Bitcoin’s identity crisis

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The writer is a software engineer and author of ‘Popping the Crypto Bubble’

Remember when cryptocurrency was supposed to disrupt and replace finance? Well, history had other plans. As bitcoin surges past $85,000, doubling in price over the past year, we find ourselves in what might be called an “institutional legitimacy paradox”.

Consider the historical irony: bitcoin, conceived as a peer-to-peer electronic cash system that would eliminate the need for financial intermediaries, is now primarily traded through funds managed by the very intermediaries it was meant to circumvent.

Two years ago, the collapse in crypto prices seemed to confirm what sceptics like myself had long maintained: crypto assets were a speculative bubble inflated by easy money and pandemic-era exuberance. The implosion of Sam Bankman-Fried’s crypto exchange FTX, coupled with rising interest rates, appeared to sound the death knell for crypto’s mainstream aspirations.

Yet here we are in 2024, witnessing what can only be described as a zombie-like reanimation.

This recovery is different from the last bitcoin high. It is fuelled by both individual investors and institutional money, with UK pension funds and City asset managers increasingly experimenting with exposure. BlackRock’s spot bitcoin exchange traded fund is accumulating billions of dollars in assets. The shift towards “respectability” should concern us all.

The financial industry’s embrace of crypto is less a validation of its alleged revolutionary potential and more an attempt to extract fees from what is, essentially, gambling. It has effectively neutered crypto’s radical promise of disintermediation.

Regulators have not put in the necessary controls needed to address underlying disclosure, manipulation and systemic risks. Now we are in a precarious situation where oversight is fragmented, inconsistent and incoherent — with different agencies working at cross purposes and no clear principles guiding policy.

This is the era of institutional crypto capture. Bitcoin’s grand vision of a trustless financial system has been reduced to just another entry in the ledgers of the Depository Trust & Clearing Corporation — the massive clearing house that processes nearly all stock trades in the US. In other words, the revolutionary technology meant to bypass the establishment has become another product it controls.

The implications for pension funds and their beneficiaries — ie those of us hoping to retire one day — are worrying. While crypto allocations remain relatively small, a precedent is being set. Fiduciaries are increasingly pressured to consider crypto exposure part of a “modern” portfolio.

This is despite the fact that its fundamental characteristics remain unchanged. It still produces no cash flows, has no intrinsic value and its price movements are overwhelmingly driven by retail sentiment.

An even more frightening scenario looms on the horizon. Consider the next US administration, swept into power on a wave of deregulation promises. In this regulatory vacuum, we could witness things that make FTX’s misdeeds seem like mere child’s play.

Institutional players, freed from meaningful oversight, could create byzantine investment vehicles, packaging and repackaging digital assets into synthetic products that bundle both financial and software risks in new and unseen ways.

The next crypto winter — and rest assured there will be one — could affect retirement savings and institutional portfolios in ways we’ve not seen before.

Far from validating crypto’s fundamental value, the current bull run exposes a more precarious reality: the financial industry’s embrace of crypto represents nothing more than a perpetual talent for transforming speculative trends into fee-generating products.