people whose right to ownership has been encoded in legal precedent and cultural norms for generations. If I live in a community where the police absolutely use eminent domain to claim my private property and I cannot do anything about it, that sense of everyday powerlessness would make the promise of blockchain sound pretty good. To me, though, it presents more questions than answers. |
Those questions are about the culture of blockchain, not about its technical innovation. Blockchain promises to decouple trust in our financial transactions from institutions. I do not have to trust that someone owns something, or trust that an institution will defend my ownership of something. Blockchain says trust moves from institutions — like banks and regulators — to the apolitical ledger. In theory, no one owns the ledger. That means no one can undermine your bargaining power in an exchange. But is that actually how the ledger works? Is an apolitical platform possible in a world where everything we do has a political cause and effect? I’m skeptical on that front. And healthy skepticism is a good place to start when deciding whether something is a scam or merely risky. |
Last week I did something I wish I had done before that Thanksgiving dinner conversation. I talked with some people about cryptocurrencies and NFTs. First was a far-ranging conversation with Anil Dash, a writer and entrepreneur best known, perhaps, as the C.E.O. of Glitch, a software development company. He has taken a lot of heat for having a nuanced assessment of blockchain, crypto and NFTs. We used to write together on a culture and technology vertical on Medium, where Anil has blogged about tech for years now. Anil is thoughtful and erudite on the cultural history of internet technologies. He is also pragmatic and has a keen interest in inequality. That mix of expertise and sensibility made him the first person I wanted to talk to about the intersection of citizen consumers and the alternative financial technologies infiltrating our everyday lives. The conversation was so rich that I will write about it in a two-part discussion starting next week. |
My friend Darrick Hamilton, an economist, has warned that we shouldn’t be too aggressive on replacing the danger of unjust financial systems with wildly risky alternative currencies. That sounds about right to me. It reminds me of another legitimate scheme in higher education, which I researched and wrote about for years: Telling people that their very expensive, low-quality degrees from these schools may not be a good solution for them rarely worked. That is the power of culture. And that’s the reasoning behind my first question to Anil: What social problem is blockchain trying to solve? I’ll ask this time and time again as we talk about the idea of institutional failures and the unsatisfying stop-gaps we create to navigate them. |
No comments:
Post a Comment