The President’s Working Group on Financial Markets has released its long-awaited report on how to regulate “stablecoins,” one of the many types of crypto assets that have emerged in recent years.
Most people don’t really understand what crypto is or why they should care about it, but the growth of crypto poses significant risks for our financial system — and when our financial system fails, our broader economy fails with it. On top of that, the crypto markets are awash in scams, ransomware, tax evasion, hacks, market manipulation and glitches (and then there are the steep environmental costs of processing crypto transactions).
There are, therefore, lots of reasons for regulators to be concerned about crypto. The good news is that the report recommends that regulators continue to use their existing authority to respond to the threats posed by stablecoins. The potentially bad news, though, is that the report treats this as a stopgap measure until Congress can respond. Why might this be a problem? Because Congress is besieged by hordes of pro-crypto lobbyists, hawking crypto as a solution to the problems that people and businesses face in accessing financial services. These problems are real, but many of the lobbyists’ claims are myths that deserve to be busted.
- Myth #1: Crypto will democratize finance. Right now, most people use crypto to bet on movements in the crypto market, not to make payments. Crypto transactions are currently much more expensive than traditional forms of payment, and the vast majority of crypto assets are held by a few crypto “whales” instead of underserved people and businesses. Maybe these problems will be addressed at some point in the future, but how long should we be expected to put up with crypto’s risks while waiting for cheaper financial services for the masses? Crypto has been around for more than 12 years and still hasn’t delivered applications that are useful for much other than trading crypto.
- Myth #2: All financial innovation is good. Sen. Pat Toomey (R-Pa.) recently warned Treasury Secretary Janet Yellen not to interfere in the development of stablecoins because regulation would “cause tremendous damage to an emerging technology.” This was reminiscent of the blind faith in innovation that led to the enactment of the Commodity Futures Modernization Act in 2000. That legislation prohibited regulators from looking at swaps, and without regulatory oversight, the number of credit default swaps grew exponentially until they became the “weapons of mass destruction” that helped ignite the 2008 financial crisis. Those swaps had at least some tenuous connection to a real-world asset, but there’s no limit on the number of crypto assets that can be manufactured. The exponential growth of crypto could lead to financial markets that are far more bloated than we’ve ever seen before, and yet the real economy may still be called upon to bail them out.
- Myth #3: Crypto gets rid of intermediaries. The claim that crypto gets rid of financial intermediaries is neither accurate nor realistic. The crypto-verse is filled with intermediaries, including self-hosted wallets (where investors store their crypto), exchanges (where investors exchange sovereign currencies and crypto) and miners (who charge fees to validate crypto transactions — and can profit from their power to decide which transactions to approve and in what order). Some more familiar intermediaries are involved too — Goldman Sachs, for example, is providing an ever-expanding range of ways for its clients to invest in crypto, and JPMorgan offers its own JPMCoin.
- Myth #4: Crypto can take care of its own risks. SEC Commissioner Hester Peirce recently complimented crypto communities on their ability to “collectively figure out how to deal with unanticipated problems.” But claims that crypto markets can take care of themselves rest on the same kinds of assumptions about self-correcting markets that Alan Greenspan conceded were wrong after the 2008 crisis. In particular, we shouldn’t assume that those involved in the crypto markets have either the incentives or information needed to address the problems that crypto can create for the broader economy.
- Myth #5: You just don’t get it. If all other arguments fail, crypto defenders will sometimes assert that regulators “just don’t get it.” This is an “Emperor’s New Clothes” myth trotted out in the hope that regulators (and other policymakers) will be too afraid to admit they see nothing to get. Hopefully busting the previous myths will help bust this one too — while the House did just pass tax reporting requirements for crypto despite aggressive lobbying, the lobbying won’t stop.
If both Congress and regulators fail to restrain crypto assets going forward, then we’re in big trouble.
Hilary J. Allen is a professor at the American University Washington College of Law, and the author of the new book “Driverless Finance: Fintech’s Impact on Financial Stability.”