Crypto, Bitcoin and other forms of digital technology that store value and/or make payments are the rage these days, particularly among younger folks not brought up on bank accounts, check books, and credit cards. The newer forms of storing value or making payments clearly offer value and solve some problems, but it is also clear they pose very substantial risks that must be addressed very soon by policy makers throughout the world. The last thing we need right now is another economic meltdown or blowup similar to what we experienced in the 1980s and 2008-2100. My longtime friend and colleague, Tom Vartanian has written another article on this subject which I urge you to read.
Crypto mania is in full swing. Some people just can’t get their heads around it, and others can’t get enough of it.
Watching the testimony last week of six innovative leaders of crypto-asset firms before the House Financial Services Committee was an educational experience. They explained the crypto phenomena like astrophysicists talking about the dark matter in the universe that we don’t yet understand. But I found myself wondering about the questions that went unasked, particularly what long-term risks crypto assets may pose to national and global economies.
There is already about $3 trillion of cryptocurrency trading throughout the world. Those crypto products are being used and sliced and diced into another $2.7 trillion of derivative crypto-securities traded on traditional markets and crypto exchanges.
Assuming that some of these financial instruments are purchased on margin or otherwise leveraged, we are talking about a potential crypto global footprint approaching $10 trillion. Except for stablecoins, those are financial instruments supported by little if any intrinsic value beyond the decentralized networks that create and transmit them.
Some take solace in the fact that if a crypto market collapsed due to some form of cyberattack, for example, no taxpayer would directly lose money. After all, crypto is not insured by the FDIC or SIPIC, and many investors are just that — investors. But that ignores how smaller financial issues can cascade into global panics as confidence dissipates.
Digital money has been around for quite a while in wholesale form. The Federal Reserve, banks, clearinghouses and exchanges have traditionally “moved” money without physically “moving” it through electronic book entries and the daily netting of transactions between businesses and financial intermediaries communicating largely through proprietary networks. No significant effort to create digital money for consumers occurred until companies introduced smartcards and digital wallets to transmit electronic money in the late 1990s.
I participated in the Mondex electronic money and smartcard beta test in Swindon, England, in the mid-1990s and worked with an alphabet soup of regulatory agencies on the issues that these products created. Unfortunately, consumers were not prepared to swap cash and credit cards for smartcards, regulators were skeptical and merchants saw no reason to spend millions to retool point-of-sale terminals and upgrade software programs.
When whoever Satoshi Nakamoto is introduced bitcoin in 2009, it ignited a second round of digital money euphoria. A new generation of digital pioneers were eager to once again experiment with new, real-time methods of creating and moving retail money that could be more efficient and cost-effective. But money and payments systems are as much a product of trust and confidence as they are convenience and effectiveness. Crypto seems to have transcended these values by creating a new category of “aspirational money” that lies somewhere between money and a security.
Crypto products are innovative and will ultimately transform the next generation of financial services products and delivery systems. There is no stopping that progress. Blockchain and technologies like it boast of relying on a new “peer-to-peer” system of transaction validation instead of traditional trusted intermediaries such as banks. It may be more accurate to say that blockchain substitutes traditional intermediaries with new ones. In any case, these new platforms offer a glimpse of a future that purports to “cooperatize” financial networks by allowing crypto miners and investors to “own” a portion of the ones they create.
Proponents argue that such an end-run around banks and Big Tech companies create systems that “should” be safer because of the way that blockchains eliminate the centralization of data and require every user’s approval to generate or change it.
Similarly, they point out that inconsistent regulation across borders will inevitably shove the developments of new technologies into geographic sanctuaries that are willing to accommodate them.
There is both truth and salesmanship to these arguments. We need progress to grow, and the drive of pioneers helps to realize that progress. But as even the crypto executives volunteered before Congress, we also need a balancing of interests.
I evaluate progress through the eyes of a financial services pragmatist, understanding that since 1980 more than 3,500 financial companies have failed in the United States. Not everything goes the way it is planned. The benefits, efficiencies, inclusiveness and cost-savings that blockchains and crypto assets can produce must be vigorously pursued. But as we tap the benefits of groundbreaking new financial products, everyone – entrepreneurs, users, legislators, regulators and system providers – should understand the new risks and how they must be managed.
Global financial services markets come under strain when there is a rapid migration of money and capital from traditional sources to alternative systems. The events leading up to the financial panics of the 1980s and 2008 are evidence of that. Simply replace money market funds and subprime mortgages with crypto assets, and the picture gets a little clearer.
But even more concerning is the obvious insecurity of the internet. Can crypto banks and exchanges guarantee that the coins they store will always be there in the morning, or that the data they control is protected?
Similarly, should central banks be introducing digital currencies because they can, or only when they know that they will withstand the unrelenting cyberattacks that will inevitably come? In such an increasingly insecure ecosystem, it is hard to imagine crypto assets not aggravating financial stability risks, even before the impact of quantum computing is felt and every form of online security today must be revamped.
The potential threats created by cryptocurrencies would be easier to deal with if we had a safer and more secure internet, greater online transparency, smarter regulation, global online security protocols, absolute authentication and standardized rules of conduct in the virtual world backed up by enforcement capabilities. Unfortunately, we don’t have any of those things.
We must do a better job of balancing the innovation, speed, efficiency and attractiveness of new crypto products with their potential impact on the security and stability of financial systems. If we do, we will avoid a larger economic price tag down the road. The choice is ours to make.
Thomas P. Vartanian is executive director of the Financial Technology & Cybersecurity Center and the author of “200 Years of American Financial Panics: Crashes, Recessions, Depressions And The Technology That Will Change It All.”