It’s time to get serious about regulating cryptocurrency
If regulation means fewer people will 'get into crypto,' that's not a bad thing.
This week I had the privilege of writing a guest column for Josh Barro's Substack while he was on vacation. Josh is one of my favorite writers and I highly recommend checking out his newsletter and associated podcast. He’s a great interviewer and a consistently independent and insightful writer about politics and policy. I’ve reproduced my guest column below.
Last February, comedian Larry David starred in a Super Bowl ad hawking the cryptocurrency exchange FTX. In a series of faux-historical scenes, David dismissed some of humanity’s greatest and most useful inventions—including the wheel (“I don’t think so”), coffee (“it’s awful,”), and the lightbulb (“it stinks”).
In the final scene, a man tells modern-day Larry David that FTX is a “safe and easy way to get into crypto.”
“Eh, I don’t think so,” David replies. “And I’m never wrong about this stuff.”
“Don’t be like Larry,” the commercial concludes. “Don’t miss out on the next big thing.”
“Larry” was vindicated last month when FTX filed for bankruptcy and admitted it had lost around $8 billion in customer deposits.
FTX’s campaign to get more people “into crypto” went far beyond Super Bowl ads. Last year, FTX bought naming rights to the stadium where the Miami Heat plays basketball for $135 million. FTX signed endorsement deals with famous athletes like Tom Brady and Steph Curry. And recently FTX CEO Sam Bankman-Fried has spent a lot of time in Washington lobbying for legislation to allow more widespread use of cryptocurrency in the US.
We now know that FTX was a bad way to “get into crypto,” but the larger question is whether ordinary Americans should be getting into crypto at all. Over the last decade, policymakers in the US and much of the world have taken a hands-off approach to cryptocurrency to avoid strangling a supposedly promising technology in its cradle. But cryptocurrency isn’t so new any more, and it doesn’t seem to be living up to the early hype.
In recent years a lot of people have “gotten into crypto” as a speculative investment, as a way to buy illicit drugs or to make ransomware payments. But we’re still waiting for truly mainstream uses like purchasing a cup of coffee.
And since that FTX Super Bowl ad aired, a lot of ordinary people have lost their investments in ways that US financial regulations are designed to prevent. Maybe it’s time for policymakers to stop treating the crypto industry with kid gloves and start rigorously enforcing those laws. If that means a lot fewer people using or investing in cryptocurrency, that wouldn’t necessarily be a bad thing.
One of the first times bitcoin was mentioned in a mainstream news story was in June 2011, when reporters started writing about the bitcoin-based drug marketplace Silk Road. The site’s existence drove Sen. Chuck Schumer (D-NY) nuts.
“Literally, it allows buyers and users to sell illegal drugs online, including heroin, cocaine, and meth, and users do sell by hiding their identities through a program that makes them virtually untraceable," Schumer said. He called the Silk Road “the most brazen attempt to peddle drugs online that we have ever seen,” and described bitcoin as “an online form of money laundering used to disguise the source of money.”
I started writing about bitcoin around this time, and back then there seemed to be a real possibility the US government might try to shut down the bitcoin network. US law requires payment networks to follow “know your customer” rules and report suspected money laundering to the authorities. The bitcoin network not only doesn’t do this — it’s designed to make compliance impossible.
In May 2013, the feds shut down a digital payment network called Liberty Reserve that the government said was heavily used for money laundering. As I pointed out at the time, the US government’s arguments against Liberty Reserve could easily be used against Bitcoin. Indeed, I believe this is a big reason Satoshi Nakamoto chose to create Bitcoin using a pseudonym: If he had identified himself, he might have wound up in prison like Liberty Reserve founder Arthur Budovsky.
But early bitcoin advocates convinced US officials that it was better to take a hands-off posture. The network’s decentralized structure meant that it would be almost impossible to shut it down. Stopping US-based bitcoin activity would simply push the network overseas — potentially beyond the reach of US subpoenas.
These arguments persuaded the Obama administration, which signaled in late 2013 that no crackdown would be forthcoming. At a November Congressional hearing, a Justice Department official praised bitcoin’s “many legitimate uses.”
This had a big impact on the bitcoin ecosystem. Venture capitalists poured hundreds of millions of dollars into bitcoin-related startups in 2014, and prominent venture capitalists started to tout the technology.
In 2014, a little-known 20-year-old named Vitalik Buterin launched the Ethereum network with a crowdsale of its cryptocurrency, ether. People copied his approach, and by 2017 there was a craze for “initial coin offerings,” with hundreds of new coins being offered for sale.
Once again, there was a plausible case that most of this activity was illegal. US law requires anyone selling stocks, bonds, or other securities to register with the Securities and Exchange Commission (SEC) and follow complex rules designed to protect customers against fraud. A lot of these crowdsales seemed to be covered by US securities laws, yet very few of them followed the SEC’s rules.
But for the first year or two, the SEC mostly looked the other way, only prosecuting a few of the most egregious frauds. When Biden’s SEC chairman, Gary Gensler, took office in 2021, he had a mess on his hands. His predecessor’s hands-off posture had enabled the development of a sprawling industry that was largely out of compliance with SEC rules and — perhaps not coincidentally — also rife with scams, conflicts of interest, and other problems. Gensler started pressing for stricter enforcement of securities laws, but he faced pushback from cryptocurrency companies, their backers in the venture capital world, and their allies in Congress.1
Launch first, change the law later
Cryptocurrency isn’t the first new technology to fit awkwardly into existing legal frameworks. It’s interesting to compare it to the ride-sharing model that Lyft pioneered—and Uber quickly copied—in the early 2010s.
A decade ago, most big cities had taxi regulations that didn’t allow someone to just start offering people rides in their personal vehicle. Rather than getting cities to change their laws, Uber and Lyft largely ignored the laws and launched their services anyway. They were gambling that they could quickly build a large customer base that would then help them lobby for changes in the law.
Uber and Lyft argued the rules were outdated and propping up a corrupt taxi monopoly. It helped that there was some truth to these critiques, but the main reason their lobbying succeeded was that their services really were better. Customers came to depend on the convenience of hailing a car with their smartphones, and that created a strong constituency to let them keep operating.
Over the last decade, the cryptocurrency industry has been pursuing a similar strategy. They’ve warned that strict enforcement of existing laws could strangle a promising technology in its cradle. And they’ve built a community of bitcoin users and investors who have lobbied for pro-bitcoin legislation.
But I think that — as with ride sharing — the success of this lobbying will depend on whether cryptocurrency actually proves useful. And while the utility of Uber and Lyft was obvious, the value of blockchain technologies is not. The longer things continue this way, the harder it will be to argue that governments need to give crypto more time to prove its value.
Waiting for cryptocurrency’s killer app
Early advocates thought bitcoin would become a mainstream payment system that people would use for everyday purchases. And they also expected it to open up a lot of other new possibilities.
In a 2014 interview, for example, venture capitalist Marc Andreessen imagined a scenario where someone drives their car into a parking garage and then the car uses bitcoin to automatically reserve and pay for a parking space. He also talked about the potential to use bitcoin-based micropayments to prevent spam by charging a fraction of a penny for each email. If ideas like this had panned out (and at the time I thought they might) the early hype would have been justified.
But over the last decade, venture capitalists have poured billions of dollars into cryptocurrency startups exploring ideas like this:
There were startups to help businesses accept bitcoin payments.
There were plans to have large companies use blockchains to track their supply chains.
People tried to use blockchains to build apps that did a better job of protecting user privacy.
There were plans to use smart contracts to build decentralized autonomous organizations.
Some of these efforts are still around in some form, but after a decade of experimentation, we seem to be no closer to building blockchain-based applications that are useful to ordinary Americans. The applications that have thrived have mostly been tools that let people speculate on the value of tokens. That certainly describes the two most recent cryptocurrency crazes, non-fungible tokens and decentralized finance (DeFi).
DeFi uses blockchains to enable people to directly borrow, lend, and trade cryptocurrencies. While the technology is fun for finance nerds to think about, it doesn’t really work as finance. The conventional financial industry funds the construction of homes, office buildings, factories, and so forth. The decentralized finance industry only seems to “finance” gambling on cryptocurrencies.
And there’s a good reason for that: a core feature of most cryptocurrencies is that transactions are irreversible. If a hacker steals your bitcoins, you generally won’t have any recourse because no one has authority to reverse transactions. But nobody would want the real estate system or the stock market to work like this, because it would mean that hackers could steal your house or your retirement savings.
A technology for freedom
Ultimately, I think the most valuable application for blockchains is the one that hard-core bitcoin advocates have focused on since the beginning: freedom from government interference.
This isn’t that valuable in a developed country like the United States. We’re blessed to have a stable currency, a functional financial system, and a government that largely respects individual freedom.
But it’s not hard to see how bitcoin could be attractive in countries without these advantages. If your country suffers from hyperinflation, then bitcoin’s independence from government control might be quite valuable. Usage of bitcoin may be growing in Argentina for this reason. It’s not hard to see how bitcoin could be useful to dissidents in authoritarian countries.
But for bitcoin to be a useful technology for resisting government overreach, it’s important that people have custody over their own bitcoins rather than relying on intermediaries. When I first invested in bitcoin back in 2012, the existing bitcoin exchanges seemed shady so I printed out my private keys (strings of letters and numbers that control access to bitcoins) on a piece of paper and put them in my filing cabinet. Today there are “hardware wallets” that make this easier than it was a decade ago, but it still requires a certain level of technical sophistication to do well, and there’s still a real risk that your coins could be lost or stolen.
This created a market opportunity for intermediaries like FTX. FTX told ordinary users that its platform provided users with all the benefits of cryptocurrencies while being “safe and easy.” Obviously, that was wrong as far as FTX was concerned, but bitcoin purists argue that it’s wrong in a broader sense too: that the whole point of bitcoin is to avoid relying on intermediaries like FTX.
If you buy this argument, one implication is that we shouldn't worry too much about excessive government regulation of the cryptocurrency industry. The core bitcoin network is robust — so robust that the US government probably couldn’t shut it down if it tried to. And the most valuable applications of cryptocurrency don’t actually require an extensive cryptocurrency industry, since they involve people taking direct ownership of their own coins.
If US regulators had been enforcing existing US law in a rigorous fashion over the last decade, much of the contemporary crypto industry wouldn’t exist. Many — perhaps even most — cryptocurrencies are probably securities under US law, which means that they shouldn’t have been sold to non-wealthy Americans without first undergoing extensive due diligence.
There are also serious questions about whether leading crypto exchanges are following applicable US regulations pertaining to money laundering and the safekeeping of customer assets. And there are long-standing questions about the solvency of “stablecoins” like Tether.
So far, the SEC and other regulatory agencies have proceeded gingerly in this area. One reason is that the cryptocurrency industry has cultivated powerful allies in Congress. Back in March, eight members of Congress sent a letter to the SEC basically complaining that the agency was investigating cryptocurrency companies too aggressively.
The collapse of FTX is likely to change the politics of this issue and focus the minds of regulators. Perhaps now they’ll make a serious effort to shut down the many shady companies that operate at the margins of US law.
And hopefully that will mean a lot fewer celebrity endorsements and and a lot fewer Super Bowl ads encouraging ordinary Americans to invest in cryptocurrency. Because most Americans shouldn’t invest in cryptocurrency—both because it’s unlikely to be a good investment and because most Americans lack the technical skills required to do it safely.
Thanks to Josh for asking me to write this piece. Please check out his excellent Substack, Very Serious.
The New York Times recently described a March 2022 meeting between Gensler and FTX CEO Sam Bankman-Fried. Bankman-Fried and his colleagues were trying to convince Gensler to allow FTX to expand its operations in the US, but “at about the second slide, Mr. Gensler cut them off and launched into a roughly 45-minute lecture on his vision for crypto regulation, preventing any further discussion.”