ECB Blog: Bitcoin is a "criminal currency" and ETF approval will lead to a terrible outlook

Original authors: Ulrich Bindseil, Jürgen Schaaf, European Central Bank Market and Payment Infrastructure Department

Original compilation: Ehan, Wu Says Blockchain

On January 10, the U.S. Securities and Exchange Commission (SEC) approved the Bitcoin spot ETF. For supporters, the official approval confirms that Bitcoin investment is safe, and the previous surge proves an unstoppable victory. We disagree with these claims and reiterate that the fair value of Bitcoin remains zero. For society, the resurgence of Bitcoin's boom and bust cycle is a terrifying prospect. This will have enormous side effects, including environmental destruction and a wealth redistribution that ultimately comes at the expense of some individuals.

Previously, a blog post by the European Central Bank in November 2022 debunked the false promises of Bitcoin and warned that if not effectively addressed, it would pose social dangers. We believe that Bitcoin has failed to fulfill its initial promise as a global decentralized digital currency. The second promise that Bitcoin, viewed as a financial asset, will inevitably continue to rise in value is also incorrect. If the Bitcoin lobbying group reignites an economic bubble with the unintentional help of legislators, it will pose risks to society and the environment, as legislators may provide support for something perceived as favorable, when in fact what is needed is a ban (Bindseil, Schaaf & Papsdorf, 2022).

Unfortunately, all these risks have already become a reality.

To this day, Bitcoin transactions remain inconvenient, slow, and expensive. Apart from the dark web, it is hardly used for payments, and regulatory initiatives aimed at combating the misuse of the Bitcoin network by criminals have not succeeded. Even with the full support of the Salvadoran government, which granted Bitcoin legal tender status and gave citizens $30 worth of Bitcoin for free, it has not succeeded in making it a universal payment method.

Similarly, Bitcoin is still unsuitable as an investment. Unlike real estate or stocks, it does not generate any cash flow, cannot be used for production (goods), does not provide social benefits (like gold jewelry), or subjective appreciation (like art). Retail investors with less financial knowledge fear missing out but are more likely to lose principal during market fluctuations.

Moreover, Bitcoin mining using the proof-of-work (PoW) mechanism continues to pollute the environment on a massive scale, with energy consumption increasing as Bitcoin prices rise, as miners need to mine at higher costs.

Despite all this being known, the reputation of the entire cryptocurrency industry has been damaged by an increasing number of scandals. Since the end of December 2022, Bitcoin has rebounded sharply from just below $17,000 to over $52,000. Small investors are slowly returning to cryptocurrency, although not as eagerly as they did three years ago (Bloomberg, 2024). Table 1 Bitcoin Market Capitalization (in billions of dollars)

Source: IntoTheBlock

Why Such a Strong Rebound?

For many, the rise in the fall of 2023 is attributed to the rapid shift in the Federal Reserve's upcoming interest rate policy, as well as the comprehensive support for Bitcoin from the upcoming halving in spring and the SEC's approval of the Bitcoin spot ETF.

Lower interest rates will increase investors' risk appetite, while the approval of the spot ETF will open the doors of Wall Street to Bitcoin. Both promise a significant influx of funds—this is the only effective fuel for a speculative bubble.

However, this may be short-lived. In the short term, the influx of funds may have a huge impact on prices, unrelated to fundamentals, but in the long run, prices will ultimately revert to their fundamental value (Gabaix & Koijen, 2022). Without any cash flow or other returns, the fair value of an asset is zero. When prices deviate from economic fundamentals, every price can be reasonable or unreasonable.

Similarly, using ETFs as a financing tool does not change the fair value of the underlying asset. An ETF that contains only one asset undermines its actual financial logic. ETFs are typically designed to diversify risk by holding many individual securities in the market. Why would someone pay an asset management company for the custody service of just one asset, rather than using a custodian directly, or even holding tokens for free without any intermediaries? Moreover, there are already other simple ways to gain exposure to Bitcoin or purchase Bitcoin without any intermediaries. The issue has never been a lack of opportunities to speculate with Bitcoin, but rather that it is merely speculation (Cohan, 2024). Ironically, the cryptocurrency units intended to overcome the demonization of the traditional financial system require traditional intermediaries to reach a broader investor base.

The Bitcoin halving will take place in mid-April. Approximately every four years, after 210,000 blocks are mined on the Bitcoin network, the block reward given to Bitcoin miners for processing transactions is halved. The current daily supply limit of 900 BTC will be reduced to 450 BTC. The halving will reduce Bitcoin mining rewards, although mining costs remain high. Historically, prices have risen after halving. But if this is a reliable pattern, then the increase has already been fully priced in.

Although the current surge is driven by temporary factors, three structural reasons may explain its seemingly strong performance: ongoing price manipulation in unregulated markets, lack of regulation and fair value; growing demand for "criminal currency"; and flawed judgments and measures by authorities.

Price Manipulation Since Bitcoin's Inception

Bitcoin's history is characterized by fraud types such as price manipulation. This may not be surprising for an asset without fair value. In the initial cycles, cryptocurrency exchanges were shut down due to fraudulent activities, and some operators were even prosecuted. During last year's surge, its pricing remained questionable. An analysis by Forbes in 2022 found that 51% of the reported daily Bitcoin trading volume across 157 cryptocurrency exchanges may be fabricated.

During the downturn of the "crypto winter," trading volumes significantly decreased, and manipulation may have become more effective. When liquidity is low, market interventions have a greater impact. It is estimated that the average trading volume of Bitcoin from 2019 to 2021 was about 2 million Bitcoins, while in 2023 it was only 500,000 Bitcoins (Athanassakos & Seeman, 2024).

Criminal Currency: Financing Malfeasance

As critics often point out, a key use of cryptocurrencies is to fund criminal activities such as terrorism, money laundering, and ransomware. The demand for this criminal currency is enormous and continues to grow.

Despite the market downturn, the volume of illegal transactions is still rising, with a wide range of possible applications.

Bitcoin remains the preferred choice for money laundering in the digital world, with the amount of cryptocurrency transferred from illegal addresses reaching $23.8 billion in 2022, a 68.0% increase from the previous year. About half of these funds were funneled through mainstream exchanges, which, despite having compliance measures, still serve as channels for converting illegal cryptocurrencies into cash (Chainanalysis, 2024).

Additionally, cryptocurrencies remain the preferred method for ransomware payments, with attacks on hospitals, schools, and government offices bringing in $1.1 billion for criminal gangs in 2023, compared to $567 million in 2022 (Reuters, 2024b).

Misjudgment by Authorities?

The international community initially recognized Bitcoin's lack of positive social benefits. Legislators hesitated to clearly formulate relevant regulations due to the abstract nature of guidelines and concerns about the deviation of Bitcoin from traditional financial assets. However, pressure from well-funded lobbyists and social media activism led to compromises that were seen as partial recognition of Bitcoin investment (The Economist, 2021).

In Europe, the Markets in Crypto-Assets Regulation (MiCA) enacted in June 2023 aims to curb fraudulent issuers and traders in the cryptocurrency industry. Although initially targeting genuine cryptocurrency assets, it ultimately focused on stablecoins and service providers, without regulating or restricting Bitcoin itself. Meanwhile, outsiders with insufficient understanding may mistakenly believe that with MiCA, Bitcoin will also be regulated and safe.

In the U.S., the SEC initially took a compromise stance on Bitcoin ETFs, leaning towards futures ETFs, as they were believed to have lower volatility and lower price manipulation risks. However, a court ruling in August 2023 forced the SEC to approve spot ETFs, leading to a significant rise in the crypto market.

Despite evidence that Bitcoin has a huge negative impact on the environment, neither the U.S. nor the EU has taken any effective measures to address Bitcoin's energy consumption issue.

The decentralized nature of Bitcoin poses challenges for authorities, sometimes leading to unnecessary regulatory fatalism. However, Bitcoin transactions provide pseudonymity rather than complete anonymity, as each transaction is associated with a unique address on the public blockchain. Therefore, Bitcoin has always been a cursed anonymous tool that facilitates illegal activities but can also be tracked to take legal action against wrongdoers (Greenberg, 2024).

Furthermore, the belief that Bitcoin should not be subject to strong regulatory intervention, or even prohibition, seems misguided. The notion of being immune to effective access by law enforcement is quite deceptive, even for decentralized autonomous organizations (DAOs). DAOs are member-owned digital communities based on blockchain technology, without central leadership. A recent case involved BarnBridge DAO, which was fined over $1.7 million by the SEC for issuing and selling unregistered crypto securities. Despite claiming to have autonomy, the DAO reached a settlement after the SEC pressured its founders. When the managers of decentralized infrastructure are identified, authorities can effectively prosecute them, highlighting the limitations of the claimed autonomy.

This principle also applies to Bitcoin. The Bitcoin network has a governance structure where roles are assigned to verified individuals. Given the large-scale illegal payments made using Bitcoin, authorities may decide to prosecute these individuals. Legislators believe that strong regulation of decentralized finance is necessary when deemed appropriate.

Recent developments, such as increased fines for regulatory failures (Noonan & Smith, 2024) and the EU's agreement to strengthen anti-money laundering rules for crypto assets, indicate a growing demand for increased regulation in the cryptocurrency space.

Conclusion

The price level of Bitcoin is not an indicator of its sustainability. Detached from economic fundamentals, there is no fair value to make reliable predictions. In a speculative bubble, there is no such thing as "price proof." Instead, the expanding bubble once again demonstrates the influence of the Bitcoin lobbying group. The "market" capitalization quantifies the overall social damage that will occur when the house of cards collapses. Authorities need to remain vigilant to protect society from money laundering, cybercrime, economic losses for retail investors, and widespread environmental destruction. This work is far from complete.

Note: The views expressed in this article are those of the authors and do not necessarily represent the views of the European Central Bank and the euro system.