Let's not experiment with cryptos

Academic experts question promise of liberation and security pushed by cryptocurrency supporters

Let's not experiment with cryptos

This article was provided by the Smith School of Business, Queen’s University

Though the topic received virtually no attention during the recent federal election, the financial shadow of cryptos is growing at an alarming rate and political attention is urgently needed to protect the Canadian public.

Promoters claim that cryptos carry a political project—namely, to liberate common citizens from reliance on financial institutions and central banks by decentralizing the power of money creation. Yet behind the guise of this supposedly decentralized system, power remains in fact massively concentrated.

A 2021 study from the National Bureau of Economic Research in the United States found that just 0.1 per cent of bitcoin miners (about 50 individuals) control half of all mining capacity. Worse, according to the researchers, this concentration is most likely “an understatement.” Who are these new digital central bankers? A “shadowy, faceless group of super-coders,” as Senator Elizabeth Warren put it, who remain politically unchecked.

Another pillar of crypto’s image as a positive political project is its alleged guarantee of immutability. Proponents argue that the blockchain technology underlying the currencies is immutable, maximizing security and stability by ensuring that no one can change the code once a transaction has gone through.

However, this promise of security sounds dangerously naïve in light of the revelation that just 50 individuals (and probably less) could collude to take over the network. It also sounds dangerously short-sighted given that, even if it were real, true immutability could have catastrophic effects.

For example, consider the fall of Mt. Gox, a Tokyo-based bitcoin exchange that simply “lost track” of an equivalent of $480 million. The root cause of its demise? A dysfunction in the source code, which rendered the exchange susceptible to irreversible hacking that lasted for years. At its peak, Mt. Gox handled 80 per cent of bitcoin trading before filing for bankruptcy in 2014. In practice, therefore, crypto codes must be frequently modified by developers to correct the flaws and bugs that may enable continuous hijacking of the supposedly secure platforms.

In short, the current crypto system is delivering the opposite of its political promises. Anonymity has turned to secrecy. Decentralization has led to an unprecedented concentration of power over new types and amounts of money that even central bankers could not have imagined.

We should not be entirely surprised by this trajectory, since cryptos have always been designed and operated by human beings through the help of machines. In other words, the crypto realm is more a product of human actions and human controls, including the taste for power and greed, than of the machine era. However, we must be fully aware of the threat that these currencies pose to our own financial system. It is deeply troubling to see Canada developing a reputation as a “crypto miner’s top choice” and “a safe haven for miners coming from politically and financially unstable environments to carry out operations within a relaxed framework.”

The Canadian Securities Administrator (CSA) now considers digital tokens as securities and has forced crypto exchanges to register with one of Canada’s provincial securities regulators. But while the Canadian blueprint could be imitated in other jurisdictions, it still completely misses the political nature of cryptos by treating them like historical financial products, implicitly tolerating and embedding their anti-democratic underpinnings in our real economy.

As we learned the hard way with the subprime crisis, when a systemic risk is financialized and diluted into a myriad of “new” traditional financial products, which no one fully understands or knows how to audit, it is an excellent recipe for disaster.

A recent research report shows that $7.1 trillion in market capitalization is exposed, directly or indirectly, to cryptos. There is no justification for taking so much risk collectively with a politico-financial project that remains, at best, experimental. As long as their governance remains underground and their risk unauditable, cryptos should be banned from our financial markets.

Bertrand Malsch is an Associate Professor of Accounting, a PriceWaterhouseCoopers/Tom O’Neill Fellow of Accounting, and the Director of the CPA Ontario Centre for Corporate Reporting and Professionalism at Smith School of Business, Queen’s University.

Erica Pimentel is Assistant Professor of Accounting, Assistant director of the CPA Ontario Centre for Corporate Reporting and Professionalism, Smith School of Business, Queen’s University.

Nathaniel Loh is a Fellow of the CPA Ontario Centre for Corporate Reporting and Professionalism, Smith School of Business, Queen’s University.