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Crypto: too big to ignore but not too big to fail

The blockchain prize may prove gargantuan but expect scary price swings in 2022
Crypto: too big to ignore but not too big to fail

Perhaps Raiders of the Lost Ark will be on the holiday television schedules; the film makes a good analogy for hunting long-term crypto profits. Bold investors must crawl through a series of financial death-traps while beset by scoundrels to claim a mythical prize and even then, it may be snatched from their grasp at the last.

To say cryptocurrency has no place in a sensible investor’s portfolio is a fair, if old fashioned, stance. After all, the asset prices are still based on sentiment rather than earnings and many could turn out to have zero intrinsic value.

But is it still worth owning some and having a toehold in the blockchain revolution? Arguably, we’re talking about the most spectacular potential network effects the world has ever seen. Like buying Amazon (AMZN) or Google, before it was Alphabet (GOOGL), at the very outset but with the potential for even higher growth rates.

Those who say 'you should buy the picks and shovels' are missing the point – blockchain protocols are the picks and shovels of the entire next internet. For those keen to explore the possibilities of Web3, owning and staking coins that are integral to how the networks operate is the most accessible way to get in at the ground floor. (Web3 is a set of protocols led by blockchain that intends to reinvent how the back end of the internet is wired.)

Blockchains such as Ethereum (network token ether, ETH), Solana (SOL), Cardano (ADA), Polkadot (DOT) and Internet Computer (ICP) are talking up exciting developments. Will the OpenChat network launched on ICP flourish in 2022 and present a threat to Meta Platform’s (FB) Facebook and Instagram? Could the privacy-focused Brave web browser (co-founded by javascript creator Brendan Eich) truly take off and take a bite out of Google’s dominance in search?

It’s not certain when or whether any of these or new, as yet unheard of, blockchain players will prevail if the promised riches materialise. Hence there must be a realisation that purchasing coins and holding on for dear life ('HODL') is like a lottery ticket and psychologically should be treated as expenditure. In other words, only buy crypto with spare cash out of income after everything else in life has been taken care of.

While waiting for blockchain to supersede internet incumbents, evangelists for the technology must have the courage of their convictions and hold their digital assets in cold storage, away from the crypto exchanges. In practice that means there is a set-up cost of buying a clean laptop (preferably one that isn’t used for work or streaming from the sorts of websites known to attract viruses) and, as an added layer of security, a hardware wallet. This device can manage crypto wallets and be used to store unique keys for those coins that it doesn’t directly support.

 

Monetary tightening in 2022 could expose crypto exchanges

Ironically, given the decentralisation credo, crypto exchanges are remarkably vulnerable to the wider financial system. They rely on punters for liquidity so suffer badly if confidence takes a nosedive. Many cynics have noted how often exchanges seem to suffer 'maintenance issues' when markets are choppy.

Given the role of sentiment, there is a risk that retail investors will get spooked when institutions holding bitcoin, the world’s largest cryptocurrency, sell to crystallise profits and help cover positions in traditional assets. The dynamic was explained in a Financial Times article on 7 December following a 20 per cent weekend flash fall in the price of bitcoin. It’s a scenario that has scope to replay in 2022 as central bank tightening increases the likelihood traders will need to sell assets, for example to fund margin calls on other positions.

Supply of fiat currencies, especially the US dollar, can affect crypto in other ways. One of the most controversial features of crypto trading is the role of stablecoins. These nominally track the value of fiat currencies 1:1 and they exist to facilitate trading when many other digital assets have volatile prices.

Back in the autumn, Bloomberg Businessweek broke the scandal that the largest stablecoin, US Dollar tether (USDT) had been using Chinese commercial paper as part of the collateral underpinning its value. There must be a worry that in a tighter policy regime, as dollar scarcity becomes an issue in asset markets, more paper of questionable quality will find its way into stablecoin collateral baskets.

The opacity of stablecoin backing is a factor that could accelerate the development of central bank digital currencies. A truly digital dollar may go against purist principles of decentralisation, but it would make the crypto ecosystem more resilient.

Greater regulation of crypto markets wouldn’t be a bad thing, either, with even Emilie Choi of the Coinbase exchange calling for “rules of the road”. Before any consensus is reached, there will undoubtedly be more negative headlines for would be speculators to digest in 2022. The key things are to be organised, patient and above all not overexposed.