A Solution in Search of a Problem: Cryptocurrency and Institutional Trust

Imagine a cutting-edge new platform for economic development. It has value because everyone says it does. That value tends to fluctuate wildly. Accessing an account requires remembering a random string of letters and numbers. Some services allow users to use a traditional password, but if someone cracks that password or steals from that company, users are out of luck. Also, this proposed technology requires more energy than Argentina.

This is essentially the value proposition that underlies Bitcoin and other cryptocurrencies. The industry goes by many different names: decentralized finance (de-fi), crypto, and blockchain, but at its core, these systems all attempt to move away from the traditional financial sector and its regulation and central banks. Both blockchain and the cryptocurrency ecosystem represent a solution in search of a problem. These pseudo-financial assets look, smell, and act like securities, meaning Congress should pass legislation explicitly giving the Securities and Exchange Commission (SEC) permission to regulate the nascent industry. Only then can the expert regulators effectively end the endless series of grifts endemic to cryptocurrencies.

In the wake of the 2008 financial crisis, many disaffected Americans viewed the legacy financial system with distrust if not outright disdain. They felt that the rich and powerful had built a house of cards out of their personal finances and while Congress bailed out the banks, people like them were holding the bag. Movements like Occupy Wall Street embodied a feral scream aimed at monied elites who rode high on a financial system that had grown too complicated for main street consumers. In that environment, a pseudonymous figure named Satoshi Nakamoto published a white paper outlining a proposed fiat currency that relied on peer-to-peer distributed ledgers to create a monetary system. The short version: instead of having a central entity manage everyone’s account balances, all members of the network must receive all transactions to remain in sync. If this sounds inefficient, that’s because it is, hence the massive energy consumption.

The purported benefit of this protocol lies in decentralization. Cryptocurrency could replace Wall Street or the Federal Reserve with a “democratic” system of exchange instead of white shoe traders playing with risky assets and derivatives crashing the global economy. Unfortunately for these crypto utopians, they confused technological advancement comes with an ignorance of history. After multiple collapses of currencies, crypto-banks, and exchanges, both regulators and civil society must pick up the pieces and realize the underlying fallacy and regulatory future of the cryptocurrency industry.

Plenty of cryptocurrency’s core features all but doom its adoption. The volatility against traditional currencies or really anything else rules out use as a means of exchange or store of value. Cryptographic keys may make it secure but inaccessible for non-technical users. Decentralization may remove politics or legacy industries and their assorted baggage, but these institutions also provide deposit insurance, fraud protections, and fractional reserve banking (although some crypto advocates may point to that last one as a benefit to de-fi).

All this points to a larger issue with the legacy financial system: a loss of faith in institutions. The Federal Reserve, Federal Deposit Insurance Corporation (FDIC), Commodity Futures Trading Commission (CFTC), and SEC currently maintain the guardrails on the American economic system, an economic system that the rest of the world turns to as a refuge during times of uncertainty. While these institutions have had their share of mistakes and need significant oversight and attention, they oversee a system that provides sufficient safeguards for thriving capital markets.

For the future of cryptocurrency, policymakers need to rely on existing institutions to protect consumers from the ever-growing list of scams plaguing the nascent industry. Many advocates may find the overall value proposition of crypto to be dubious at best, but bringing this new technology under an effective regulatory framework provides the only way to uncover any potential benefits. Congress should explicitly declare that cryptocurrencies qualify as securities under the Howey Test. As such, they will have decided the “major question” of who should govern cryptocurrency. Opponents to this plan may say that the SEC will stifle innovation, but the SEC already oversees the American stock exchanges which maintain sufficient transparency for trustworthy innovation to lead the world in liquidity. Additionally, Congress must build up expertise in financial services to effectively oversee the aforementioned institutions to restore public confidence. Only through careful regulation and rulemaking can policymakers decide the future of cryptocurrency, as of now the wild, wild west approach is leaving far too many consumers in the lurch.