The Breakdown - Don't Ban Crypto! The Case for Pro-Innovation Regulation

Episode Date: April 30, 2023

On this edition of Long Reads Sunday, NLW reads "The Case for Regulating, Not Banning, Crypto" by the Blockchain Association's Kristin Smith. The article is a response to the growing argument against regulation.  Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribeto the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW “The Breakdown” is written, produced and hosted by Nathaniel Whittemore aka NLW. Research is by Scott Hill. Editing is by Rob Mitchell and Kyle Barbour-Hoffman. Our theme music is “Countdown” by Neon Beach.

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Sunday, April 30th, and that means it's time for Long Read Sunday. A couple quick notes before we dive in. First of all, there is an excellent breakdown community that I would love you to be a part of. We call it Breakers, it's on Discord, we chat about everything going on in the world of Bitcoin, crypto, macro, and even a little bit of AI. If you're interested in being a part of that community conversation, check it out at bit.ly slash breakdown pod.

Next, speaking of all sorts of different topics, the breakdown is now part of the breakdown network. It's an entire network of shows dedicated to big picture power shifts. Go look up Bitcoin Builders or the AI breakdown to get a sample of some of our other shows. Finally, if you were enjoying this show, I would so appreciate it if you would leave a rating or a review. All right, with that out of the way, let's get to our Long Read Sunday. Now, regular listeners will have heard me reference a number of times, a recent essay in foreign affairs by Professor Hillary Allen called The Case for Banning Crypto. Hillary Allen is a professor of law at American University, and she has appeared numerous times in front of Congress as a congressional witness about the crypto industry. The point being that she's not some fly-by-night critic, she is a respected and legitimate voice in Washington, D.C.,

Her argument is quite clear in this piece. It's that, as the subtitle says, blockchain's risks far outweigh its rewards. I don't need to go through piece by piece or line by line. A few weeks ago, I read a couple of rebuttals. It is notable that she threw many of the arguments that crypto advocates have right back in their face, including the idea that America could lose leadership and push crypto companies overseas. Alan basically says, we shouldn't want them here because this isn't an industry we should want to be a leader in. Anyways, I don't think that the point of this piece was actually Hillary Allen thinking that she could get people to ban crypto. I think the point of this piece was to shift the Overton window to include banning crypto as an option. If that's the case, it's obviously very important

to have voices who are also respected in Washington, bring the conversation back to a more middle ground. And for that, we turn to the blockchain association's Kristen Smith. Kristen is extremely sharp, you can go see her in my holiday interviews from last year, and she has just published a piece on coin desk called The Case for Regulating, not Banning Crypto. Kristen writes, American University professor Hillary Allen, who recently wrote an article titled The Case for Banning Crypto in the influential publication Foreign Affairs, is part of a very small cohort of, quote, crypto banners working toward that end. In addition to engaging the media, Alan and her peers are pushing the argument that crypto does more harm than good while speaking with

federal agencies. She is testifying before the congressional hearing on the future of digital assets on Thursday afternoon. The case for banning crypto is a pipe dream. It won't happen. By Allen's own admission, blockchain is a general purpose database technology that supports a trillion dollar industry employing thousands globally. Nonetheless, the efforts to ban, rather than regulate crypto, have only backfired and harmed Americans. Banning crypto is simply the wrong policy. The crypto industry instead should be effectively regulated. No use case for banning crypto. A complete ban of crypto is an unattainable distraction by the industry's naysayers, as Congress, the courts, and the international community have already rejected the idea.

Indeed, many in Congress support embracing and regulating crypto. This includes the Republican House leadership and heads of the most relevant economic committees, the House Financial Services Committee, and the House Committee on Agriculture. They work alongside progressive Democrats, such as representatives Richie Torres of New York and Rokana of California. Additionally, multiple U.S. senators have been willing to introduce bipartisan legislation on this issue, such as Senators Kirsten Gillibrand from New York and Senator Cynthia Lummis from Wyoming. These officials could block any attempts to quash crypto because the number is seeking to regulate crypto significantly outnumbered those calling for an outright ban.

Similarly, the White House has written that it seeks to work with Congress to regulate, not ban crypto. The courts are the next insurmountable obstacle. As Alan knows, Congress simply won't agree with her, and so she cheers on the efforts of allies at administrative agencies, such as the U.S. Securities Exchange Commission and banking regulators. But the courts would gut these efforts. Over the past several years, the Supreme Court has reigned in agencies operating beyond congressional mandate. First, agencies cannot make, quote, decisions of vast economic and political significance unless Congress has said clearly that it, quote, wishes to assign

that power to an agency. This is known as the major questions doctrine and was recently invoked in West Virginia v. Environmental Protection Agency in 2022. Banning crypto, an industry that supports tens of thousands of American jobs is a major economic question requiring Congress, not just the SEC or banking regulators to answer. Additionally, the SEC has failed to engage in any kind of rulemaking on crypto, and instead has resorted to bringing individual enforcement actions. The SEC's authority here, by its own admission, is, quote, transaction by transaction, not technology by technology.

And so a ban on crypto via enforcement action will require the SEC to prove that each digital asset is a security, and even that each transaction is a security offering. one by one in court. Since there are already thousands of tokens, it would likely take 400 years to get through these lawsuits against all existing tokens, according to the math of SEC Commissioner Hester Perce. The SEC has been in litigation against just one company, Ripple, for over two years. This kind of extended litigation could be the reason for the SEC's $411 million shortfall last year, a number that was surely only rise were the SEC to continue its futile efforts to pick off the industry one by one. So reality again gets in the way.

Finally, crypto is global, and other countries won't agree to ban crypto. Indeed, several nations are vying to be the capital of crypto, seeing the benefits of embracing and regulating a nascent industry. Those nations include the UK, Singapore, Japan, and France, along with the entire European Union, which passed a comprehensive and thoughtful markets and crypto assets regulation framework last week. US efforts to ban crypto will make it only easier for these jurisdictions to compete for American talent. Moreover, even if crypto companies leave the United States for greener regulatory pastures, it is unlikely that crypto would be quote-unquote banned for U.S. consumers seeking to access those platforms. Both FtX and Binance to quote-unquote foreign crypto exchanges that ostensibly geofenced U.S. users

had a large number of U.S. users using virtual private networks, shell companies, and other methods. Banning crypto in the United States means that foreign companies re-import even more and less controllable risk back into the United States. The International Monetary Fund has asserted that, quote, comprehensive regulations are preferred to blanket bans, because blanket bans, because blanket bans may, quote, stifle innovation, drive illicit activities underground, be costly to enforce, and motivate users to access illegal markets. Americans harmed. There has been a real cost to the obsession to ban crypto by figures like Allen and Senator Elizabeth Warren from Massachusetts. Their misguided focus caused them to miss

the real risks in the financial system that led to the collapse of three banks within a week, Silvergate, Silicon Valley Bank, and Signature Bank. According to Nellie Lang, the Undersecretary of the Treasury for Domestic Finance, crypto didn't necessarily. play a direct role in any of those bank failures. Yet the bank failures threatened the faith in the nation's banking system and could have destabilized the global economy in a way that none of the cryptocurrency failures could. The Senate Banking Committee where Elizabeth Warren sits, and which has jurisdiction on this issue, held 33 hearings last year. Four were on crypto, although the nation's systemic risk watchdog concluded crypto doesn't pose a systemic risk. Not one hearing was held on the banking

system's safety and soundness or the specific risks that banks pose. Beyond missing, the eventual realized risk of bank collapses, crypto banners also failed to protect Americans from the main bad actors in the cryptocurrency sector itself. Alan cheers on SEC Chairman Gary Gensler, but most of the largest crypto scams and failures harming Americans have happened during his watch, not those of his predecessors. Gensler has been a remarkably ineffective cop on the beat. For example, Gensler missed the collapse of the now infamous exchange F-TX. The banking regulators in the SEC cheered on by Alan have exhibited a clear pattern of misallocating resources away from real risks like banking collapses and crypto scammers and focusing their limited resources on attacking

the crypto industry as a whole, including its safest actors. Is crypto worth it? So the crypto banners are chasing a pipe dream and harming Americans, but are they right in theory? Do the harms of crypto clearly outweigh the benefits? No, the benefits of crypto outweigh the harms, which could have been prevented by good regulation. Further, the financial harms caused by crypto are overstated and not unique to the industry. Alan writes, The root of the problem is that cryptocurrency assets can be created at no cost and without limit, and an unlimited supply of assets makes a system more vulnerable to booms and busts. This sentence captures the essence of Alan's argument, and it's worth unpacking the weakness

of her assumptions and arguments. Crypto's root problem, according to Alan, is what economists calls zero marginal costs, the idea that the cost to produce each additional unit of a good or service typically approaches zero. This type of cost structure isn't unique to crypto and is well understood in economic literature. Many assets can be created at no cost without limit, including most software, broadcast radio, or TV reception, digital books, digital articles such as this one, digital songs, and even emails in a marketing campaign. This prevalent cost structure evidently doesn't lead inexorably to booms and busts. Investment assets, including the shares of publicly traded companies, may be created at no cost and without limit. Any company following the usual

corporate governance that crypto companies usually follow can decide to issue a nearly infinite number of shares without cost. Every startup in America could decide tomorrow to issue billions more shares, and that would likely not lead to economic calamity, because the booms and busts turn on people being willing to buy those shares. Finally, an overwhelming majority of the volume and value in cryptocurrency is in a handful of tokens that are created at great cost, not no cost, and with clear limits, not without them. Bitcoin and Ether, and one of the top stablecoins, USDC, account for over 70% of volume. One Bitcoin costs roughly $17,700, not zero, to mine, and there isn't an unlimited supply, but instead, a hard cap of 21 million tokens.

Unlike with shares, no single company can increase the total number of Bitcoin. Ethereum has a negative supply schedule, and so its native token, Ether, decreases in supply. USDC is backed by dollars one-to-one held in regulated banks. All of these assets, which account for most of the volume in the crypto ecosystem, aren't created at no cost and without limit, and so Allen's root argument doesn't apply to 70% of the market. In short, the root problem of crypto, Alan puts forward, isn't an economic problem at all. It is common across many digital and some non-digital goods, applies to stock certificates, and doesn't even apply to most of the value in the cryptocurrency industry.

Crypto's benefits. Turning away from a discussion of crypto's harms, Alan dramatically undersells blockchain's benefits. She writes, quote, many of the most hyped innovations, including central bank digital currencies, do not require a blockchain at all. Blockchain technology itself has extremely limited utility. The consensus mechanisms that make blockchain's work are inherently less efficient and more costly than centralized alternatives. Once again, the assumptions do most of the work. First, central bank digital currencies aren't one of the most hyped innovations. They are unpopular in the crypto community and elsewhere. In fact, House Republicans recently introduced the CBDC Anti-surveillance State Act, a bill that would prevent the Federal Reserve from issuing a

CBDC without further congressional approval. Second, crypto users understand that there are tradeoffs between efficiency and decentralization, just as there may be tradeoffs between efficiency and many other qualities that are at times desirable, such as democracy or pluralistic decision-making. Despite innovation being constrained by continued regulatory uncertainty, crypto networks are already having a positive global impact. For example, crypto has been an inflation hedge for many struggling families holding hyperinflationary non-dollar currencies, including millions of desperate Turks, Venezuelans, Afghans, Argentinians, Ethiopians, and Nigerians. Or look to humanitarian uses. Many refugees fled with their own assets and crypto wallets, and the United Nations High Commissioner for

refugees dispersed humanitarian aid to displaced Ukrainians via stablecoins, even as banks were in disarray. Turning to creators and artists, non-fungible tokens enable people to effectively own digital art. NFTs are a roughly $15 billion market and benefit both collectors and the artists. Crypto networks are changing the internet itself, an internet that's now dominated by a few private companies. Indeed, several crypto projects have introduced blockchain proposals designed to be open-source alternatives to the corporate giants, including for data storage such as Filecoin. Blockchains also enable databases where users can control their own identity and data and easily

ported to new social media applications, such as a potentially decentralized Twitter, Twitter co-founder Jack Dorsey's Blue Sky Project, and the Lens Protocol. Finally, the crypto industry is ushering in a new era of trusted open finance. Many decentralized finance applications remove trusted intermediaries and replace them with transparent software. Decentralized exchange uniswap, which pioneered automated market maker functions, enables 24-7 trading rather than 40 hours a week. Exchanges like Uniswop also offer transparent pricing and supply rather than the dark pools of money flows in traditional finance, as well as instant

settlement. In fact, at least two multi-government international projects known as Project Guardian and Project Mariana are using variations of the Uniswap protocol for experiments in foreign exchange trading, which a study by crypto researchers suggest may be highly efficient and tokenized bonds. How should countries regulate crypto? Despite a lack of regulatory clarity in some countries, including the United States, figuring out how to regulate crypto is not an insurmountable challenge. For example, the European Union passed MECA, which is a framework requiring disclosure through white papers and exchange registrations. Additionally, several groups of bipartisan senators and congressmen have proposed comprehensive

or partial frameworks. As these efforts show, good faith actors can come together across party lines and land on a proposal that would foster innovation and access while stamping out the real fraud, manipulation, and security risks. Calls to ban crypto or leave it entirely unregulated, merely distract from and slow down these important efforts. All right, guys, back to NLW here. And I'll just say quickly, the reason that I wanted to share this piece is that even

unlike the first reactions to that foreign affairs article that I shared a couple weeks ago, this is the considered response of a key DC actor in the crypto and blockchain space that's clearly designed to set the template for what the blockchain association and others that work with them are saying in the halls of Congress. These are then presumably some of the chosen counter arguments to that banning idea. One thing that I'm watching for is the extent to which the passage of Mika either A puts pressure on Congress to do something, or B, makes it just feel more possible to do something, and perhaps that doing something just seems better than doing nothing. I've talked extensively about the fact that Mika has the legacy of where it came from. There's provisions and aspects to it that are largely driven by ICOs, which haven't been a thing for years, as well as the way that Facebook's Libra was going to be designed, which just obviously isn't a thing anymore.

And yet still with all that, from the standpoint of regulatory clarity for European crypto projects, it's a heck of a lot better than if it didn't have those things in because they made it imperfect in some way. Regulation is going to be imperfect. There's just no way around that. But at least when it exists, it exists to fix. Until next time, guys, be safe and take care of each other. Peace.