By Reda Aboutika, chief analyst at XTB France.
So-called fiduciary currencies depend on a central body: a central bank. Central banks have various levers to fight against inflation, such as raising their key rates. However, it should be noted that inflation very often finds its origin in expansionary monetary policies, leading to ultimately a drop in personal savings. This central body therefore has decision-making power over the monetary supply, and retains the right to deviate from its trajectory if it deems this necessary. How to ensure that this decision-making power is exercised wisely? Unfortunately, this is not possible and we have to trust these organizations, an imposed trust.
The limits of centralization are all the more evident on a smaller scale, as the giants of blockchain technology have shown by their use of our personal data. When a deviation, whatever it is, is revealed in broad daylight, the implementation of new rules is necessary. This is how the General Data Protection Regulation (“GDPR”) was born, granting us the right to be forgotten, the right of access, the right to modify or even the right to data portability.
Another sector, more mature and more representative of centralization perfectly illustrates the risks of the latter: the banking sector. Moreover, this sector is highly exposed to systemic risk, and constantly reminds us that “too big to fail” is only an illusion. The regulation of this sector has been made according to bankruptcies, and this since 1974, with the creation of the Basel Committee, in the wake of the disappearance of the German bank Herstatt, source of a serious crisis on the foreign exchange market .
In the 1980s, the crisis in emerging countries and borrower defaults in the United States gave rise to the Cooke ratio, a bank solvency ratio, recommended by the Basel Committee as part of its first recommendations.
In 1995, the bankruptcy of the Barings bank following fraudulent manipulations by one of its employees, a trader in Singapore, whose cumulative losses represented twice the bank’s capital, highlighted the operational risk. This scandal is at the origin of the amendment for market risks. And yet, the operational risk has not disappeared, and the gold medal is attributed to Société Générale, with no less than 7.3 billion dollars in operational losses in 2008, a record.
The year 2004 will have been marked by Basel 2, in response to the bankruptcy of LTCM, the hedge fund founded by the legendary John Meriwether, former director of the fixed income department of Salomon Brother, accompanied by two big names in financial theory, Myron Scholes and Robert Merton, two Nobel Prize winners for the famous Black & Scholes model.
Basel’s latest evolution saw the light of day in 2010, in the aftermath of the subprime crisis and the collapse of Lehman Brothers. This unprecedented financial crisis that raged between 2007 and 2008 is what connects the banking world to cryptocurrencies, given that bitcoin was created in reaction to this financial crisis, with the aim of circumventing financial institutions, using a system decentralized ledger, the blockchain.
As we can see, the cryptocurrency market has some similarities with the banking industry. The crises that hit this market primarily penalize individuals, but the lessons learned from them help to make it more robust by guiding regulators. Thus, one of the next bullish catalysts for the cryptocurrency market could arise on the Old Continent, with the MiCA regulation which should begin to frame the European cryptocurrency market during the year 2024. A regulatory framework which should facilitate the institutional investment.
It is clear that the cryptocurrency market is no exception, and that the dangers of centralization remain present due to the actions of centralized organizations operating in this sector.
Anyway, in the world of investment, there is no reward without taking risks. Regardless of the regulatory framework in place, no market is immune to major shocks, as Meriwether, Merton and Scholes learned when Russia found itself unable to honor its debt in 1998, leading to the collapse of LTCM, with a loss of $5 billion. A scenario that has not been integrated into the model put in place by the two Nobel Prize winners associated with the project.
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“Why regularizing the crypto-asset sector is not the solution” – Mieux Vivre Votre Argent