The Crypto Crackup

Shortly after becoming New York City’s mayor-elect in 2021, Eric Adams declared on Twitter that he planned to take his first three paychecks in Bitcoin, an unusual pledge supposedly intended to highlight his commitment to making the Big Apple “the center of the cryptocurrency industry.” Since it is not in fact legal to pay workers in crypto, the city explained in a statement that the mayor’s initial salary disbursements were really just being converted after the fact, which prompted one observer to quip that “Adams isn’t being ‘paid in Bitcoin’ any more than using his paycheck to buy Shake Shack equals being ‘paid in cheeseburgers.’”

It might be easy to write off this whole episode as a silly stunt, but Adams is just one of a growing number of politicians from both major parties promoting cryptocurrency as an economic boon for America. New Jersey Congressman Josh Gottheimer, one of the most corporate-friendly Democrats in the House of Representatives, has claimed that the “expansion of cryptocurrency offers tremendous potential value for our economy” and has introduced legislation to ensure it will “grow and thrive here in the United States, instead of overseas.” Sen. Cynthia Lummis (R-WY), nicknamed the “Crypto Queen” for reportedly being the first senator to own Bitcoin, has cosponsored a bill with Sen. Kirsten Gillibrand (D-NY) that would establish a new regulatory framework to unleash the “substantial potential benefits” of crypto.

But what exactly are these benefits? Whatever other valuable applications there might be for the blockchain technology on which it is built, cryptocurrency as it exists today seems to be producing negative net value for society by creating myriad new occasions for fraud, channeling resources into unproductive speculative trading, and degrading the environment through the consumption of astonishing quantities of energy. It is concerning that so many elected officials—some of whom have substantial crypto holdings themselves or accept donations from major crypto players—are now hyping it as a ticket to prosperity.

The dramatic rise of cryptocurrency has taken place over an incredibly brief period of time. It was only fifteen years ago that the idea of Bitcoin was first proposed in a short white paper about how methods from the field of cryptography (the origin of the term “cryptocurrency”) could be used to securely verify and record financial transactions on a “blockchain,” a type of “distributed ledger” in which a database is maintained by the activity of an entire computer network rather than stored in one central location.

In theory, this held out the promise of creating a currency system that would not depend on faith in the trustworthiness of any particular governmental or banking institution. While acknowledging that the idea had legitimate appeal after the crisis of 2008, the economist Paul Krugman recently pointed out that it has in some sense “never been clear exactly why anyone other than criminals would want to do this.” Crypto’s image problems have stemmed not only from its obvious utility to crooks but also from its reputation as unserious business, a fringe hobby for tech geeks or an ideological obsession of libertarian anarchists. A former coworker once told me that her experience of visiting a physical cryptocurrency exchange in New York City was “like walking onto the set of a high school play about Wall Street.”

Crypto’s growth in recent years has been bolstered by a concerted effort to cultivate mainstream credibility, with prominent companies hiring famous spokespeople and even running commercials during the Super Bowl. But scams and fraud involving crypto and other blockchain-based products such as “non-fungible tokens” remain rampant, partly because they have gone mainstream: enormous amounts of new capital from “normies” now allow the scammers and fraudsters to operate on an even greater scale than before.

The most spectacular example of this can be seen in the recent collapse of FTX, a cryptocurrency exchange that allowed customers to trade crypto easily, in the same way that online brokerages like Fidelity have made it simple for non-experts to trade stocks and bonds. Founded in 2019 by Sam Bankman-Fried, the Bahamas-based FTX grew to become the second-largest such exchange in the world through high-profile advertising featuring celebrities like Larry David and financial support from venture capitalists like Shark Tank’s “Mr. Wonderful,” Kevin O’Leary. At its peak, FTX was estimated to be worth over $30 billion.

Things began to go south in early November after the publication of a balance sheet for the crypto investment firm Alameda Research, also owned by Bankman-Fried, showed that it held a large amount of a cryptocurrency known as FTT that had been created by FTX itself. This suggested that Alameda could be at serious risk of insolvency if the price of FTT were to drop significantly—and indeed, that is exactly what happened.

Following the disclosure, FTX rival Binance sold off its sizable holdings of FTT, spooking many FTX investors and effectively triggering a “bank run.” As masses of people sought to withdraw money from the platform all at once, FTX was overwhelmed; within days both it and Alameda filed for bankruptcy. Though no one should shed too many tears over sharks like Mr. Wonderful losing millions, many ordinary customers had their accounts wiped out too. Bankman-Fried and his supporters insist that the disaster was just an unfortunate accident, but what has since come to light suggests that he and his associates may well have committed real crimes.

Even if we put aside the pervasive criminality, there are still plenty of other problems with crypto. For one, the vast majority of trades are undertaken for purely speculative purposes. Speculation is not always harmful and sometimes can even improve economic efficiency, as when large price disparities between different markets are smoothed out by traders who “buy low and sell high.” The German Jesuit economist Oswald von Nell-Breuning, ghostwriter of the encyclical Quadragesimo anno, posited a moral distinction between what he dubbed “stock market speculation” that produces nothing of value, and “tradesman’s speculation” that helps guarantee the sustainability of businesses. In the case of crypto, however, speculative activity is not something that takes place alongside genuine commerce: speculation is the whole point.

The ecological costs of crypto are also steep. Until recently, the process that most cryptocurrencies have employed to verify transactions relies on a competition between many different computers on a network to solve complicated math problems; whichever does so the fastest receives a small payment in crypto. This process—known as “mining” because of the way it expands the supply of a particular cryptocurrency over time—has a substantial carbon footprint. The Cambridge Centre for Alternative Finance has estimated that crypto now accounts for around half a percent of global electricity consumption, or about as much energy as Sweden uses in a year.

Given that crypto is by nature a speculative asset, cycles of what the economic historian Charles P. Kindleberger called “manias, panics, and crashes” are inevitable even in the absence of intentional chicanery. In a way, it is darkly funny that crypto is essentially recapitulating the history of banking crises before the advent of modern regulation, and proving why safeguards like reserve requirements, deposit insurance, and central banks are vital for the stability of any monetary system. Whether these should be applied to crypto itself, however, is an open question.

Crypto policy debates today feature roughly three competing camps. One, comprising those like Gottheimer, Gillibrand, and Lummis, maintains that crypto should be treated like any other type of investment asset, and that a sophisticated new set of regulations should be crafted to bring predictability to the markets, build investor confidence by weeding out the bad actors, and boost the industry’s ability to realize its allegedly great potential.

A second camp thinks that such a project would be unwise, and could even make the entire financial system less safe. In an editorial for the Financial Times, business professors Stephen Cecchetti and Kim Schoenholtz insist that we should simply “let crypto burn.” Attempting to regulate and supervise the sector would only encourage traditional banks, insurance companies, and pension funds to invest more of their own funds into it, magnifying the impact of crypto price crashes and setting the stage for financial contagion. “The overriding goal of policymakers,” they write, “should be to keep crypto systemically irrelevant.”

Finally, there are those who advocate putting legal limits on the use of cryptocurrencies or even prohibiting them outright, as countries such as Algeria, Bolivia, China, Ghana, or Nepal have already done. Although this position does not yet have much traction here in the United States, it does have some influential proponents. When asked for his thoughts on crypto, Warren Buffett’s business partner and Berkshire Hathaway Vice Chairman Charlie Munger told one interviewer that “I wish it had been banned immediately, and I admire the Chinese for banning it.”

Policymakers, then, seem to face a trilemma. Regulating cryptocurrencies more stringently might decrease the risks to individual investors, but granting the industry a regulatory imprimatur could make it seem more respectable than it really is and heighten the risk of systemic breakdown. “Letting crypto burn” while keeping it walled off as much as possible might prevent fires from spreading to other financial markets or the real economy, but at the cost of allowing swindlers to go on hoodwinking gullible investors. Keeping the sector “systemically irrelevant” while also cracking down on malfeasance might not be possible without banning crypto entirely—and even that might not solve the problem if black markets pop up to fill the void. To use an old slogan, it would appear that cryptocurrencies cannot be made simultaneously “safe, legal, and rare.”

So which path to take? I lean toward some version of Door Number Three, since the priority should be to mitigate crypto’s harm to society without legitimizing it further, even if that means resorting to legal restrictions. This should certainly include prosecution of fraud and other crimes under existing laws, but also targeted interventions to attack crypto’s inordinate energy usage—like a ban on mining recently passed in New York. Critics complain this will only lead mining operations to migrate elsewhere, but, if enacted in enough places, such bans could also accelerate the adoption of less energy-intensive protocols for verifying crypto transactions.

At the same time, more public investment should be allocated to research into new applications for energy-efficient blockchain technologies, so that those with expertise in the field can put their talents to productive use. Such applications could include the use of distributed ledgers to organize unions and worker cooperatives or to create systems for anonymous and verifiable reporting of sexual harassment or abuse.

They could also have value within the Catholic Church, where interest in this area seems to be growing. For example, participants at a “Catholic Crypto Conference” held last year in Malvern, Pennsylvania, discussed ways that blockchain could be used to make parish bookkeeping more secure. As one speaker put it, the technology can have real benefits, but only “if it is accompanied by…a vision of the common good.”

It is hard to see how large-scale cryptocurrency trading could ever fit into such a vision. Pope Francis once lamented the fact that dips in the stock market seem to get more media attention than the death of an elderly homeless person from exposure. With all of the real crises in the world today, why should the price of Bitcoin ever make the news?