Disrupting Central Financial Services in the Metaverse with Neeraj Satija

How does encryption go to zero?

If only everyone would stop using it. This, in five words, is how encryption will go to zero. However, the journey is more exciting than the destination. The death of FTX, an exchange that declared bankruptcy on November 11th after a spectacular explosion, will encourage some people to turn their attention elsewhere. What needs to happen for everyone to give up?

The answer requires an idea of ​​how the industry works. At the base of cryptocurrencies are block chains, such as Bitcoin and Ethereum, that record transactions that have been verified by computers, a process catalyzed by the issuance of new tokens. The Ethereum blockchain validates lines of code, which has made it possible for people to issue their own tokens or build applications. These include stablecoins, which are pegged to real-world currencies, and tokens like Uniswap, which run decentralized finance (DeFi) protocols. Mainchains and a few Ethereum-based tokens, such as stablecoins, account for 90% of the cryptocurrency’s value. Big corporations are built on top of this world, including stock exchanges, investment funds, and lending platforms.

Taking out cryptocurrency completely requires killing the underlying layers of the blockchain. They can either make way first, by expelling feces from under everything else. Or the industry can unravel from top to bottom, layer by layer like a knitted scarf.

Passing feces is very difficult, and the current high value of bitcoin and ether makes it even more difficult. To attack and shut down the blockchain requires having 51% control over the computational power or value of the tokens stacked to verify transactions. The higher the value of the token, the more power it takes to attack a Proof-of-Work chain, like Bitcoin, and more money to attack a Proof-of-Stake chain, like Ethereum. The security of these chains – as measured by how much someone would have to spend to attack them – is now between $5 billion and $10 billion. To launch such an attack would require either a government or a very wealthy individual. And even if Elon Musk is so inclined, he seems a little preoccupied nowadays.

So the collapse is the most conceivable path. The events of this year revealed just how viable this type of cryptocurrency is. The implosion that appears to have unleashed the chaos is Terra Luna, a decentralized stablecoin, worth about $40 billion at its peak. It crashed in May, wiping out $200 billion from the cryptocurrency market cap. This led a few weeks later to the bankruptcy of several lending platforms and a hedge fund, wiping another $200 billion from the market cap. The margin calls these platforms faced appear to have put Alameda, a trading company owned by Sam Bankman-Fried, at risk, and led to the decision to use ftx clients’ funds to bridge the gap. When ftx failed, it wiped another $200 billion from the cryptocurrency market cap. Now other exchanges and lending platforms seem to be in trouble.

Small-eyed readers will notice that most of these things, aside from Terra-Luna, are in the “on top” category and not actually on the technology chain. DeFi exchanges and lending protocols have continued to fluctuate even as business-like institutions have collapsed one by one. But the collapse of these companies could put the underlying technology at risk by removing parts of its value, making the chains more vulnerable to potential attackers and prompting miners or executors to turn off their machines. The value of on-chain activity and self-reinforcing tokens. The more people use DeFi, the higher the value of Ethereum. The higher the price of ether, the higher the hurdle for attacking the blockchain and the more confident people are that the blockchain will survive. This also works the other way around. The more people shy away from cryptocurrencies out of fear, the less secure they become.

The total cryptocurrency market cap is currently $820 billion. This is 70% down from the peak a year ago, but still high compared to most of cryptocurrency’s history. It’s higher than it was at the beginning of last year, for example, and any point before that, including the peak of the bull market in 2017. Many other layers — like a major stablecoin, large companies, or maybe other on-chain protocols — It would have to crash to bring the value of the cryptocurrency back to the levels it traded just three or four years ago. Crypto’s reputation has been undermined before. His worth collapsed again and again throughout his life. Although fewer people will be using cryptocurrencies as a result of the ftx crash, it is very difficult to imagine that the number will be small enough to take its value to zero.

© 2022 The Economist Newspaper Limited. All rights reserved.

From The Economist, published under license. Original content can be found at https://www.economist.com/finance-and-economics/2022/11/23/how-crypto-goes-to-zero


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