If cryptocurrencies are integrated into the Australian financial system, we will be lucky to avoid a contagious collapse John Quiggin

AJim Chalmers, principal advisor to then Treasurer Wayne Swan, was ringside to watch the impact of the global financial crisis on the world. Australian economy And the financial system. We escaped the initial impact of the global financial crisis largely because Australian financial institutions, still bearing the scars of the financial disasters of the 1980s and early 1990s, were slow to embrace the exotic financial derivatives that brought down their US and UK counterparts. This delay has bought time to deliver strong fiscal stimulus (here and in China, our main export market) to stave off the long and deep recessions we have seen elsewhere.

But a few days ago, Jim Chalmers made comments suggesting that the Australian financial system will not be insulated from the crisis that looks likely to arise in the next few years. When Donald Trump takes office as President of the United States, he will put an end to the policies that have maintained a wall of separation between the traditional financial system and the cryptocurrency sector. Chalmers, citing Trump’s moves, said He suggested Australia should follow suit.

Much of the concern about integrating cryptocurrencies into the financial system focuses on the fact that cryptocurrency prices are highly volatile. This should not be a cause for concern: commodity prices are volatile, but commodity futures have been trading in financial markets for more than a century. In fact, the central role played by financial markets is to manage risks and volatility.

The real problem is that cryptocurrencies are essentially worthless. A typical crypto asset, such as Bitcoin, is a certificate that the producer has performed a complex, but uninteresting, mathematical calculation (roughly, finding the inputs to a complex function that produce an output close enough to zero). No one can benefit from this.

In contrast, other assets, including those used as currency, have value either because they are useful or desirable in themselves (such as gold and silver) or because the government is willing to accept them as payment for tax liabilities, such as paper currency. Stocks and corporate bonds represent a claim on the profits and assets of the companies that issue them. And so on. Unless the Trump administration decides to treat Bitcoin the same way as the US dollar (the idea has been suggested!), none of this applies to cryptocurrencies.

What this means is that once people decide that cryptocurrencies are worthless, they will become worthless. As coin holders seek to cash out their funds, the price will fall, leading to more sales, with no fixed floor above zero.

At this point, it might be reasonable to object that critics (like me) have been calling cryptocurrencies worthless since they were introduced in 2009, and yet their prices have skyrocketed. It is worth noting that the relatively simple Ponzi scheme run by the late Bernie Madoff continued for at least 17 years, with the amount growing to tens of billions of dollars. It was only disclosed by the GFC.

In previous recessions in the cryptocurrency market, the loss in value has affected cryptocurrency owners who are unwilling or unable to “Hold on for dear life“, but has had no impact on the mainstream financial sector. In contrast, in the next few years, the exposure of traditional institutions will likely reach the hundreds of billions, perhaps trillions. Mortgages will increasingly be secured against cryptocurrency collateral and serviced through profits. (It is hoped) that speculation in cryptocurrencies will be allowed and encouraged, creating more opportunities for a contagious collapse.

The obvious starting point for a collapse would be the failure of one of the crucial, but obscure, “stablecoins,” which were designed to trade at a fixed price of US$1 and facilitate the conversion of cryptocurrencies into fiat currency. Tether, the leading stablecoin, claims more than $100 billion in assets, but has never produced more than a vague account of what those assets are. Chalmers’ statement includes a promise to legislate “stablecoin payment” reforms, but it is difficult to see how Australia could regulate a global company like Tether.

A combination of good luck and good management, in which Jim Chalmers played a prominent role, helped Australia avoid most of the consequences of the global financial crisis. If cryptocurrencies are allowed to play a prominent role in our financial system, we will rely entirely on luck to avoid future disaster.