Representations of cryptocurrencies are seen in an illustration photo. Dado Ruvic/Reuters
Commentary
A major battle in Washington is taking place between traditional banking and money and the newly emergent industry involving cryptocurrency. A decade and a half following the invention of Bitcoin, there is still a lack of legal clarity on its status within the regulated financial industry.
Last July, the House passed CLARITY (H.R. 3633) and the Senate recently took it up with some major alterations in the text. It was originally designed to resolve many regulatory problems to the benefit of major players in the crypto industry. The consensus on that bill has fallen apart now that the company Coinbase has said it cannot support it.
The reasons cited by Coinbase are that the bill includes a de facto ban on tokenized equities, prohibitions on decentralized finance, the giving to the government of unlimited access to financial records and removing your right to privacy, the erosion of the authority of the Commodity Futures Trading Commission’s authority in favor of the Securities and Exchange Commission, and draft amendments that would kill rewards on stablecoins that would allow banks to ban their competition.
The problem with crypto regulation has been the same since the start. Regulators continue to try to make crypto behave like an existing and traditional financial asset. More concretely, stablecoins are paying a far higher rate of return than traditional bank deposits and thus threatening a deeper invasion of market share. Stablecoins are pegged to the U.S. dollar and pay a return more like a money-market fund, whereas banks pay checking accounts below 0.1 percent.
The CLARITY bill was supposed to shore up the legal status of the crypto industry but the bill was rewritten at the last moment at the behest of traditional banking. The failure of the bill puts us back at square one, leaving the big battle to another day.
Meanwhile, the crypto industry is itself performing in a way very differently from what anyone imagined 10 years ago. The stablecoin industry deploys the speed and low cost of blockchain-based money transfers without any of what the originators of the technology imagine would be common. Plainly put, crypto was invented with the hope that it would serve as a non-state money and held in personal custody.
The industry has evolved very differently. Stablecoins move a tokenized version of state money while deposits are largely invested in national debt instruments. They are certainly mediated transactions, utterly reliant on large private companies that act as custodians. Meanwhile, Bitcoin, which was invented to be peer-to-peer cash, is now treated as a high-performing financial asset not to be used but held in hopes of ever-higher valuations.
From the very start of the industry in 2009–2010, there were certain unresolved problems with Bitcoin. Once the viability of the currency became apparent, there was the pressing issue of how exactly the on-ramps and off-ramps to and from national money would work. Would the freedom to move from one to the other and back again be allowed or would these be regulated in the same way as regular financial markets?
The answer became clear as early as 2013, when the U.S. Treasury Department decided on its own that anyone trading from dollars to Bitcoin and back would have to register as a money exchange same as any other. That move put out of business thousands of burgeoning businesses that simply could not afford the compliance costs. Worse, it turns a generation of clever entrepreneurs into criminals for continuing to provide such services.
Here the troubles for the new innovation became obvious. There was simply no chance that the legacy financial and banking worlds would allow this new toy to utterly crash its party. It also became obvious to the major players in the crypto industry that they had better learn to play the regulatory game or else they would be crushed by it. Following that new rule, the number of businesses involved in making trades possible was reduced from thousands to just a handful.
Two years later, the biggest problem of all presented itself. In the early days of Bitcoin, the size of the blocks that were permitted on the chain was throttled to prevent spammers and to avoid clogging up the new technology. Trades were few enough to keep the system operating with low fees and speed the way the inventors imagined it. The problem came when use and adoption expanded. Instead of opening up to allow scaling, the core developer team froze the old system in place.
As a result, the functioning of the entire system dramatically changed. It became more expensive to use and generally slower to settle than conventional credit cards. At the same time, there was a slew of innovation in regulated money transfer that was based on the other methods of permissions and know-your-customer rules. Venmo, PayPal, Zelle, and so many others flooded in to provide an alternative to traditional ACH, and using credit cards became ever easier.
A major use case for Bitcoin was suddenly gone. The legacy holders of Bitcoin even switched up their message. Instead of adoption and use, the new slogan was never to use it but rather hold it and watch its valuations go to the moon. This provoked what was called the block-size wars that ended in new forks of the blockchain and hundreds and then thousands of new tokens, none of which could compete with the legacy infrastructure that Bitcoin had built.
If you are curious about how all this unfolded, I urge you to read the most detailed account yet in print. It is Roger Ver’s “Hijacking Bitcoin: The Hidden History of BTC.” I wrote the introduction to this astonishing account of how the most disruptive technology of the century turned into something more familiar, a new financial asset designed to make money for its early adopters.
As one might expect, the performance of Bitcoin as a financial asset has disappointed its biggest champions. Over 10 years, the return was an astonishing 20,000 percent. Over five years, it is +130–150 percent, still higher than the return on the S&P but not by that much. Over one year, Bitcoin has been down by -2 percent whereas the S&P is up 16 to 20 percent. Meanwhile, traditional safe havens have performed exceedingly well: gold up 70 percent and silver up an eye-popping 190–192 percent. So much for magically guaranteed crypto profits forever.
The dreams of Bitcoin going to the moon might still materialize in time, but we’ve travelled a very long way from the original vision we see in the 2009 White Paper. This technology was invented to be a replacement for state currency. The whole history of money underscores one central point: moneyness flows from use in circulation. Once the developers turned against adoption and use—cobbling together an alternative theory that this digital asset would instead serve as some kind of base currency only to be held in vaults—they effectively gave up on the dream.
For my own part, I wrote a book and endless essays on the promise of Bitcoin between 2012 and 2016 but lost enthusiasm once I saw where this whole thing was headed. Instead of a tool of freedom, it would become a state-regulated device to create a technological advanced financial mediation service.
That’s something far less exciting. It also creates certain dangers, for there has never been a better method of financial surveillance and record-keeping than a blockchain. A blockchain that is regulated by the state could actually end in the worst-possible nightmare one can imagine. This is why huge companies like Chainalysis and BlackRock are so interested. It could mean the permanent end of anything once regarded as financial privacy.
In general, this is a story of missed opportunities and bad theory mixed with a long industrial habit of housetraining new technology to play along with the old rules. The Trump administration has indeed ended the war on crypto and shown tremendous interest in integrating the technology into national finance. That’s welcome but it is not the same as simply permitting the freedom that is necessary for crypto to thrive outside old-world finance. If we are ever going to get there, it will have to happen with more innovation and adoption and not through lobbying and playing ball with regulators.
What was exciting about Bitcoin was not its promise as a high-earning financial asset much less as a surveillance tool for the state. It was the hope it kindled in finally erecting a wall between money and state. The dream is still there even if the reality is far from showing itself.
