CAMBRIDGE, Mass. (Project Syndicate) – As cryptocurrency prices fall while central banks start raising interest rates, many are wondering if this is the beginning of the end of the bubble.
Maybe not yet. But a higher opportunity cost of money disproportionately depresses the prices of assets whose primary use is in the future. Ultra-low interest rates flattered crypto, and young investors are now getting a taste of what happens when interest rates rise.
A more interesting question is what will happen when governments finally start regulating Bitcoin BTCUSD in earnest.
and his brothers. Of the major economies, only China has started doing so so far. Most policymakers have instead attempted to change the subject by talking about central bank-issued digital currencies (CBDCs).
But that’s something of a non sequitur.
A growing problem
Although CBDCs are likely to include privacy features for small transactions, larger transactions will almost certainly require individuals to reveal their identities. In contrast, one of the biggest draws of private cryptocurrencies is the ability to bypass governments. While cryptocurrency transactions are fully traceable via the blockchain ledger, users typically set up accounts under pseudonyms and are therefore difficult to identify without other information that is expensive to obtain.
Some economists naively argue that there is no particular urgency to regulate bitcoin and co. because cryptocurrencies are difficult and costly to use for transactions. Try saying that to policymakers in developing countries, where crypto has become a key means of avoiding taxes, regulations, and capital controls.
“ Investing in some advanced economy crypto vehicles is in some ways no different than investing in conflict diamonds. ”
For poorer countries with limited governmental capacity, crypto is a growing concern. Citizens don’t have to be computer geniuses to evade the authorities. You can easily access one of several simple “off-chain” exchanges. Although cryptocurrency transactions brokered by third parties are inherently traceable, exchanges take place in advanced economies. In practice, this makes the information virtually inaccessible to poor country authorities in most cases.
money laundering, tax evasion
But doesn’t this crypto simply fulfill its promise of helping citizens bypass corrupt, inefficient and untrustworthy governments? Maybe, but just like $100 bills, cryptocurrencies are just as likely to be used by malicious actors as ordinary citizens in the developing world.
For example, Venezuela is a major player in crypto markets, in part because expatriates use them to send funds back and forth without having it confiscated by the country’s corrupt regime. But crypto is certainly also being used by the Venezuelan military in its drug smuggling operations, not to mention wealthy, politically connected individuals who are subject to financial sanctions.
With the United States currently maintaining financial sanctions on more than a dozen countries, hundreds of companies, and thousands of individuals, crypto is a natural haven.
One reason advanced economy regulators have been reluctant to act is the view that as long as cryptocurrency-related issues primarily affect the rest of the world, they don’t affect them. Apparently regulators believe in the idea that cryptocurrencies are essentially assets to invest in – and that the value of each transaction is unimportant – and are more concerned about protecting domestic investors and financial stability.
Crypto = conflict diamonds
But economic theory has long shown that the value of any money ultimately depends on its potential underlying uses. The biggest investors in crypto may be in advanced economies, but uses – and damages – so far have mostly been in emerging and developing countries. One could even argue that investing in some advanced economy crypto vehicles is in some ways no different than investing in conflict diamonds.
Advanced economy governments will most likely find that cryptocurrency issues will eventually come home to settle down. When that happens, they will be forced to impose a broad ban on digital currencies that don’t allow users’ identities to be easily traced (unless technological advances ultimately remove all traces of anonymity, in which case cryptocurrencies prices will collapse by themselves). The ban would certainly have to extend to financial institutions and businesses, and would likely include some restrictions on individuals as well.
Such a move would greatly undercut today’s cryptocurrency prices by reducing liquidity. Of course, the more countries applying restrictions, the more effective they are, but universal implementation is not required for significant local impacts.
Hard lobbying to prevent regulation
Can a version of a ban be implemented? As China has shown, it is relatively easy to shut down the crypto exchanges that the vast majority of people use to trade digital currencies. It’s harder to prevent “on-chain” transactions because the underlying individuals are harder to identify. Ironically, an effective ban on 21st-century crypto might also require phasing out (or at least scaling back) the much older device of fiat currency, as cash is by far the most convenient way for people to get funds into their “ramp” digital wallets without being easily recognized.
Just to be clear, I’m not suggesting that all blockchain applications should be restricted. For example, regulated stablecoins backed by a central bank balance sheet can still thrive, but there must be a simple legal mechanism to trace a user’s identity if necessary.
When, if ever, could tighter cryptocurrency regulation actually happen? Without a crisis, it could take many decades, especially if major crypto players are pouring huge sums into lobbying, much like the financial sector did in the run-up to the 2008 global financial crisis. But it probably won’t last nearly that long. Unfortunately, the crypto crisis is likely to come sooner rather than later.
This comment is courtesy of Project Syndicate – What’s the Crypto Regulation Endgame?
Kenneth Rogoff, professor of economics and public policy at Harvard University, was chief economist at the International Monetary Fund from 2001 to 2003. He is co-author of This Time is Different: Eight Centuries of Financial Torly (Princeton University Press, 2011) and author of The Curse of Cash (Princeton University Press, 2016).
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