The Superficial Allure of Crypto
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Bibliographic details
- Authors: HILARY ALLEN
- Published: September 1, 2022
Core thesis
- Cryptocurrencies cannot deliver their claimed benefits (revolutionizing money, payments, or finance) and instead pose grave risks.
- Policymakers have been too willing to support crypto experimentation despite significant negative impacts; strong regulation is needed if crypto is unlikely to deliver on its promises.
Key findings on harms and systemic risks
- In the 14 years since Bitcoin emerged, promised benefits remain unfulfilled and increasingly unfulfillable.
- 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.
- Ethereum keeps promising to shift from proof of work to the more energy-efficient proof of stake, but this never seems to happen.
- A crypto-based financial system would likely amplify traditional finance problems:
- Potentially unlimited supply of tokens/coins could multiply leverage by serving as collateral for loans.
- Rigid self-executing smart contracts could remove necessary flexibility and discretion in unexpected, dire situations.
- Complexity of the crypto ecosystem increases susceptibility to “normal accidents” and regular destabilizing booms and busts.
- Decentralization claims are largely illusory:
- Bitcoin centralized quickly and depends on a small group of software developers and mining pools.
- Over the spring and summer of 2022, multiple purportedly decentralized players stumbled and failed, revealing intermediaries, founders, and “whales” calling the shots.
- Voting rights and wealth in decentralized autonomous organizations tend toward concentration even more than in traditional finance.
- Blockchain consensus mechanisms tend to concentrate power, creating a “decentralization illusion.”
- Practical limitations of blockchain technology:
- Decentralized blockchain technology cannot handle large volumes of transactions well and does not accommodate transaction reversal, making intermediaries inevitable.
- Consumer protection and inclusion concerns:
- Crypto businesses are often unregulated and sometimes unidentified, exposing users to hacks, scams, and predatory practices.
- Crypto asset value is driven entirely by demand with no productive capacity behind them, so founders and early investors profit by finding new investors.
- Crypto lending platforms require significant crypto collateral, limiting benefits for those lacking 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.”
- Political vs. technological problems:
- Many failings of traditional finance are political rather than technological; simpler, centralized technological solutions (for example, real-time payments) often exist but lack political will.
Empirical episodes illustrating risks
- Terra stablecoin lost its peg to the dollar in May 2022:
- Rescue attempts involved crypto loans from a nonprofit established by founder Do Kwon.
- Loaned crypto allegedly allowed large holders (“whales”) to redeem Terra stablecoins near par value while smaller investors lost nearly everything.
- Episodes showed power of founders and whales in platforms ostensibly administered by decentralized autonomous organizations.
Policy recommendations
- Erect a firewall between crypto and traditional finance to limit fallout from crypto implosions and protect the broader economy.
- 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 often be carried out within existing banking law frameworks, frequently without new laws or rules.
- Consider enacting new laws or rules targeting the crypto industry directly; given crypto’s lack of benefits and negative impacts, an outright ban may be appropriate.
- If not banning, manage negative impacts with more targeted laws or rules:
- Applying laws to centralized crypto intermediaries would be relatively straightforward (though jurisdictional issues may arise).
- Application to nominally decentralized players may face extra hurdles, but enforcement is feasible because no part of crypto is entirely decentralized (for example, barring people from holding governance tokens in noncompliant decentralized autonomous organizations would be relatively easy to enforce against founders, venture capital firms, and whales).
- Policymakers should not be swayed by promises of decentralization and democratization; prioritize simplest and most direct solutions to finance’s real problems rather than retrofitting crypto assets and blockchains.
Conclusion
- Crypto’s complexity, centralization tendencies, consumer risks, and systemic vulnerabilities outweigh its unfulfilled promises.
- Proactive regulatory action is warranted to prevent crypto’s negative impacts from affecting the real economy.
Hilary Allen, F&D Magazine, September 2022 — “The Superficial Allure of Crypto”