"The bubble of a generation" - ECB highlights 3 dangers of cryptocurrencies

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Investing.com - In what is yet another testament to the ECB's aversion to cryptocurrencies, Fabio Panetta, a member of the European Central Bank's board of directors, gave a speech on Wednesday in which he methodically outlined the flaws and damaging effects on the economy of Bitcoin and other crypto-currencies.

Cryptocurrencies are "the bubble of a generation" that is "doomed to burst", and are just a "new way of gambling" he explained.

To support his opinion, he put forward three specific arguments: The uselessness of cryptos from a social point of view, the risk posed by the illusion of security of stablecoins, and the danger of the high leverage used by crypto traders.

Cryptos are useless from a social point of view and harmful from an environmental point of view

Panetta noted that "unbacked crypto-assets do not perform any socially or economically useful function," pointing out that "they are not used for retail or wholesale payments" because they are all "too volatile and inefficient."

Cryptos, on the other hand, are "widely used for criminal and terrorist activities, or to evade taxes," according to him.

Panetta also pointed out that cryptocurrencies "can cause huge amounts of environmental damage."

He feels that "crypto-assets deemed to have an excessive ecological footprint should also be banned," referring to cryptos such as bitcoin that use an energy-intensive "proof-of-work" network security mechanism.

The illusion of security in stablecoins

The second major flaw in cryptocurrencies noted by Panetta concerns "the purported stability of stablecoins, which the entire crypto ecosystem has relied on."

He explained that stablecoins "appeal to users because it is claimed that, unlike unbacked cryptos, they provide stability by having their value tied to a portfolio of assets," making the distinction with algorithmic stablecoins, which "aim to match supply and demand to maintain a stable value."

Referring to the TerraUSD stablecoin crash earlier this year, however, Panetta asserted that "stablecoins are stable in name only," pointing out that even the stablecoin leader Tether "temporarily lost its peg amid the ensuing market stress," which he said shows that "even for collateralized stablecoins, risks cannot be eliminated easily."

The risk of excessive leverage offered to crypto traders

Finally, the third structural weakness of cryptos noted by Panetta "is the fact that crypto markets may have incredibly high leverage and interconnections."

He pointed out that "crypto exchanges allow investors to increase exposures by up to 125 times the initial investment," explaining that "when shocks hit and deleveraging is needed, they are forced to shed assets, putting strong downward pressure on prices"

Panetta also lamented the mechanisms behind this leverage, with "pervasive over-collateralization adopted in DeFi lending to compensate for the risks posed by anonymous borrowers."

Indeed, he explained that "funds borrowed in one instance can be reused as collateral in subsequent transactions, allowing investors to build large exposures," pointing out that "these are precisely the dynamics we have seen at work in the recent crypto failures," referring here to the FTX bankruptcy.

Translated from French.