Since the beginning of this year, Wall Street banks have been competing to launch cryptocurrency investment and trading services, and some institutions have made high-profile announcements about their holdings of cryptocurrencies, mainly Bitcoin, such as Tesla and Bridgewater funds. The successful listing of the Coinbase exchange on Nasdaq has pushed this investment boom to a peak, with the price of various cryptocurrencies rising steadily.

In May, the cryptocurrencies that had been soaring all the way to the top suddenly saw a crashing market. on May 11, Tesla boss Elon Musk announced his plan to suspend accepting payments for bitcoin car purchases, and the price of bitcoin and other cryptocurrencies plunged in response, sinking 30% in a week; as the cryptocurrency circle (coin mining and speculation) was unusually active in China, the Chinese government began cracking down on crypto on May 18 from the perspective of protecting investors’ interests As the cryptocurrency community (coin mining and speculation) is exceptionally active in China, the Chinese government began to crack down on cryptocurrency trading on May 18 in order to protect investors’ interests.

May was an extremely unsettling month in the cryptocurrency world, with those wealth managers eager to launch their cryptocurrency businesses caught in a dilemma. This brings us back to a few classic questions about cryptocurrencies: are they real money or not? What are the fundamental properties of cryptocurrencies? Are cryptocurrencies, as virtual assets, risk assets or risk aversion assets? Where will cryptocurrencies, represented by Bitcoin, go from here? All these questions deserve our deep thoughts.

  I. Cryptocurrency as money: Utopian imagination

  According to the cryptocurrency community, the original intention of Bitcoin’s creation was to provide a cryptographic digital currency that does not require central bank endorsement or bank intermediation, and to completely solve the trust problem of money through blockchain technology. This grand design has aroused widespread and intense curiosity. So, what is cryptocurrency? Why do we need cryptocurrencies?

  Money exists because it serves a fundamental economic purpose: to facilitate the exchange of goods and services. Without money, people would have to engage in barter, exchanging goods and services for other goods and services. In a barter economy, each exchange requires an exact match of needs between the two parties; a butcher who needs rice and a farmer who needs pork must be in exact agreement in time, space, quantity, and consideration to trade, which greatly constrains economic development. To solve this dilemma, money emerged. If all members of society agree to accept some commonly accepted representation of value (money) as a medium of exchange, payments can be made quickly, people’s needs can be met effectively, and economic efficiency is enhanced. Therefore, the primary function of money is to serve as a medium of exchange. What can be used as a medium of exchange? This leads to two other subtleties of money: first, money is used as a unit of account to express prices, which requires money to have relatively stable price characteristics; second, in order to express prices, money needs to reflect the store of value function, that is, money needs to carry the trust of people on value, gold In Gold We Trust, and In God We Trust, which is written on the top of the U.S. currency, also means this.

  Bitcoin is named “coin”, but does it really have the characteristics of a currency? The answer is clear: no. On the surface, Bitcoin seems to fit the bill as a medium of exchange, otherwise Musk would not have announced in March that he was considering accepting Bitcoin payments. However, the reality of bitcoin as a medium of exchange presents many insurmountable challenges, most notably a lack of liquidity. We know that cash is fully liquid and readily available for payment; treasury bonds are the next most liquid; and stocks again.

As a virtual digital currency, Bitcoin is limited by system storage space and security confirmation requirements, limiting the size of the blocks used to store transaction records and the speed of generation, thus fundamentally limiting the speed at which Bitcoin can process transactions.

The customer experience with Bitcoin as a medium of exchange is extremely poor, the wait time for transaction confirmation is too long, and the volume and depth of the overall cryptocurrency market remains very limited.

  Similarly, Bitcoin does not meet the requirements as a unit of account and store of value. It has too much price volatility to be a useful unit of account; nor is it a credible store of value, having neither any real value nor the credit backing of governments and central banks.

However, the view in the cryptocurrency world is that governments and central banks are not inherently trustworthy, with governments turning on the printing presses to deflate money in a big way and inflation constantly eroding the purchasing power of legal tender. The debate continues, and from an official perspective, the odds of challenging the dictatorial power of a sovereign state to issue currency should not be good. So far, no country has recognized Bitcoin or any other cryptocurrency as a true currency.

  Nevertheless, as a medium of exchange, Bitcoin and other cryptocurrencies demonstrate unique possibilities in the cross-border payments space. Due to its decentralized, anonymous, borderless and portable nature, coupled with the capital controls and anti-money laundering compliance review requirements faced by cross-border payments, Bitcoin is widely used for extortion, drug trafficking, gambling, pornography, money laundering, tax evasion and other illegal cross-border transactions. Although, the extent and scale of cryptocurrencies used for illegal transactions is not easy to count due to the anonymous encryption. However, it is foreseeable that cryptocurrency cross-border payments will face an increasingly stringent regulatory and enforcement environment.

  II. Cryptocurrencies as an asset class: high risk

  Unlike as a currency, cryptocurrencies as a tradable asset class are still increasingly widely recognized by financial markets. The CFTC treats bitcoin as a “commodity” and China defines bitcoin as a “virtual commodity”, as opposed to a physical commodity. As with all financial assets, cryptocurrencies ultimately trade at prices determined by supply and demand.

  According to our friends in the cryptocurrency community, there is a clear upper limit to the supply of bitcoin. This is different from all fiat currencies and is therefore inflation-proof. The supply of bitcoins is generated by what is often referred to as the “mining” process, which provides the incentive to maintain the entire bitcoin system, and the “miners” are at the heart of the entire bitcoin system, issuing, maintaining, verifying, and record transactions throughout the network. Mining is the process of solving mathematical puzzles by computer operations, with successful solutions resulting in the mining of a certain number of bitcoins. The reward for mining started at 50 bitcoins per block and has been halved every four years to the current level of 6.25 bitcoins per block. The mechanism of halving the mining reward (bitcoin halving) has resulted in a fixed pace of bitcoin supply and a gradual decay in increments. The final number of bitcoins is limited to 21 million, which is expected to be mined out by 2040, with about 18.7 million bitcoins already mined so far. In fact, given the number of “lost” bitcoins, the number of bitcoins in circulation is significantly smaller than the theoretical value, which means that bitcoin is even a deflationary system in terms of supply.

  This reminds us of gold. A few years ago, archaeologists found a large amount of gold, over 120 kg, in the tomb of Liu He, the Marquis of Haihang. More than 2,000 years ago, the Marquis of Haihang took this gold underground, which at the time may have caused severe deflation in the Western Han economy. Today, many investors in the cryptocurrency world see bitcoin as a potential “digital gold” alternative to gold. Between March of last year and April of this year, the price of bitcoin skyrocketed 12 times. This year, bitcoin is considered by many investors to be an effective hedge against inflation in the context of vaccine recovery and inflationary expectations. Millennial cryptocurrency investors, in particular, seem to prefer bitcoin to gold.

  Bitcoin has attracted the attention and favor of an increasing number of institutional investors over the past year, a significant departure from the retail-led bitcoin bull market of 2017. Some of the big Wall Street banks (Goldman Sachs, JPMorgan) believe that bitcoin can serve as a store of value/wealth and inflation hedge in portfolios, and expect “digital gold” to eventually replace traditional gold. Gold currently stores about $2.7 trillion in private wealth, more than three times the total market value of bitcoin. Some foreign research reports suggest that if Bitcoin’s market capitalization reaches the level of gold, its price will exceed $140,000 per coin.

  The term “digital gold” seems to me to be more of a marketing term and deserves some consideration. While gold has practical uses as a precious metal, such as making jewelry and chips, bitcoin has no intrinsic value. Even as an investment asset, gold has proven to be a safe-haven asset in times of high uncertainty due to its high market value, good liquidity, low volatility, and lack of correlation with stock movements. Cryptocurrencies, on the other hand, have behaved more like a risk asset, and the market volatility in May is ample evidence that Bitcoin is really no risk-averse. On a longer time series, bitcoin price action is highly similar to that of stocks (especially small-cap stocks), which are also risk assets.

Even as a hedge against inflation, bitcoin’s role may be overstated, or at least not empirically tested. Cryptocurrency enthusiasts often emphasize that the supply of bitcoins will not exceed 21 million at most, thereby proving that bitcoins will not keep depreciating in value as inflation goes up, like fiat currencies do. This argument is still flawed. This is because cryptocurrencies like Bitcoin are springing up all over the place. A small team of ten programmers can develop some sort of cryptocurrency with no more than a master’s level of expertise. In fact, we are seeing all types of “coins” popping up, and the technical design is even more novel. Therefore, there is no upper limit to the number of cryptocurrencies, just as there is no upper limit to the number of fiat currencies. An accurate count of how many cryptocurrencies there are is difficult, with a less outrageous estimate of over 6,000, of which at least 1,600 are dead. With the emergence of various cryptocurrencies, Bitcoin’s market share has dropped from 90% before 2017 to near 50% today.

My conclusion is that Bitcoin, as a tradable virtual asset, has high-risk characteristics. It is similar to gold in that it is a hedge against inflation, although this conclusion remains dubious; the difference is that it is not a safe-haven asset, but a high-risk asset. So the argument for replacing gold is not necessarily valid, at least in times of high uncertainty. The divergence between bitcoin and gold since late May shows just that.

III. Bitcoin and China: Bigger than Half the Sky

  Bitcoin is on fire thanks to the enthusiasm of the Chinese people. He wasn’t kidding. In fact, Chinese miners and investors have, for more than a decade of Bitcoin’s development, and especially in its early stages, supported a large part of the Bitcoin world. According to estimates from the University of Cambridge Centre for Alternative Finance, China controls 65% of the world’s bitcoin mining capacity (in terms of computing power) (two out of every three bitcoins are mined in China), having reached 75% five years ago (three out of every four bitcoins are mined in China). three out of every four bitcoins are mined in China).

  From 2013 to 2017, RMB-denominated bitcoin transactions accounted for over 80% of the volume, and at one point accounted for 95% of transactions, so it’s not too much to say that it’s all Chinese speculation in bitcoin.

  At the time, the bitcoin network had more than half of the global share of nodes located in mainland China. after the government’s move to crack down on bitcoin trading in 2017, the number of nodes is now down to 3%, but bitcoin mining is still active. Most investors either open accounts to trade offshore or trade peer-to-peer over-the-counter within the country. Currently, four of the five largest cryptocurrency exchanges in the world have Chinese investors as their primary users.

  As a result of this development, bitcoin has had a degree of “negative externality” on China’s social welfare. First, Bitcoin as a financial innovation has not improved financial efficiency, and decentralized payment systems are nowhere to be found in China’s mobile payment sector. It is estimated that carbon emissions due to bitcoin mining in China can rank ninth among all cities in the country. Without regulation, carbon emissions from bitcoin mining will peak at 130 million tons by 2024, surpassing the carbon emissions of the Czech Republic (which ranks 39th globally). This runs counter to China’s policy goals. Bitcoin’s negative externalities may also be the reason why Elon Musk has gone back on his word, after all, Tesla electric cars are an innovative company that boasts of being environmentally friendly.

  At the same time, the expansion of bitcoin trading poses a certain threat to China’s financial stability and investor protection. As the price of bitcoin continues to reach new highs, the level of leverage in the bitcoin market continues to climb. At the same time, more and more individuals and investors are getting involved in unregulated bitcoin trading, expanding the correlation between bitcoin prices and other financial markets and further escalating the strength and scope of the impact on financial stability. While few investors are said to have lost their positions in May, the opaque and irrevocable nature of bitcoin trading has made it more difficult for investors to claim their legitimate rights.

IV. The Future of Cryptocurrency: Facing a Realistic World

  Since the introduction of Bitcoin, the understanding of cryptocurrency has been evolving. Although we are still full of doubts, the future is showing an increasingly clear picture. In my opinion, at least three points are now conclusive.

  First, there is zero chance that Bitcoin and other cryptocurrencies will replace sovereign fiat currencies, while the process of launching digital currencies by central banks accelerates. The decentralized payment mechanism built by Bitcoin is not necessarily more efficient than existing mobile payments, even in technical terms. However, the anonymous and trusted mechanism of Bitcoin payments is likely to become an alternative tool for cross-border payments that is evolving towards dark web transactions and underground economic activities. Against this backdrop, governments are bound to start cracking down on the illegal transactions that Bitcoin may be involved in.

  Second, cryptocurrencies, as a new type of risk asset, will gain more institutional investors and take a place in the market portfolio. The trend is to clarify the characteristics of cryptocurrencies as risky assets, and thus to properly regulate the related investments and transactions. In fact, increased regulation would be beneficial to the health of the market for trading bitcoin and other cryptocurrency assets. Regulation is not the biggest risk facing Bitcoin, but rather the opportunity for Bitcoin to survive in the long run. Bitcoin itself is not a demon. The price of Bitcoin had fallen 90% during the two big bubble bursts in history, but it survived and lived a wonderful, heart-wrenching life.

  Third, the blockchain technology on which cryptocurrencies are based holds a great deal of promise. However, the key to understanding this is to remove the mystery, sanctity and charm of blockchain, and give up the illusion of anarchy and centerlessness. If the object of decentralization is the government and financial intermediaries, it can only be a utopian imagination. Moreover, in terms of economic logic, financial intermediaries appear precisely to solve the trust problem and reduce transaction costs. Although blockchain technology has proved that decentralization can solve the trust problem, it cannot reduce transaction costs.

  Looking to the future of cryptocurrencies is like a youthful paradise lost. Come on, welcome to the real world.