No one, let alone the government, is in a good position to know what the long-term effects of a potentially disruptive innovation will be.
This week, the President’s Council of Economic Advisers (CEA) issued its annual report, which contained an entire chapter devoted to digital assets. When it comes to cryptography, the report is both critical and lukewarm, as if its task for the cryptography chapter was to "make the case that cryptography is overrated but could be useful someday." Even though the report isn't all bad, it doesn't see much value in the current crypto ecosystem, especially when compared to the federal government's own financial products and tools.
The way a government evaluates an instrument that needs to be regulated shouldn't affect how that instrument is regulated. When it comes to crypto, the CEA report makes claims that can be questioned and has internal inconsistencies that show why making a decision about the value of a class of technology or financial instrument ahead of time is not likely to help us predict the future or make good policy.
The report was biased against crypto from the start, saying that the way crypto assets are made "often shows a lack of understanding of basic economic principles." Crypto is a lot of things, but one of them isn't usually a lack of understanding of basic economics. The design of Bitcoin, the first cryptocurrency, shows a deep understanding of game theory, whether or not you like the asset class it created. The Bitcoin protocol solved "The Byzantine Generals Problem," which is the problem of coordinating action in a distributed system where some actors might not be trustworthy. So, it may not come as a surprise that economists Bhagwan Chowdhry and Tyler Cowen have said that Satoshi Nakamoto and Vitalik Buterin, the creators of Bitcoin and Ethereum, should win Nobel Prizes in economics. Even though the report is snarky, the CEA does acknowledge (albeit lukewarmly) that a peer-to-peer network that lets people who don't trust each other "transact securely" is a "notable achievement of computer science."
The report often uses negative language and contradicts itself when it comes to the facts. For example, the report tries to make hay out of the claim that "most crypto assets have no fundamental value," unlike, say, "commodities like gold and silver." Is the Biden CEA a place where gold bugs congregate? Unlikely. In fact, the report says, "[i]n fact, sovereign money does not have a fundamental or intrinsic value either." However, it still does what money is supposed to do, which has been said many times (e.g., being a medium of exchange, unit of account, and store of value). So, does the report find that these functions aren't met by cryptocurrencies? No, in fact. According to the CEA, cryptocurrencies do "serve each of these functions right now," but only "in limited ways in the United States."
The report says that these problems show that cryptocurrencies are not "a good replacement for the U.S. dollar." One of the main points of the CEA's digital asset chapter is that the government's own products and tools, like the dollar, a regulated banking sector, and the upcoming FedNow instant payment system, are already better than crypto alternatives or are likely to be in the future. Any government group that sees private payment innovations as competitors will find it hard to look at them in a fair way. When a government body sets rules based on how good it thinks its competitors are, the rules will be based on a core conflict of interest.
The part of the report about stablecoins is a great example of how a biased view can paint financial innovations into a corner where they can't win. The CEA says that the biggest problem with stablecoins is that, like bank deposits, they "can be subject to run risk." However, unlike bank deposits, stablecoins are not "subject to a comprehensive set of regulatory and supervisory requirements." This review isn't very good for a number of reasons. For one thing, the failure of Silicon Valley Bank showed that regulation does not protect banks from runs. Stablecoin reserves can also be kept in banks, which makes them part of the banking system anyway. (And, in any case, there are other ways to deal with stablecoin reserve risk, since a simple framework for collateral and disclosure could do the job more easily.) But the CEA report also worries that stablecoins could be too safe. It worries that stablecoins fully backed by safe assets could beat bank deposits, which could make it harder to get credit.
The short discussion in the CEA report about how securities laws might apply to crypto projects is just as confusing. The report says that "stocks are claims on the future profits of firms and debt is a claim on interest and principal payments," but that "unbacked crypto assets" are "traded without fundamental anchors" and probably aren't "claims on cash flow" because they are not backed by anything. In that case, the CEA should call the head of the Securities and Exchange Commission, Gary Gensler, as soon as possible. Gensler has said that "everything but bitcoin" involving crypto projects is a securities arrangement. In enforcement actions, the SEC has said that crypto projects have been selling unregistered securities like profit-sharing to users. This week, the cryptocurrency exchange Coinbase got a Wells notice about a possible SEC enforcement action. The action could be related to Coinbase's listing of digital assets, its staking as a service product, and other parts of its business, according to the notice.
The CEA must know this general background because the report says, "One of the main areas where there is mass noncompliance is disclosure around crypto assets that are securities. This lack of information makes it hard for investors to see that most crypto assets have no real value. There's a lot to figure out, but a few things stand out. One, the CEA goes back on what it said before, which was that crypto assets are mostly different from equity and debt securities. And two, the CEA should bring up its own observation that "digital assets require at least some regulations to be updated" with the SEC. So far, the SEC has refused to officially update its own regulations to fit the specific risk profiles of crypto projects, so crypto companies can't register their offerings.
The pitfalls in the CEA report show some of the problems that can happen when policy decisions are based on opinions about how good a new type of technology or financial instrument is. Even though the CEA recognizes some of the new things that crypto technology has brought about, the report's own contradictions show that they don't fully understand the ecosystem and are more likely to have a negative view of it. Neither of these can be used to make good policy. Any government body will have limited information and knowledge, as well as biases, which will make it hard for it to make the best decisions about new technologies and products. No one, let alone the government, is in a good position to know what the long-term effects of a potentially disruptive innovation will be. Users should use technology and financial products based on how much risk they are willing to take. Instead of focusing on merit, policymakers should give entrepreneurs and developers the regulatory clarity they need and stop fraud against consumers. If not, American policymakers may regret that they turned away from crypto technology too soon.
