The (Crypto) Genie Can’t Be Put Back in The Bottle: What Do Regulators Wish For?
The Genie grants three wishes and warns: “Be careful what you wish for”. Waiting around while central bankers and securities regulators ponder what to do about cryptocurrency and crypto assets, a frustrated Genie finally says: “Let me help out here. I can grant three wishes. Here are your choices: make it all go away (too late for that); compete with it; or learn to live with it. It’s decision time. I can’t wait around forever”.
Central bankers are fiercely protective of their monopoly over the issuance of official currency and the control of monetary policy which that monopoly facilitates. Central bankers have seen privately issued cryptocurrencies, especially “stable coins”, as a threat to their role and that goal.
In the face of new asset classes and novel schemes to finance everything from tulips to (non fungible) tokens, securities regulators agonize as they have for centuries over the question: “Is it a security? And how can we regulate it”? (This is the securities equivalent of a finance official saying that if something has any utility, he’ll tax it.
Still other financial sector regulators faced with new developments, like the availability of technology for “open banking” worry about consumer protection, privacy, the impact on the un-banked and opportunities for financial inclusion.
Political policy makers worry about keeping and attracting high paying tech jobs. They exhort regulators not to turn the screws too tight and chase way the tech investors who are developing the next new thing. Surprisingly, Canadian techies and tech investors have been in the forefront of much of what has been happening. There is no guarantee that will remain the case. Every jurisdiction is competing to be the financial hub of this new financial age.
As recently as two years ago, central bankers observing the emergence of crypto (bitcoin and ethereum) decided (big yawn) to keep an eye on it. Early adventures in crypto could be dismissed then as too shady, and the value of crypto too speculative, to be much of a threat to official currency and its use as a basic unit of account, store of value and legal tender. Who would use crypto to buy stuff? But with the emergence of “stable coins” (like Facebook’s “Libra” now renamed “Diem”), essentially a more stable crypto pegged to a basket of official currencies, central bankers could no longer play ostrich. Decisions by China and Bermuda to issue official digital currencies added to the pressure.
All the while, and pricing volatility concerns aside, purchases of, and trading in, crypto grew exponentially. Yes, some were merely trading and for them, price volatility was oxygen. Yes, some early movers and savvy traders made obscene amounts of money. But along the way, crypto continued to creep towards the mainstream. “Buy bitcoin here” in the window of the corner store is more about duping people to part with real money than heralding a financial revolution. But when businesses began to incorporate crypto into their strategic thinking and find ways to process and accept payment for goods with this new, new thing, regulators really had to ask themselves: is it time to act? Why yes, it is.
Central bankers and financial regulators may have initially perhaps misunderstood and possibly underestimated the upheaval taking place. That policy makers have been slow to move is no surprise. The changes taking place have been unprecedented. But the financial system and its constellation of financial institutions has worked well and the legacy technology underpinning it has not changed much in hundreds of years.
Upending the existing system and the players with vital roles in it, is technology (blockchains) which allow individuals to bypass all the usual financial services intermediaries and think and act for themselves. Canadians like the Tapscotts (Father and son), have been thinking deeply about the implications of all this and sounding the warning for years about the threats and opportunities of a technological future which has arrived. (Read more here.)
Two recent; but quite opposite developments are worthy of note: El Salvador has become the first country to approve bitcoin as legal tender-giving it a real boost and creating a petri dish…in El Salvador. More importantly, after a series of escalating steps (telling banks and payment platforms to stop facilitating transactions in crypto, banning crypto “mining”), China has now banned all transactions in crypto-currency. Virtual currency related business activities are now illegal financial activities. These actions are less about genuine concern for consumers as they are actions that a rational and aggressive central bank is taking to protect and extend its monopoly, from the paper Yuan, to its digital version. This is not a road map for other central banks.
A central banker has few choices now. It is too late to put the genie back in the bottle. Crypto is now too entrenched and incorporated into business planning and consumer expectations to ban it outright, (as China has done). Crypto has moved from being a thrillingly clandestine asset moving in the ether, to something more people think they need to have, trade, spend and be able to use as legal tender or convert into legal tender. In countries like Canada, banning it will simply drive all crypto activity into a new and wild underground economy. Underground economies (based on cash), allowed taxes to be evaded. An underground crypto economy undermines cash itself and the power over monetary policy that is the life blood and rationale for central banks. Wish #1, make it all go away, is not on. Like the Genie said: “too late for that”.
Wish #2 is to compete with crypto and crush it by issuing an official digital currency. The theory is that with the “full faith and credit” of the national government behind an official digital currency (a new iteration of the old paper “fiat currency”), the growth of private crypto would be constrained. This is based on the untested presumption that an official digital currency would be palatable to the public. Perhaps not if the public understood the degree to which that would put all kinds of personal data in the hands of central bank authorities. Paper money has one virtue-anonymity. Ironically, some people may be more content to have their private financial data recorded in a private blockchain distributed ledger than in an official (central bank) one.
Major financial institutions will fight like hell to preserve their supporting (and highly protected) role in the system as it works now. Who can blame them? They operate in a profitable and cozy oligopoly. Wish #2 preserves a paramount role for the entrenched banks. At the same time, official digital currencies are seen by the major banks as a threat, robbing them of their intermediary role as private financial assets are transferred from bank balance sheets to the central bank’s balance sheet. And there is, of course, the macro question about the appropriateness of enhancing the power of unelected central banks by exploding their balance sheets.
Wish #3 is the only option for regulators. (The Genie knew it. They get around.)
Learning (quickly) to live with what’s happening is a good place to start. Regulators and policy makers must engage urgently with the key players to really understand what is going on. And regulators cannot confer and then ignore what they have heard. They must listen to the mavericks as much as they do to the legacy players and craft a new balance of interests and a new set of guardrails for this age, not the last one. It’s time to stop looking in the rear-view mirror when making financial services sector policy and trade that in for a “heads-up” display. And regulators have to move faster than they ever have, just to keep up. Case in point: Canada cannot take three years, as it has, to figure out what to do about open banking.
Regulators will always have to balance competing priorities. Bend too far in protecting consumers from themselves and you stifle investment in the impressive tech innovations that are happening…and happening now. Buy into the libertarian: “just get out of the way” mantra and you leave investors and consumers in a wild west.
The regulators’ secret weapon is that the new and innovative players who are charting the future of financial services (the better ones anyway), crave being legitimized. They need certainty. Only government can confer that legitimacy and provide that certainty. Get on with it.