Cryptocurrency hasn’t been a smart investment for a while now

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The collapse of FTX, one of the world’s largest crypto exchanges, has rocked the world of digital currencies.

Once valued at $32 billion, FTX filed for bankruptcy protection and founder Sam Bankman-Fried resigned as CEO after the company reportedly loaned billions of dollars in client funds to its own trading firm, Alameda Research. This has led to a spate of withdrawal requests across all platforms as investors braced for possible contagion.

With more than $2 trillion in value wiped out since the 2021 high water mark, cryptocurrencies are suffering a spectacular decline and are now drawing increasing regulatory scrutiny and investigations around the world.

Michael Barr, Vice Chairman of the Federal Reserve Board of Supervisors, said recent events in the crypto markets have “highlighted the risks for investors and consumers that come with new and novel asset classes and activities, unless accompanied by strong guard rails.”

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This is in stark contrast to just a few months ago, when crypto enthusiasts advocated, and in some cases implemented, the inclusion of cryptocurrencies in institutional portfolios and 401(k) plan accounts.

If investors out there are still tempted to jump into the cryptocurrency lane at a potentially attractive lower price, consider this: the biggest risks to cryptocurrency investing may still be ahead of us, not in the rearview mirror. This is something we’ve highlighted in our conversations with customers for some time, but it needs to be reiterated. Investors considering a long-term allocation to cryptocurrencies should remain cautious for three main reasons.

First, the lack of clear and consistent cryptocurrency regulation — both within and across countries — creates tremendous uncertainty for long-term investors. In the US, for example, it is still unclear when a cryptocurrency falls under the regulatory framework of a security, subject to the regulations of the Securities and Exchange Commission, and when it qualifies as an asset or commodity, as proponents of Bitcoin and Ethereum have claimed.

In fact, cryptocurrencies are facing outright ban in some countries; China’s abrupt ban on all cryptocurrency trading and mining in 2021 is a prominent example, but by no means the only one. Regulators have also been concerned about notable and repeated outages in the infrastructure supporting cryptocurrency mining and trading – another area where significant regulatory uncertainty remains. And the aftermath of the FTX collapse makes one thing clear: self-regulation and transparency are illusory.

Second, despite all the hype that they are digital gold, cryptocurrencies have not demonstrated any “safe haven” or anti-inflationary properties when faced with actual market volatility or the first real bout of serious inflation in developed markets.

Between 2010 and 2022, Bitcoin saw 29 episodes of drawdowns of 25% or more. In comparison, equities and commodities posted just one each. Even in the market sell-off caused by the pandemic in March 2020, Bitcoin suffered significantly more losses than conventional asset classes such as stocks or bonds.

While bitcoin’s fixed supply – which is fixed in its source code – might imply resistance to monetary debasement, bitcoin has offered limited inflation protection in recent episodes of heightened global inflation, with prices falling even during US inflation spikes. UK and Europe.

Finally, cryptocurrencies remain deeply problematic from an environmental, social, and governance perspective. Of most concern are the governance issues highlighted by the FTX implosion.

Too often, non-existent control systems and decision-making confined to a small inner circle create a black box of no concern for investors and their holdings. Additionally, the decentralized framework and anonymity of cryptocurrencies make them particularly attractive for illegal activities, money laundering and sanctions evasion.

Even as the transition from Proof-of-Work to Proof-of-Stake that Ethereum is driving reduces the massive energy consumption underlying crypto mining and validation, Bitcoin — which accounts for about 40% of the current cryptocurrency market cap — will – continue to be used from an environmental point of view, a validation process in which a single transaction requires enough energy to power an average American home for two months.

Socially, too, the promise of financial inclusion in cryptocurrencies seems exaggerated, as crypto wealth is distributed as unequally as traditional wealth, and simple mobile payment services such as M-Pesa in Kenya or Grameen Bank’s international remittance pilots in Bangladesh already offer a digital solution Platform for households with little bank balance – without the need for a new currency or payment infrastructure.

The FTX collapse has put cryptocurrencies in another bright spotlight and only time will tell if the remaining players will have what it takes to survive. Dark clouds remain on the cryptocurrency horizon that long-term investors should watch carefully from the sidelines to better understand the true value vs hype before deciding to invest in cryptocurrencies.

— By Taimur Hyat, Chief Operating Officer, PGIM

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