It’s been a wild week in the world of crypto.

Hundreds of billions of dollars in ephemeral wealth evaporated as the price of bitcoin plunged to its lowest point since 2020, down more than 50% in about six months. The exchange Coinbase dropped to about a fifth of last year’s initial public offering price. An algorithmic stablecoin called TerraUSD, a digital token that purported to be worth a dollar, melted down along with the blind confidence it had relied on.

The crypto market may well bounce back. But the message is clear: this stuff is not ready for prime time.

Those who stand to gain from crypto have been making great efforts to popularise and legitimise what they call a new asset class. In the US, they’ve renamed stadiums and hired celebrities to stoke people’s fear of missing out. They’ve encouraged state and local governments to provide tax incentives and even make cryptocurrency “legal tender”. Established financial institutions are launching exchange-traded funds focused on bitcoin futures and offering over-the-counter trading to wealthy clients.

Yet underlying all this activity is a technology that, for all its ingenuity, hasn’t found much practical use. Bitcoin, by far the largest cryptocurrency, is a terrible substitute for government-issued money. It’s highly volatile, transactions are slow and often expensive, and there’s little recourse when tokens get lost or stolen, as they often do. The computer calculations required to ensure security consume the energy resources — and hence produce the carbon footprint — of a medium-sized country. Efforts to remedy these flaws remain in their infancy and may never come to fruition.

Crypto is thus an unusually pure speculative vehicle: without the real-world purposes or cash flows that tend to underpin more traditional assets, it’s worth only what a greater fool will pay. The most reliable benefits flow to intermediaries — the exchanges, investment banks, payment apps, custodians and miners who take a cut every time somebody makes a trade. And, of course, to the scammers who hype new products only to take the money and run.

Dangers

The dangers go far beyond the risk that unsophisticated investors will lose their shirts. The more crypto grows — the more it insinuates itself into the financial system and attracts leveraged investors — the greater the chances that the next rout will trigger broader contagion. Even after the past week’s declines, the total amount deployed in cryptocurrencies and decentralised finance still exceeds US$1-trillion, more than enough to cause trouble.

US President Joe Biden’s administration has laid out a sensible framework for regulation. But officials and lawmakers need to act. Among other things, they should require that digital tokens claiming to be worth a dollar be backed by an actual dollar; ensure that important financial institutions don’t get overly exposed to crypto, directly or indirectly; and demand that all relevant intermediaries collect the customer information needed to enforce sanctions and anti-money-laundering laws.

No doubt, crypto has the potential to improve on an unnecessarily expensive and precarious financial system — for example, by making payments cheaper, more accessible and less vulnerable in times of crisis. The current speculative boom, though, isn’t helpful. Without a measure of restraint and some well-placed regulation, this could all end in disaster. — (c) 2022 Bloomberg LP