Cryptocurrencies based on blockchain technology may be a novel concept.
But the idea of private currencies not minted by the government is not.
History offers many examples of currencies that emerged as alternatives to government-issued notes.
You’ll never hear about those from Wall Street’s growing army of cryptocurrency analysts.
As the late economist John Kenneth Galbraith observed, “The financial memory is very short.”
But if you want to understand the possible fate of Bitcoin and other cryptocurrencies, study the fate of private currencies of the past.
A Cautionary Tale
Following the end of the English Civil War in 1651, the “Royal Prerogative” of the English monarchy to mint base-metal coins was suspended.
Imagine the U.S. government stripped of its monopoly on printing U.S. dollars.
England quickly began to suffer from a shortage of state-issued coinage.
As always, market forces stepped in.
Shopkeepers and innkeepers commissioned “moneyers” to produce coins specific to their businesses. The merchants then used these new coins to issue their customers’ change.
By 1672, there were about 4,000 types of coins in circulation in London.
These trust-based solutions worked well enough.
People trusted that the merchant who issued the coins would redeem the currency for goods. The fact that a government did not issue the coins mattered little in practice.
The newly restored monarch Charles II soon saw these private currencies as a challenge to the crown’s authority.
So he promptly banned all private currencies to be replaced by coins minted by the Royal Mint.
What does this little-known story have to do with the fate of today’s cryptocurrencies?
A lot more than you think.
If a cryptocurrency is widely accepted as a store of value and can be produced and traded by anyone…
The difference between it and the private currencies of King Charles II starts to narrow.
And so far, cryptocurrencies – at least in Western developed economies – are still enjoying a regulatory honeymoon.
But that policy of salutary neglect is fraying at the edges.
China banned banks from making transactions in Bitcoin in 2018, closing down many crypto exchanges in the process. Turkey banned crypto payments this past weekend, citing the dangers of anonymity and lack of regulation. India is contemplating doing the same.
Could a crackdown by Western governments be far behind?
Crypto’s “Netscape” Moment
Meanwhile, crypto bulls are keeping their heads firmly in the sand.
Last week was dubbed a historic milestone for crypto.
Coinbase, one of the best-known and biggest cryptocurrency exchanges, listed its shares on the Nasdaq.
Cryptocurrency bulls hailed the listing as crypto’s equivalent of Netscape’s IPO in August 1995.
The Netscape IPO marked the moment the internet and the World Wide Web entered into popular consciousness.
At the time of its IPO, investors had no idea how to value Netscape. Coinbase investors are similarly puzzled.
Here’s what we do know.
Coinbase’s market cap peaked at $112 billion on its first day of trading. That made it briefly worth more than every other major asset exchange.
It surpassed CBOE Global Markets ($11 billion), Nasdaq ($26 billion), New York Stock Exchange parent company Intercontinental Exchange ($67 billion) and CME Group ($74 billion).
Even bulls have a tough time swallowing these valuations. Coinbase has already pulled back 50% from its first-day highs.
Like most exchanges, Coinbase makes its money on transaction fees. But price wars between stock trading platforms have already driven trading fees for stocks down to zero in some cases.
If Coinbase earned the stock industry’s standard fees, its $1.5 billion in revenue in the most recent quarter would have tumbled to $30 million.
That’s a 98% drop.
Cryptos on the Defensive
Yet the greatest threat to Coinbase and crypto is neither shrinking margins nor alternatives like exchange-traded funds that trade on mainstream platforms.
Instead, the greatest danger is Western governments pulling a Charles II on cryptocurrencies.
It’s no secret that governments don’t like crypto.
And it’s not just authoritarian regimes like China and Turkey.
Just last week, Fed Chairman Jay Powell called cryptocurrencies “vehicles for speculation.” That is a far more diplomatic expression for what Warren Buffett’s business partner Charlie Munger called “rat poison” and “trading turds.”
Cryptocurrencies have also drawn the ire of prosecutors and regulators.
Officially, they are concerned about money laundering and the environmental damage caused by Bitcoin mining.
Unofficially, governments don’t like assets they cannot regulate. Just like King Charles II and the Chinese government didn’t.
The threat of a regulatory clampdown is the biggest danger to cryptocurrencies.
And with the Bank of England – the U.K. version of the Fed – announcing yesterday that it is exploring creating its own digital currency, the clampdown on unregulated rivals is not a matter of “if” but “when.”
And when it does happen, look out below.
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