The Breakdown - Is Crypto Already Soft-Banned in the U.S.?

Episode Date: April 7, 2023

Wednesday, Foreign Affairs published an argument from American University professor Hilary Allen that the U.S. should consider a full ban on crypto. The argument gives explicit voice to a position that has been held quietly in the Biden Administration, and represents a ratcheting up of the rhetorical war around crypto in the U.S.  Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   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 narrated by Nathaniel Whittemore aka NLW, with editing by Michele Musso and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Foothill Blvd” by Sam Barsh. Join the discussion at discord.gg/VrKRrfKCz8.  

In the wake of one of the most tumultuous years in crypto history, the conversations happening at Consensus 2020 have never been more timely and important. This April, CoinDess is bringing together all sides of the crypto, blockchain, and Web3 community to find solutions to crypto's thornyest challenges and finally deliver on the technology's transformative potential. Join developers, investors, founders, brands, policymakers, and more in Austin, Texas, April 26th to 28th for Consensus 2020. Listeners of the breakdown can take 15% off registration with Code Breakdown. Register now at Consensus.coindex.com and join CoinDesk at Consensus 2023. 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. The breakdown is produced and distributed by CoinDess. What's going on, guys? It is Thursday, April 6th, and today we're discussing whether crypto is already soft banned in the U.S. Before we dive into that, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly L.Y slash breakdown pod. All right, friends, today we are exploring a really interesting thesis that while crypto and

Bitcoin are nominally legal in the U.S., there is effectively a soft ban on them that has much the same effect that any real ban would. The context for this exploration is a piece that came out in foreign affairs. yesterday. Professor Hillary Allen published an article entitled The Case for Banning Crypto, and it's pretty much exactly what it sounds like. It is a full-throated defense of an explicit total crypto ban rather than the half measure of implicit regulatory restriction. Now, to understand the context of who this person is, Alan is a law professor from the American University Washington College of Law, and her opinion carries substantial weight in policy circles. She has made multiple appearances before

the Senate Banking Committee in recent years, including appearing before Congress to speak to the risks of stable coins, as well as the causes of the FTX collapse. She spoke in July 2021, addressing climate as a systemic risk. She spoke in December 2020, crypto crash why the FTX bubble burst. She spoke in July 21, addressing climate as a systemic risk, the need to build resilience within our banking and financial system. She spoke in December 21, stablecoins, how do they work, how are they used, and what are their risks. And she spoke in December 22, Crypto Crash, why the FTX bubble burst and the harm to consumers. More generally, she was also appointed to the Financial Crisis Inquiry Commission by Congress after the global

financial crisis. She has scores of papers on all-thing crypto risk from defy the stable coins, but she primarily specializes in systemic financial risk. The point being that this is not one of your random crypto critics on Twitter. This is someone who has the ear of many in Washington, D.C. The latest article in foreign affairs spells out the problem as she sees it. When assets have nothing behind them, she writes, no reliable financial accounting practices or evaluation techniques exist to expose the fraudulent manipulation of those assets. The result is that fraudsters have rushed into cryptocurrency,

exploiting the complexity and hype to dupe the unwary. The core of Allen's argument is that the many risks that crypto introduces into society are not worth taking. She cites sanctions evasion, money laundering, ransomware attacks, and trafficking, arguing, arguing that the anonymity that crypto grants users inhibits law enforcement efforts. However, her primary concern, which is again her academic specialty, is systemic risk. She writes, if allowed to proceed unchecked, the unrestricted growth of the cryptocurrency industry

and its future integration with the traditional financial system could produce a major crisis. She calls back to the 2008 financial crisis and notes that the seemingly infinite supply of crypto assets that can be created and then leveraged could create similar risks to those that surrounded mortgage-backed securities products leading up to the financial crisis. Essentially, she argues that leveraging up using a collateral base of highly volatile assets with highly questionable value could introduce significant contagion risk into the financial system. As you'd expect, the article also touches on environmental concerns. Now, moving on to the promise of crypto, Alan rejects the dream of fully functional, disintermediated, decentralized finance as a fantasy.

She writes, decentralizing the technology does not guarantee that the actual control of the technology will remain decentralized. Rather, economic incentives have led to extremely concentrated pools of transaction validators, leaving users dependent on these small groups of people. Furthermore, blockchains are software and users depend on the people programming the software, people who may have conflicts of interest or may make mistakes when programming. She notes that software is inherently fragile and faulty degrading over time and prone to errors and bugs. Financial software, she claims, is even more prone to this issue as hackers have increased financial incentives to seek out and exploit shortcomings in the code and system design. To sum it up, Alan Wright,

the best that the cryptocurrency industry can offer is a version of the traditional financial system that remains economically centralized, but has more vulnerabilities because of its attempts at technological decentralization. Because blockchain-based finance is so complex, it is inherently fragile. The collapses that began in 2022 were not outliers, but symptoms of systemic problems in the crypto industry. Now, I have done as much as I can to present her argument in good faith, but lest we think that it is a piece of just good faith arguments, let's add a few of the more specious quotes in here, shall we? There is a Dane Alan writes that members of cryptocurrency communities embittered by their losses may be funneled

into extreme online communities. It's a stretch, but okay. In her discussions of decentralization, she quotes that gem of a Wall Street journal piece recently. Recent reporting, she writes, reveal that there are currently just five people who can improve proposed changes to Bitcoin's core blockchain software. Presuming, as the WSJ article does, that Bitcoin core software developers are all powerful actors, even though the entire history of Bitcoin social layer shows that that is not the case. And then, of course, it wouldn't be a critical crypto piece without comparing energy consumption to some country somewhere. Powering these computers, she writes, has sometimes required as much energy as that consumed by the entirety of the Netherlands, a country of some 17 million people.

In addition to the emissions that results, the mining burns through computer equipment relatively quickly, contributing to electronic waste and the global semiconductor chip shortage. Share these quotes to point out that she really is hitting all of the cryptocratic talking points, the ones that they love bringing up, and the ones that sound like gotchas to politicians who are just finally digging into this space. Now, given all this, her policy prescription, as you might imagine, is extremely heavy-handed. Alan calls for a complete ban and recognizes that, quote, policymakers who recognize that blockchain technologies harms outweigh its benefits, might believe that state intervention is justified, but wonder if it is even possible.

She points out that although industry figures make bold claims about decentralization and regulatory resistance, there are in fact a wide range of intermediaries to which regulation can be applied. For example, she writes, traditional business entities operate the centralized exchanges that serve as gateways to the cryptocurrency markets. If Congress were to pass legislation banning them from listing cryptocurrency assets, the cryptocurrency market would quickly fade. She even claims that decentralized exchanges could be vulnerable to regulation due to highly concentrated control in the hands of a few people. Alan addresses the argument that such a harsh regulatory crackdown could limit the potential of blockchain innovations with a swift dismissal.

Any of the most hyped innovations, she writes, including central bank digital currencies, do not require a blockchain at all. Blockchain technology itself has extremely limited utility. And if policymakers do not have the stomach for an outright ban, Alan argues that the stringent enforcement of existing regulation could be sufficient to crush the industry. Quote, banking regulators should use existing prudential rules to keep banks from being exposed to the risk of cryptocurrency assets. And securities regulators should enforce existing rules to protect retail investors from unregistered cryptocurrency offerings and fraud. And when it comes to the concern that this could push the industry offshore, first of all, Alan doesn't think that the industry could actually survive such a move. If the United States cracks down, she writes, it is possible that cryptocurrency may migrate elsewhere.

But because the global cryptocurrency industry relies heavily on funding from U.S. venture capital firms, it remains an open question whether the industry could survive without that funding. But still, this is where the boldest line of the entire piece comes in, where the mask has fully been ripped off, and where the expression of the true goals of crypto's upon opponents in Washington is revealed. Alan writes that the U.S. should not fear falling behind as a leader in blockchain because, quote, it is undesirable to be a leader in an innovation this harmful. Now, first of all, I don't know how anyone could read this from this person in this publication and still call all of the cryptocurrency's claims for an Operation Chokepoint 2.0

some sort of heavy-handed conspiracy theory. This is a person whose perspective has been called on numerous times over the last two years for policymakers, arguing that this industry should not be allowed to exist. Now, as you might imagine, the crypto industry was not a super fan of this. Punk 6529 writes, I just read an article in foreign affairs on the case for banning crypto. I'm not going to give it the dignity of a link, but rest assured, I absolutely am not smarter for having read it. Stablecoin savant writes this article is a mess of unrelated anti-crypto arguments that are conflated on top of each other to create a boogeyman. I can't decide if it's attacking the technology, the idea, or fraudulent business is associated with the tech.

And indeed, this was a theme that others picked up on as well. Mad Chemist writes, this author inflates good old-fashioned fraud like FTX and Alameda with blockchain tech and cites the old and tired narrative about Bitcoin's environmental impact without considering its use of green energy and wasted energy. Shatoshi quotes the article, when assets have nothing behind them, no reliable financial accounting practices or valuation techniques exist to expose the fraudulent manipulation of those assets and rights, almost sounded like they were talking about USD for a moment. This article angers the living F out of me. Person who wrote this either works for the government or doesn't understand the first

thing about Bitcoin and crypto, truly embarrassing. FDX was a centralized exchange. It wasn't crypto that brought it down. It was fraud and theft. You know the same thing that banks and companies have been doing for over a century. Hello Enron, Lehman, Bernie Madoff, and I could go on and on and on. But we don't blame U.S. dollars for these crimes. Please make it make sense. Centralization is the problem, not fiat, not crypto, the people that we trust with our money. Bitcoin isn't 100% flawless by any means, but it's a way better system than what we've got. But this all gets us to the take that I think is the most interesting. Stephen Deal, who's obviously emerged as one of the most prominent crypto critics, writes,

there's a compelling argument that since crypto assets can be created at zero costs without limit and have no intrinsic value, then regulating them is an aimless and unbounded expensive public burden. So perhaps we should consider a total crypto ban. Now, crypto developer Maksi quote tweeted this and said, Part agree, the only coherent approach to crypto regulation are one, use tech to automate and lower compliance costs 1,000x, or two, a global ban. I tend to think it's better to choose a cheaper, positive sum option, than a more expensive, negative someone, but I'm not an authoritarian.

Macy goes on. The current approach of the U.S. government is an implicit ban on private sector development through aggressive enforcement of overbroad interpretation of existing securities and banking laws, which the author refers to as the, quote, second-best alternative. Alan's novel contribution to the discourse here is advocating for dropping the implicit nature of the ban by encoding it in law and making it fully explicit. Given that these approaches are functionally equivalent under the current presidential administration, the only change would be that explicitly encoding the ban in law would make it binding on future administrations as well.

While I believe Alan grossly mischaracterizes how the tech works and its promises, as well as the benefits and feasibility of such a ban, I do respect the honesty and coherence with which the dystopian, authoritarian, and unconstitutional impulse of a crypto ban are expressed in this article. I prefer this to the dishonest gaslighting of the current administration, which suggests that such actions aren't being taken, but if they are, they're a good thing. The dishonest-slash-implicit and honest-explicit authoritarian banhammer approaches can be contrasted with a more epistemically humble position

that we should not depart from what were long-standing shared cultural values, of protecting the civil liberties enshrined in the Constitution, even if we don't see a benefit in a given technology at the time. One could even go so far as to express optimism that privacy-preserving blockchain tech might one day allow users to retain digital property rights and monetize their data, and that this could be a preferable state of affair to training their own AI replacements for free as digital serfs of nationalized tech monopolies. Given that Alan has found sympathetic years in multiple congressional hearings, I think we should view her seriously as representative of the current administration's approach to crypto.

even if most prefer the, quote, second-best alternative of a dishonest-slash-implicit ban of private sector blockchain development over a more honest, explicit one. Voters in constitutional democracies are going to need to choose between the centralized, nationalized, and permission CBDC described by Allen, Warren, and the Biden administration, or open competing blockchains developed in the private sector, and it's important to have an honest debate about the implications of such a decision. And this, of course, gets to the question at the heart of this episode. Is crypto softband already? So let's talk about for just a second, Operation Chokepoint 2.0, but let me reframe it just a little bit.

I think when we hear this, we think about a set of malicious institutions all conspiring to be aligned against the crypto industry. However, institutions are just people, right? Sure, maybe they have institutional norms and history that they have to align with, but ultimately they're people. Now imagine that there are three categories of people in these regulatory institutions, things like the OCC or the FDIC. Those three categories of people are those who are opponents of crypto, those who are supporters of crypto, and those which are, I'm sure, the biggest category, neutrals. Imagine that those three groups are relatively in balance. Maybe it shifts around a little bit, given who's in power or not.

But by and large, there's different takes. However, imagine now that there's a context which gives the crypto opponents much more cloud cover, which makes their case much more sympathetic. Even if all the supporters stand up to defend crypto in that context, it's likely that the are just a bit more likely themselves to get out of the way of the opponents, which would mean that you don't need some full coordination effort, secret backroom meetings between the OCC and the SEC, for it all to have the same effect. In other words, for the loud opponent voices to win, especially because the vehicle for them to exert power is not rulemaking per se, but influence.

What I mean is put this in the context of banks. Does it need to say on a piece of paper that Bitcoin and crypto are banned? If banks are watching those others of their peers who have worked with the industry being publicly castigated by senators, of course not. Those banks are going to take one look at that, say, I don't want any of that energy up in my house, and the fees from banking the crypto industry are simply not worth it. Politicians then have used soft power and market mechanisms against crypto. Now, I think at this point it's actually fascinating to compare this strategy with China's strategy. In 2021, we saw China have a nominal mining and exchange ban. It was presented as a hard ban in the narrative. However, in many ways, you could see it as a soft ban too. Lots slipped through

the cracks, and many especially miners were either able to bribe or evade their way out of a crackdown. The U.S. now sort of does the reverse. It's presenting itself as having not banned constitutionally protected activity, but opponents of that activity are exerting soft power on institutions to do whatever level of banning they see fit under the threat of nebulous repercussions. Ergo, China is a soft ban presented as a hard ban, while the U.S. is a hard ban presented as a soft ban. I think it's worth us asking if that's really the type of country we want to live in, where what industries are and are not allowed are dictated by how loud politicians can be in exerting pressure on institutions that might service those industries. I don't know, man,

seems pretty shh-y to me and pretty far outside of the bounds of what we think makes America great. Anyways, guys, I expect there to be more, not less of this going forward, especially as political positions harden around crypto. For now, it's certainly something I'm going to keep an eye on, and like Maksie, I agree. At least they're saying the quiet part loud now. Until tomorrow, be safe and take care of each other. Peace.