The current banking crisis which began on 8 March is uniquely characterised by its relation to high-tech start-ups and industries whose business models are high-growth, high-risk, rendering them unreliable for investment from typical banks (see Banking article). Silicon Valley Bank and Silvergate Bank were known for providing services to venture capital firms and tech companies focused on all types of tech from biotechnology, solar power, and semiconductors to streaming services, online gaming, and cryptocurrencies. In particular, Silvergate Bank, whose failure triggered the ongoing crisis, was known as the crypto bank, notorious for financing the now bankrupt cryptocurrency exchange and hedge fund company Futures Exchange (FTX). In fact, the origins of the current banking crisis can be traced all the way back to FTX’s collapse in November 2022.
The total global cryptocurrency market is massive and highly variable. It reached a peak value of over $3 trillion in November 2021 although it is today valued at $1.21 trillion after dropping below $1 trillion in November and December 2022 when FTX’s collapse dropped value across the global crypto market. Where does this purported ‘value’ come from?
Manufacturing cryptocurrencies
Cryptocurrencies like Bitcoin gained popular appeal just after the 2007-08 financial crisis when many developed a deep distrust of central banks’ commitment to regulate bank activities and protect everyday people. Instead of correctly identifying the system of capitalism as the cause of the 2007-08 financial crisis and all financial crises, crypto fanatics pinpointed the main cause of financial instability as centralisation of banking services. From this reasoning appears one of the foundational principles of cryptocurrencies: decentralisation.
‘Decentralised’ cryptocurrencies depend on a few different technical components. The first component is one bandied about as the solution to all types of ‘centralisation’ issues and is called the blockchain. Blockchains are a way to store data, a specific type of database. Traditional databases, used by most well-known banking systems, have a centralised system stored in one ‘place’, a server, where records of transactions are maintained. Blockchains store data in a decentralised way that means that every individual in the system has a copy of the various transactions that have taken place (in the case of cryptocurrencies). When a traditional database server goes down, nobody can access the stored data; decentralised approaches (of which blockchain is just one among many) do not have that problem. What makes blockchains special is the way they organise data: data is put into blocks with each block connecting to its predecessor forming the ‘chain’. Each of these data ‘blocks’ stores transactions (the movement of ‘tokens’ or values from one account to another) to serve the same function that traditional banking databases serve in recording histories of transactions in centralised systems. Within this blockchain system, special software programmes are used to ensure that records of transactions are not fraudulently changed.
Much of the supposed ‘value’ of cryptocurrencies comes from the ‘work’ involved in extending this chain of data blocks. To add a new data block capable of recording new transactions, a software programme must compete to solve a mathematically ‘hard’ problem whose solution others in the system can easily verify, a process called ‘mining’. Solving this problem and appending a new block to the chain comes with an associated reward in cryptocurrency received by the creator of the successful software programme, a reward that can be exchanged for other currencies. Along with this ‘mining’ comes huge expenditures of energy equivalent to that of medium-sized countries, an expenditure that grows with each block appendage as computationally harder and harder problems are required to be solved to create the newest block.
Another key component of the cryptocurrency market is cryptocurrency exchange platforms. Binance is the largest cryptocurrency exchange in the world closely followed by Coinbase and, until November 2022, FTX. These platforms are used to trade cryptocurrencies or digital currencies for other assets such as fiat money (US$ or GBP) or other digital currencies, similar to conventional stock exchanges in their use and purpose.
FTX and Alameda Research
FTX’s collapse was triggered by a CoinDesk article hinting at widespread fraud and swindling at FTX. FTX’s hedge fund arm Alameda Research, founded and owned by FTX founder Sam Bankman-Fried, was holding billions of dollars worth of FTX’s own cryptocurrency FTT and apparently using these token holdings as collateral for its loans. These loans, along with billions of dollars of customers’ money in FTX, were being used by Alameda to gamble on other highly speculative cryptocurrencies. As crypto markets began to drop, losses cascaded through the system, wiping out hundreds of billions in ‘value’.
At this point, facing margin calls on its loans, Alameda borrowed, at one point, as much as $10bn from FTX customers’ funds to cover them. On top of this, FTX and Alameda had invested billions into illiquid venture capital and crypto investments. As interest rates increased and access to cheap credit disappeared, almost all of these companies were hit hard and investors scrambled to shift their investments to safety. During this scramble, a massive black hole where customers’ funds should have been quickly became apparent. Bankman-Fried had been operating FTX as a classic ponzi scheme, funneling customers’ funds into cryptocurrency investments made up and controlled by Bankman-Fried and backed by nothing aside from FTX’s pledge to buy any FTT token for $22 each.
Cryptocurrencies’ role in our financial system
FTX’s collapse reveals the real basis of value for cryptocurrencies: speculation. Typical fiat currencies like the US dollar or the euro are government-issued and are backed by the governments that issue it. The value of fiat money is linked to the stability of the issuing government but the real dominance of fiat money as a currency is due to its wide social acceptance as a means of exchange, a store of value, and a unit of account. Since the 1930s, when governments first came off the gold standard, backed instead by the ‘good as gold’ US dollar due to the 1944 Bretton Woods agreement that established a gold exchange standard, and cemented in 1971 with the collapse of the Bretton Woods agreement, fiat currencies have had no ties to a material commodity like gold or silver, functioning only as a symbol of value and opening the door to all types of horrific inflationary practices to ‘save’ the capitalist system.
Unlike fiat currencies, cryptocurrencies are not backed by any government and only have as much value as the market ‘believes’ they have, completely detached from any productive value to human society. In fact, investors only ‘make’ money from cryptocurrency if they are able to exchange the cryptocurrency for a larger amount of fiat currency than they used to purchase the cryptocurrency. Cryptocurrencies are so divorced from a material basis that their only value is derived from their ability to be exchanged for fiat currencies which are already an abstraction of material value. Cryptocurrencies are an example of what Karl Marx called fictitious capital, money invested to make more money without any corresponding real value. Cryptocurrencies like bonds, stocks, and shares do not correspond to intrinsic value and are just claims to potential future values (tax revenues or corporate profits) that may never exist. Beyond that, cryptocurrencies and many of the associated technological ‘innovations’ like NFTs and other sparkly bait depend on new people entering the system to maintain and create ‘value’.
Cryptocurrencies’ popularity in our current system demonstrate the extent to which capitalists must now go to to make use of overflowing and parasitic capital, just another speculative mechanism used to ‘generate’ new capital. They play no productive role in our economic system and are essentially a Ponzi scheme disguised with technological glitter, exemplifying yet another grotesque mutation of capitalism. The tangible role cryptocurrencies play in the current banking crisis shows the depth of rot in the capitalist system.
Soma Kisan
