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There Are Only Three Rules to Cryptocurrencies: Scale, Scale, and Scale

Validated Individual Expert

The recent spate of scandals, bankruptcies and crashes doesn’t augur the brightest future for cryptocurrencies, and risks creating a vicious circle that could see their value stabilize at relatively low levels, compared to the peaks they enjoyed until recently.

At the same time, we’re seeing a weeding out of the many profiteers, crooks and speculators attracted by the promise of getting rich quick. People who, at a given moment, believed that cryptocurrencies offered constant growth and that they could bypass control mechanisms… until they found that, coincidentally, many of those mechanisms were there for their own protection.

What happens when, for example, we see that a cryptocurrency, intended in principle to be completely decentralized and independent on a single company, becomes overly centralized? This has happened several times, most recently, with the bankruptcy of FTX: a company thinks it can play the system, and decides to issue its own currency, a move that should raise alarms, but curiously does not, or does but attracts those looking to make a killing.

Issuing a cryptocurrency is a tempting move with very low entry barriers: all you need to do is copy another cryptocurrency. Sometimes, not even that: some issuance mechanisms we have seen fail were as crude as “I acquire debts, and every time I need money to pay them, I issue my own coin and pay them with it”. The result is companies leveraging themselves into seemingly invisible debts in implausible currencies, until they create holes through which, subsequently, other entities that relied on the same artificial currency fall, creating a domino effect that robs the unwary of their savings.

Am I saying that cryptocurrencies are a pyramid scheme? In some cases, yes: companies created their own currency, capitalizing it based on its future adoption. The problem, of course, is that the link between the value of a cryptocurrency and its adoption is very, very fragile. So fragile, that so far, only two cryptocurrencies have managed to pass the adoption test, and are considered reasonably secure: bitcoin and ethereum.

The former thrives because it was a pioneer with practically unchangeable rules, and the latter for the opposite, for its ability to rewrite its rules and adapt to changing situations. These are now cryptocurrencies with more users than many official currencies issued by governments.

Because, obviously, a bitcoin or an ether is worth more than many currencies that many governments around the world have been creating in their eagerness to finance themselves and their weak economies: let us not forget that the era in which a country’s currency reflected its reserves in gold or other metals accumulated in some heavily protected basement ended in a now very distant 1971, when the last currency that had promised to keep it, the dollar, stopped holding them. Since then, a country’s currency reflects confidence in its economy. On that premise, denying cryptocurrencies such as bitcoin or ether any validity is simply a matter of conservatism: they are better protected than the currencies of many currencies.

Seen in this light, what precautions should we take? Some are very clear: shy away from anything that is not widely used. Scale, scale and scale. Beyond bitcoin or ethereum, no cryptocurrency, however attractive or interesting it may seem, offers a solid guarantee, because it lacks scale.

Secondly, other cryptocurrencies are complicated: when the adoption of cryptocurrencies allows it, we will surely see the financial sector, leverage, loans, options, futures and all kinds of financial sophistication adopt them. But as long as their value has not stabilized and their adoption is not universal and bomb-proof, cryptocurrencies are likely to lose you money in the medium term, because it means trying to apply the rules of traditional finance to highly volatile assets.

Third, and repeat this mantra: not your keys, not your coins. If your cryptocurrencies are in the hands of a third party, you assume the risks that the third party decides to incur. Buy or sell on the exchange you want, the larger the better, and with guarantees, but once the transaction is done, move your money to your personal wallet.

And fourth and fundamental: if something seems too good to be true, it is. No what you hear about cryptocurrencies, they aren’t free money, they won’t guarantee you lavish returns, nor offer you a business that will allow you to retire early. That bus has left.

In short, for a cryptocurrency to work, it requires a very large critical mass of users who accept its value. The necessary requirements to obtain that level of adoption were met, years ago, first with bitcoin and then with ethereum, and they simply have not happened again, and there are no signs any of the many contenders will gain the same kind of traction. End of.

So, if you decide to invest in another cryptocurrency that promises wonders, you do so at your own risk. But beyond that, the idea that all cryptocurrencies are a scam is misplaced. Cryptocurrencies are the money of the future, and there is no getting round it.

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