Bitcoin Fails Economics 101 As World Markets Quake

In the same month China rolled out the first digital currency issued by a major central bank, the crypto world is reminding us why it’s necessary.

Amid the just concluded Winter Olympics in Beijing, the People’s Bank of China allowed visitors to try out the e-CNY. Though at least 87 governments are exploring the mechanics of a central bank-issued digital unit, PBOC Governor Yi Gang’s institution is the first leading one out of the gate.

And not a millisecond too soon as all the top arguments why private cryptocurrencies are needed fall flat. If the last few months settled any financial debate, it’s that bitcoin and its ilk is neither a hedge against inflation or plunging stocks nor a gold-like safe haven.

The wild daily price swings are trouble enough. But the Russia-Ukraine conflict, you’d think, would be a geopolitical crisis tailor made to prove bitcoin’s status as a refuge from market chaos.

Will Russia’s invasion exacerbate inflation risks as energy costs surge? Yes. Might it send equities spiraling lower virtually everywhere? Check. Are currency traders scrambling for cover? Indeed. Are there reasons to doubt the dollar’s stability as Moscow and Washington spar at the same time the U.S. national debt tops $30 trillion? The odds surely favor it.

And yet, bitcoin stumbled along with everything else. Rather than choosing crypto as a haven, capital zoomed into U.S. Treasury securities, German government bunds and physical gold.

In years past, crypto boosters argued blockchain-derived virtual money danced to its own beat, one that only the most tech-savvy investors could hear. These days, crypto assets often trade in line with the investment mediums they were supposed to replace.

Given the opacity of the market, wild price swings far beyond those of conventional equities, bonds and currencies, how exactly does one pull crypto assets into a balanced portfolio? Such volatility might be fine for active hedge funds or high-frequency trading algorithms. For most investors, the electrocardiogram vibe bitcoin gives off is huge demerit, not a positive.

At the end of the day, cryptocurrency is acting more like an accelerant for stock volatility than a shelter from stormy markets. That, not surprisingly, has central banks like China to issue digital currencies that could leave today’s private currencies with little productive role in world finance.

The PBOC’s e-CNY is about to revolutionize a giant economy that’s effectively banned all crypto trading and mining. It won’t be the last. The Federal Reserve in Washington, the Bank of Japan in Tokyo and the Reserve Bank of India in Mumbai are just of the few of the roughly 88 governments exploring the mechanics of a central bank digital currency.

There are many reasons why governments want their own digital currencies. Ajay Mookerjee, technology adviser at Warburg Pincus, lists several benefits: reduced risks of bank runs; an end to expensive and unwieldy paper cash; easier implementation of regulatory changes; greater financial inclusion.

Stamping out corruption is another big incentive. So is giving monetary policy makers an extra gear when trying to influence consumer and business behavior. The hope is that government digital currencies will enable central banks to gain more traction when easing or tightening credit conditions.

As central banks turn science fiction into financial fact, the broader market—one that hoped to cut them out of the process—could benefit, too. In the weeks ahead, Securities and Exchange Commission Chairman Gary Gensler is expected to announce where U.S. regulators come down on private currencies.

Even if Gensler’s team gives bitcoin and the like reasonably free rein, central bank-issued digital currencies will deepen, stabilize and legitimize trading. By acting as the adult in the room, central banks can create regulatory frameworks and rules of conduct for cryptocurrency issuance, trading and security.

To virtual currency purists, this will sound completely anathema. Having governments involved, after all, defeats the purpose of bitcoin, which is based on total anonymity and inhabiting a space outside conventional finance.

At the same time, though, the cybercurrency world is on a collision course with governments averse to making life easier for ISIS, Mexican drug cartels or North Korea to hide, launder or move funds via crypto exchanges around the globe. And with governments averse to a bull market in tax avoidance.

In China’s case, it’s also about heading off ways for Communist Party bigwigs to spirit millions of dollars—or billions—of ill-gotten gains abroad. And, unfortunately, to have a powerful new tool to expand its surveillance state.

Even so, bitcoin missed Economics 101. To be a sanctuary from economic overheating, investors must believe that an asset will hold its value as inflation surges. Bitcoin and its peers are most certainly not that, as the market keeps reminding us of day after day.