“The collapse of FTX proves once again that cryptocurrencies are not a good investment”

The collapse of FTX, one of the biggest crypto exchanges, has rocked the digital currency world. The former $32 billion trading platform has filed for bankruptcy protection in the US and founder Sam Bankman-Fried has resigned as CEO after learning the company had loaned billions of client funds to its own trading company, Alameda Research. As a result, late November saw a flood of redemption requests across all platforms as investors braced for a possible spread of the crisis.

Since peaking in 2021, cryptocurrencies have lost over $2 trillion in value and are currently experiencing a dramatic crash. As a result, they are attracting the attention and scrutiny of regulators around the world. Michael Barr, Fed Vice Chairman for Banking Supervision, also said events in crypto markets “have highlighted the risks to investors and consumers that come with new and emerging asset classes. and activities if they are not accompanied by a clear framework”.

This development contrasts sharply with the situation a few months earlier, when crypto enthusiasts were advocating, and in some cases implementing, the inclusion of cryptocurrencies in institutional wallets and 401(k) accounts.

Anyone who is still considering entering the world of cryptocurrencies at a potentially attractive and lower price should consider one thing: the most serious risks of investing in cryptocurrencies are probably yet to come. Investors considering a long-term allocation to cryptocurrencies should be cautious for three main reasons:

First, the lack of clear and consistent regulation of cryptocurrencies – both within and between countries – creates enormous uncertainty for long-term investors. For example, in the United States, it is still unclear when a cryptocurrency falls under the regulatory framework of a security, subject to SEC regulations, and when it will be classified as an asset or a commodity, like Bitcoin and Ethereum. demanded it. In addition, cryptocurrencies are even completely prohibited in some countries. A stark example is China’s abrupt ban on all cryptocurrency trading and mining in 2021, but it’s far from the only one. Add to that the significant and repeated outages of the infrastructure that enable cryptocurrency mining and trading and this is another area where significant regulatory uncertainties remain. The fallout from the FTX collapse makes one thing clear: self-regulation and transparency are an illusion.

Second, despite all the hype around digital gold, cryptocurrencies failed to exhibit safe-haven and inflation-hedge characteristics in the face of real market volatility or the first serious bout of inflation. inflation in developed markets. Between 2010 and 2022, Bitcoin has experienced declines of 25% and beyond 29 times. In the case of equities and commodities, on the other hand, this has only been the case once. Even during the pandemic-related market sell-off in March 2020, Bitcoin suffered significantly larger setbacks than traditional asset classes such as stocks or bonds. Although bitcoin’s fixed supply – specified in its source code – may imply that it is resistant to debasement, bitcoin has provided only limited inflation protection during recent bouts of heightened global inflation. . On the contrary, prices fell even during inflationary spurts in the US, UK and Europe.

Finally, cryptocurrencies remain very problematic in terms of ESG. However, the corporate governance issues exposed by the FTX implosion are of most concern. Too often, the absence of control systems and decision-making confined to a small inner circle results in a black box with no regard for investors and their assets. Additionally, the decentralized framework and anonymity of cryptocurrencies make them particularly attractive for illegal activities, money laundering, and sanction evasion. Even though the move from proof-of-work to proof-of-stake that Ethereum currently aspires to reduces massive energy consumption for cryptocurrency mining and validation, it is still not justifiable from a point of view. ecological view. Additionally, bitcoin, which accounts for approximately 40% of the current cryptocurrency market capitalization, will continue to use a validation process that requires a single transaction to consume as much energy as an average US household uses for two months. And also on a social level, the promise of cryptocurrencies to enable financial inclusion seems exaggerated. Because crypto assets are distributed as unevenly as conventional assets. In addition, simple telephone payment services such as M-Pesa in Kenya or the Grameen Bank’s international money transfer pilot project in Bangladesh already provide a digital platform for unbanked households. Neither a new currency nor a payment transaction infrastructure is needed.

The collapse of FTX puts cryptocurrencies back in the spotlight and only time will tell if the remaining players can hold their own. Because the industry is still clouded by gloomy events. Long-term investors should carefully monitor cryptocurrencies from a distance to better gauge their true value before making an investment decision.

By Taimur Hyat, Chief Operating Officer at PGIM

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