President Trump’s newfound love affair with cryptocurrencies and his announcement that the United States will become the crypto capital of the world is being applauded as the dawning of a new era. Cryptocurrencies have surged in value, particularly given the president and his family’s entrance into that market.
However, crypto advocates may want to pump the brakes a bit after reading his Jan. 25 executive order — cryptocurrency is an asset like no other and will demand a customized form of regulation.
While the order extols the virtues of digital assets, it also invokes the Washington solution of creating a “working group” of a dozen government entities to “propose a federal regulatory framework” and new “provisions for market structure, oversight, consumer protection, and risk management.” These are hardly words that will comfort crypto libertarians.
The working group can set the tone for the next decade of digital asset regulation, so there are several fundamental principles that should guide it.
First, digital assets such as floating rate cryptocurrencies and stablecoins are unique multiple personality products because they purport to act both as investments and money. Instead of continuing the debate about whether cryptocurrencies are securities or commodities and should be regulated by the Securities and Exchange Commission or Commodity Futures Trading Commission (both charter members of the working group), it should recognize the uniqueness of cryptocurrencies and develop a form of regulation that addresses the new financial benefits and risks they create. Policymakers are wasting time trying to shoehorn cryptocurrencies into obsolete regulatory boxes that already exist rather than the ones they ought to be creating.
Second, if people want to risk their money on speculative investments, digital or otherwise, they should have that right. But crypto and its impact on economic stability is like nothing we have seen before — it doesn’t exist without a computer that can decipher an algorithm embedded in a blockchain of encrypted messages.
Arguing that it is digital gold is far too simplistic a comparison. Some cryptocurrencies like Bitcoin were created by people or groups we can’t even find, and floating-rate crypto coins have no intrinsic value and aren’t tethered to anything that produces income or can be liquidated. Those are hardly characteristics that have traditionally attracted huge amounts of capital.
Third, we often hear that the $3 trillion worth of crypto that has been issued is insignificant, and that if the worst were to happen, and those holders all lost their money, it would not be a problem for the rest of us. That is no longer true.
As more of our traditional securities, payments and financial services markets incorporate unregulated cryptocurrencies into everyday transactions, novel risks are being embedded into those markets. There is a ballooning crypto derivatives market that has been blessed by the SEC and embraced by Wall Street; it now boasts a monthly trading volume of about $1.5 trillion. And if you add to that the leverage and margin created to purchase such crypto products, the industry is clearly approaching a size that could impact global financial security even before you consider its role as money.
Fourth, because cryptocurrencies cannot replicate the price stability and implicit guarantees that government-sponsored fiat currencies offer, they have not yet been able to penetrate traditional retail markets to claim a legitimate role as money. The exception is their preeminent role in financing global crime, including illegal drugs, human trafficking, weapons smuggling, child sexual abuse material and terrorism. The working group must take note. If such unregulated digital assets do fully infiltrate traditional payments systems, impact monetary policy, affect market liquidity and drive legitimate commerce without significant regulation, we risk a global economic crisis if — or when — cryptocurrencies collapse from the weight of their own vagaries and misdeeds.
Fifth, cryptocurrencies have earned their own form of regulation that addresses the growing risks created by their dual personalities. That would normally require today’s banking, securities and commodities agencies to regulate together — an approach that has always been hit or miss at best and will not work with cryptocurrencies. Surprisingly, the president did not place anyone from the bank regulatory agencies on the digital asset working group to provide the financial expertise that none of the other participants have. At the very least, that must change if we are to take its work seriously.
And sixth, while we may cringe at the thought of another agency being created, since we hardly need all that we have in the financial services area today, a new regulator armed with all the requisite expertise may be the best path to crypto financial stability. A sound financial industry needs full and accurate disclosures and adequate levels of capital and liquidity to protect consumers. Those things can only be attained if a smart regulatory system is put in place. Cryptocurrency will never be mainstream if it produces more Sam Bankman-Frieds and Changpeng Zhaos.
Trump’s working group provides a forum to expose the risks that are being created by unregulated digital assets to adult discussion that can lead to a new form of oversight that safely balances their benefits and risks. Our financial future depends on it.
Thomas P. Vartanian, a former senior banking regulator and practicing attorney, is the executive director of the Financial Technology and Cybersecurity Center. He is the author of “The Unhackable Internet” and “200 Years of American Financial Panics.”
