## The Superficial Allure of Crypto ## Source details **Canonical URL:** [The Superficial Allure of Crypto](https://www.imf.org/-/media/files/publications/fandd/article/2022/september/allen.pdf) ## Other formats - [Markdown version](/-/media/files/publications/fandd/article/2022/september/allen.pdf.md) - [Structured JSON version](/-/media/files/publications/fandd/article/2022/september/allen.pdf.json) --- ### Main critique of crypto promises - In the 14 years since Bitcoin emerged, proponents have promised that crypto will revolutionize money, payments, finance, or all of the above; these promises remain unfulfilled and look increasingly unfulfillable. - Policymakers have often supported crypto experimentation as a necessary step toward a vague innovative future, despite significant negative impacts. - Policymakers must scrutinize both crypto assets and their underlying databases (blockchains) to determine whether crypto can deliver on its promises; if not, strong regulation is required to rein in negative consequences. ### Negative impacts and systemic risks - Crypto has spurred ransomware attacks and consumed excessive energy. - Bitcoin’s blockchain relies on a proof-of-work validation mechanism that uses about as much energy as Belgium or the Philippines. - The Ethereum blockchain repeatedly promises to shift from proof of work to proof of stake, "but this never seems to happen." - A crypto-based financial system would likely perpetuate and magnify many problems of traditional finance: - Leverage could be multiplied through a potentially unlimited supply of tokens and coins serving as collateral for loans. - Rigid self-executing smart contracts could deprive the system of flexibility and discretion needed in unexpected, potentially dire situations. - Extreme complexity in the crypto ecosystem makes it hard to assess risks and increases susceptibility to "normal accidents," leading to regular destabilizing booms and busts. ### Decentralization claims vs. reality - Crypto complexity arises from attempts at decentralization—distributing power and governance to avoid trusted intermediaries. - The Bitcoin white paper offered a cryptographic solution intended to allow payments without involving financial institutions or other trusted intermediaries, but Bitcoin "became centralized very quickly" and now depends on a small group of software developers and mining pools. - Tim O’Reilly observed, "Blockchain turned out to be the most rapid recentralization of a decentralized technology that I’ve seen in my lifetime." - The broader crypto ecosystem is centralized to varying degrees despite decentralization rhetoric. ### Recent failures illustrating centralization and governance concentration - Over the spring and summer of 2022, several purportedly decentralized crypto players stumbled and failed, revealing intermediaries calling the shots. - The Terra stablecoin lost its peg to the dollar in May 2022; holders looked to founder Do Kwon’s Twitter feed for guidance. - Before Terra failed, it received an attempted rescue package of crypto loans from a nonprofit established by Kwon; loaned crypto allegedly allowed some of Terra’s largest holders ("whales") to redeem near par value while smaller investors lost nearly everything. - Multiple episodes during the Terra turmoil showed the power of founders and whales in platforms ostensibly administered by decentralized autonomous organizations. - Many crypto proponents criticized affected platforms as never truly decentralized, but all crypto is centralized to varying degrees. ### "Decentralization illusion" and intermediaries - Economists at the Bank for International Settlements concluded there is a "decentralization illusion" due to "the inescapable need for centralized governance and the tendency of blockchain consensus mechanisms to concentrate power." - Decentralized blockchain technology cannot handle large volumes of transactions well and does not accommodate transaction reversal; intermediaries inevitably emerge to streamline services for users and capture profits. - Many crypto businesses make no pretense of decentralization: centralized exchanges, wallet providers, and stablecoin issuers are critical players and often are new (and often unregulated) equivalents of traditional finance intermediaries. - Crypto users must trust people who are often unregulated or unidentified; absent consumer protection regulation, claims of financial inclusion are troubling. - The value of crypto assets is driven entirely by demand with "no productive capacity behind them," enabling founders and early investors to profit only by finding new investors to sell to; vulnerable populations could be left holding the bag. ### Doubts about crypto democratizing finance - Crypto lending platforms demand significant crypto collateral before granting loans, so they do not serve those who lack financial assets. - The World Economic Forum concluded that "stablecoins as currently deployed would not provide compelling new benefits for financial inclusion beyond those offered by preexisting options." ### Context: problems in traditional finance and political dimensions - Financial inclusion and many problems with traditional finance are real and pressing; crypto firms leverage lucid critiques of the current financial system. - The largest banks performed poorly in the lead-up to 2008 (and some still do); many people remain underserved; in the United States, payment processing is too slow. - These are largely political rather than technological problems; new crypto intermediaries would likely perpetuate existing problems if underlying political issues are not resolved. - Simpler, centralized technological solutions often exist for needed upgrades (for example, real-time payments); what is often lacking is political will. ### Policy recommendations and regulatory stance - To limit fallout from crypto implosions and protect the broader economy, regulators should erect a firewall between crypto and traditional finance. - As a first priority, banks should be prohibited from issuing or trading any crypto asset, including stablecoins (which are "rarely used for real-world payments; they mostly facilitate crypto investments"). - Such prohibitions could be carried out within existing banking law frameworks, often without new laws or rules, though policymakers should consider enacting new laws or rules targeting the crypto industry more directly. - Given crypto’s lack of benefits and negative impacts, an outright ban may be appropriate; if not a ban, negative impacts should be managed with more targeted laws or rules. - Applying laws and rules to centralized crypto intermediaries would be relatively straightforward (though jurisdictional issues may arise); applying them to nominally decentralized players may face extra hurdles but is feasible because "no part of crypto is entirely decentralized." - Practical enforcement example: people could be barred from holding governance tokens in noncompliant decentralized autonomous organizations by targeting founders, venture capital firms, and whales who own the lion’s share. ### Concluding judgment - Policymakers should not be swayed by "dubious promises of decentralization and democratization" and should be proactive in stopping crypto’s negative impacts. - Architects of the future of finance should devise the simplest and most direct solutions; trying to retrofit crypto assets and blockchains to solve existing problems will in all likelihood only make things worse. *Hilary J. Allen, "The Superficial Allure of Crypto," Finance & Development, September 2022.* --- _Source: https://www.imf.org/-/media/files/publications/fandd/article/2022/september/allen.pdf_