3 Reasons to Exercise Caution Amid the Cryptocurrency Surge

Following the close of the Monday session, investors would be forgiven if they felt a sense of brewing despair. Amid the fallout associated with the failure of two major financial institutions, circumstances appeared bleak. However, the equities sector bounced back sharply on Tuesday, buoyed by positive sentiment reentering the otherwise troubled banking industry. However, arguably most eyes centered on the cryptocurrency complex.






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After suffering body blows – especially as investors fretted over certain banks’ exposure to blockchain-derived digital assets – several individual virtual currencies stormed higher. Overall, the total market capitalization of the cryptocurrency segment reached just under $1.1 trillion shortly after the close of the U.S. equities market. Last week, cryptos spent some time below the critical $1 trillion benchmark.

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Fundamentally, many cryptocurrency proponents argue that the banking fissure signals the blockchain market’s time to shine. In other words, the legacy financial system undergirded by centralized fiat currencies is broken. Therefore, humanity needs a new system, one governed by immutable decentralized protocols.

On surface level, such a notion sounds meritocratic and sensible. However, this wider frame of thinking runs into several challenges. Below are three points (among many others) to consider.

Trading on a Logical Fallacy

With the ignominious and high-profile banking failures, it’s tempting to view monetary centralization as the primary culprit. Therefore, some blockchain proponents push for a new approach undergirded by decentralization.

However, decentralized or private currencies have long existed before the cryptocurrency came into existence. In the U.S., we have a colorful history involving wildcat currencies. As I’ll explain later, decentralization in all forms is simply not effective nor efficient.

More importantly, pushing decentralization as the antonym of “failed” centralization runs into a logical fallacy. Merely the opposite of an unsuccessful approach does not necessarily mean it offers a positive or correct outcome. For instance, if two plus two incorrectly yields five, the correct answer is not negative five (the opposite of the incorrect answer).

That’s not to say that decentralization is absolutely not the proper solution. Rather, blockchain proponents must be careful in applying the either-or (false compromise) fallacy. The correct answer to monetary policy may lie anywhere across a vast spectrum of proposals.

Decentralization Has Its Problems

Although it’s tempting to view blockchain-backed transactions as quicker, more efficient and less problematic than centralized transactions, that’s not necessarily the case. Certainly, the digitalization of the cryptocurrency market carries significant advantages. But a critical flaw is that it cannot avoid centralized paradigms.

For individual cryptos to enjoy their vast success, a free market must facilitate their trading activities. And this free market is supported by high volume of – you guessed it – fiat currencies. Sure, blockchain proponents can say that crypto exchanges are backed by stablecoins. But these stablecoins are then backed by commercial and government paper.

That’s why when bank runs or other problematic events occur off-chain, they impact exposed crypto exchanges. Somebody, something must provide the volume to grease the wheels of free market transactions. Like it or not, this grease originates from fiat currencies themselves or fiat-currency-backed digital assets.

Pure Cryptocurrency Transactions Are Not Efficient

Technically speaking, decentralized applications enable investors to acquire cryptos through the exchange of other decentralized, non-fiat-backed cryptos. However, the inefficiency of this approach brings blockchain proponents to an ironic conclusion: purely decentralized cryptocurrency transactions are not efficient.

That’s not to impugn the broader blockchain industry: it’s just a fact of life. Consider the main reason why people shop at big-box retailers: convenience. If the retail ecosystem featured pure decentralization, every shopper would have to approach the manufacturer of specific goods one by one.

For example, if you want rice, you’d have to go to a rice broker. To buy your bananas, you’d have to go to a banana farm. When you realize you need new underwear, you must take a trip to your local underwear store. After just a few minutes of this nonsense, you’d realize that it makes much more economic and rational sense to have various goods under a centralized platform.

So it is with cryptos and stocks and any other standardized or commoditized asset class. Again, it’s not to say that the fiat monetary system doesn’t have its flaws. Clearly, it does. But merely jumping to the opposite extreme might not yield effective results.

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On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.

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