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The head of the European Central Bank has outlined key issues in the current state of cryptocurrency that could potentially burst the 'bubble'. However, crypto's role in digital finance is likely to continue to evolve.
In 2022, the growing debate about the rise and subsequent crash of crypto markets triggered several unfortunate events. While some promising developments support the promotion of the crypto utility, the collapse of major players in the industry has scared the public.
This article covers a range of topics, from crypto's potential as the future of finance to some calling it a bursting bubble. What does the future hold for digital finance as a whole?
Crypto and Finance
Why is cryptocurrency so exciting? As with any new technology, some see the potential, while others need a little more time to convince. Think of the Internet in the 80s and 90s. There was a time when people were afraid to shop online or go to the bank.
But now this technology controls everything. Most cryptocurrencies aim to be a fast, cheap and easy-to-use digital currency that can be accessed by anyone in the world with an internet connection.
Many cryptocurrencies are decentralized, making them less influenced by central governments. This could provide an alternative form of financial independence for many people living in difficult jurisdictions.
Many Fortune 500 companies such as Starbucks, Tesla, Burger king, Coca-Cola and many others already accept crypto as a means of payment. Crypto is starting to move into everyday life as a payment mechanism.
However, this is a niche market that will evolve over time. But even development can have setbacks. In 2022, cryptocurrencies had a strong domino effect.
Big names have caused widespread damage due to greed and shady business practices. These include Terra and its UST stablecoin, and the cryptocurrency exchange FTX, which infected more than 100 other companies after it defaulted.
The Crypto Domino Effect: One Failure After Another
One of the biggest failures in the crypto market is increasing connectivity and leverage. This creates a domino effect.
One of the first major crypto crashes of the year was Terra. It was considered by many as one of the most secure crypto ecosystems. However, the price of its LUNA token fell along with its related stablecoin Terra USD (UST) after it lost its dollar peg.
This crash set off a domino chain of massive mistrust of cryptocurrency as a whole.
Next came Celsius, a well-known crypto exchange and one of the biggest crypto borrowers. But after the Terra debacle, it also started to see massive withdrawals. For Celsius, there wasn't enough collateral to secure each loan, and the jig was up.
After Celsius, Three Arrows Capital (3AC), another crypto lender, faced the same problems as Voyager Capital, the crypto company it borrowed from. All of them have now filed for bankruptcy, further eroding investor confidence.
Similarly, the collapse of FTX in November caused a "contagion effect" that caused more than 100 related companies to file for bankruptcy or suffer huge losses.
Structural Weakness
The crypto market is still highly inflated and correlated, leading to strong pro-cyclical effects due to lack of shock absorption. Here is a practical example to support this scenario:
Some crypto exchanges have allowed investors to increase their exposure to more than 100 times their actual investment. This means that when a crash/shock hits, debt is needed. Exchanges are forced or forced to divest assets, which puts a lot of pressure on crypto prices, as shown in the chart above.
Fabio Panetta, board member of the European Central Bank, talks about this topic. The quotes from Panetta speaking at the Insight Summit at the London Business School in December. 7 shared with BeInCrypto.
Panetta noted:
"In one case, borrowed funds can be recycled as collateral in subsequent transactions, allowing investors to build significant exposure. Shocks can propagate quickly in side chains, and positions realized through smart contracts are automatically reinforced.
He further added , that more support is needed to regulate the crypto market:
Reducing Risk
European and American politicians in particular called for urgent regulations, especially after the FTX fiasco.
In addition, Panetta also expressed his thoughts on cryptocurrency taxation. In Europe especially, the introduction of a tax can facilitate the financing of goods and services.
For example, the use of tax measures can curb the high costs of the energy sector associated with crypto mining. He ended his speech by stating that he wants to ban energy-intensive crypto-assets with carbon footprints – referring to crypto-assets that rely on consensus to function, such as Bitcoin.
Balance Sheet
These stories from the head of one of the most important central banks in the world rightly scared those who have a significant part of their wealth in cryptocurrencies.
But at the same time banking systems are not without problems and shortcomings.
When discussing the future of digital finance and crypto, it is important to assess the status quo of traditional monetary systems. Banking may seem cheap when you are rich, but it is quite expensive for the common man.
A McKinsey report shows that the average American household spends $2,700 per year on banking services, which equates to about 3.5 weeks' wages per year.
So the average American spends more money or more time working to pay for banking privileges than in some cases for state taxes.
Digital finance and cryptocurrency do two things in the financial system.
First, compensation for the costs of trusting traditional financial institutions. This is why banking is so expensive. A trusted intermediary is used between two parties, while blockchains decentralize that trust and reduce costs tremendously.
They also help to optimize the working capital of companies. Today, the average SandP company holds about 14 percent of its cash on its balance sheet. Digital finance frees up that working capital because you no longer need to trade currency, which improves cash productivity.
But as innovation progresses, crypto can play an important role in digital finance?
source : https://beincrypto.com/ecb-executive-3-main-setbacks-crypto-finance-2022/
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