Stories
The US Government doesn’t know what to do about crypto. It has been dithering for ten years.
On the one hand, millions of ordinary Americans lost their shirts this year in scammy crypto projects like Celsius, as well as respectable ones like Ethereum and Bitcoin.
On the other hand, crypto is a booming industry. Just one large US crypto company, Coinbase, employs 3,750 people. American crypto companies are worth hundreds of billions of dollars. Some say crypto is the future of finance. If it is, shouldn’t it happen in America?
The stakes are high. If crypto turns out to be little more than a Ponzi scheme, and the US rolls out the red carpet, ordinary Americans will be the ones to suffer. If crypto turns out to be the future of finance, and the US cracks down on it, then the US will be left behind.
Crypto is complex and convoluted at the best of times. I’d hate to have to make this call. I can’t imagine that a crowd of elderly US senators will find it any easier.
Christopher Giancarlo is a former high-ranking financial regulator. He used to run the Commodity Futures Trading Commission (CTFC), which is one of the two big US financial regulators.
The debate over how to regulate crypto in the US has settled into a debate over which of the two agencies should do it: the CFTC or the Securities and Exchange Commission (SEC).
Giancarlo, who also wrote the book “CryptoDad: The Fight for the Future of Money”, represents the CFTC side of the debate. He thinks crypto technology has extraordinary potential, and he thinks it’s important the regulator doesn’t snuff it out.
In this interview, which is lightly edited for clarity, we discuss:
— Two philosophies on financial regulation
— Bureaucratic turf wars
— What crypto is, and what it isn’t
— How regulators should approach their job
— Regulators’ responsibility to retail investors
— The crypto winter
— Central banks’ loss of authority
— Why central banks are feeling the pressure to launch digital currencies
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Sean Keyes (SK): Why is the CFTC better placed to regulate crypto than the SEC?
Chris Giancarlo (CG): The distinction is the SEC oversees markets for capital formation: someone with a good idea, but without the capital, can find someone with the capital but doesn’t have a good idea. They can meet up and fund the enterprise.
That’s not what the CFTC does. The CFTC oversees markets for risk transfer. An enterprise with the risk of oil prices, or commodity costs, can hedge the risk of the price movement. And throughout history, those markets were mostly on things that came out of the ground: wheat, corn, soybeans, oil, metals, and gold, silver. And wherever you hedge the risk of it, it’s in CFTC-regulated markets. At least in North America.
And that worked out really well, up until the 1970s. The CFTC was a Bureau of the Department of Agriculture, which made sense. When the US went off the gold standard, in the early 1970s, it only was possible because a couple of smart guys out of Chicago invented the financial future. For the first time in history, you could hedge something that didn’t come out of the ground. Basically, an index of exchange rates or an interest rate. And it was believed that that product was so important from an institutional wholesale point of view that they didn’t want to give it to the SEC.
Because with the SEC’s investor protection mandate, they felt it would throttle the innovation. And so they took a bureau at the Department of Agriculture, renamed it the CFTC, and set it up as a separate agency, with a mandate for product innovation.
And so the difference between the two agencies: one is capital market oversight, and the other one is risk hedging market oversight. But the cultural difference is the CFTC has this mandate for innovation, it’s written into all of its rule sets. So it’s not surprising then for five years, the CFTC has had a regulated market for crypto, in the case of Bitcoin futures. And the SEC still hasn’t found a way to create a regulated ETF — a Bitcoin ETF market.
So the SEC is strong on enforcement, strong on investor protection, and continues to prosecute a lot of strong cases, and yet has no oversight over any regulated market that they’ve allowed to emerge. Whereas the CFTC, with a good enforcement record, has a very well-functioning crypto market in the case of Bitcoin and Ethereum futures. So that’s the structural and mission and cultural difference between the two agencies.
It’s not surprising that there’s an interagency rivalry. Wherever you have a government – I don’t know, conditions here, but I’m sure Michael can tell you – politics is all about power, right? And whenever you have power and budgets, you have [rivalry]. The interagency rivalries between the two agencies existed long before I arrived. And they’ll exist as long as those agencies exist.
If you look at every piece of legislation moving through Congress right now – and there are at least half a dozen on crypto – every one of them expands CFTC jurisdiction and none of them expands SEC jurisdiction. And I think that is a recognition that for five years, the CFTC rather quietly has got this functioning market that’s working pretty well. And the SEC, with a lot of hue and cry, has still not found a way to get a licenced crypto trading operation.
I think that the central bankers are very worried about this new technology overwhelming the status quo. And they’re struggling to manage the status quo. So as my views change, my views have only become more convinced that this innovation is going to change everything we know about finance.
SK: Which definition do you think crypto and blockchain more closely fit: are they more like capital formation or risk transfer?
CG: It’s very astute of you to go back to that fundamental difference. Because it’s funny how a lot of people in politics and policymaking in the United States think about it only from an investor protection point of view. And so they’re ready to give it to the SEC.
But the SEC’s investor protection mandate is only for capital formation. A lot of cryptos are not about capital formation. What is crypto? And this is something we’re gonna be talking about tonight. Crypto is not what people think. It’s not some funky new tradable asset class — although that’s part of it.
Crypto is a set of protocols that will allow us to use the internet to establish who owns what, who transfers what to whom, of things of value. As opposed to the way we’ve been doing it for about three or 400 years in the world, which is recording most value as liabilities and proprietary or balance sheets of proprietary institutions.
Most of the world’s money exists on basically one of 7000 balance sheets around the world of proprietary ownership. Or they may be titled instruments that exist on county registries, but all exist in unique proprietary databases. Your retirement money is not stacks of euros in some vault somewhere, it’s a liability of a pension fund, right? Your ownership interest in your house, or rental interest, is recorded on a registry somewhere run by a county or some other government entity, right? Why is that?
When it comes to financing and banking and money, we’re still totally relying on these financial institutions to say how much value to save for retirement and where it is. What crypto is, is saying, in the same way that we’ve turned to the internet for information we turn to the internet for communications, why don’t we use the internet to establish where value is? And all we needed was a protocol? Well, that’s what the Bitcoin protocol is. That’s what Ethereum is. They’re protocols that allow us to use the world’s network of computers to validate value.
It’s not the regulator’s job to defend the status quo. It’s not the regulator’s job to say ‘we like the financial system that exists today, and therefore we’re going to set up barriers to any changes in it’.
SK: In practice, I think crypto looks something like this: a token is issued, it supports and funds a project, which hopefully has some real-world application. And the early users of the project, via the token, are also the early funders of the project. So to me, in practice, it looks a lot like equity. Rather than what you’re talking about, which is more like its potential to rewire the financial system.
CG: So don’t put me in the bucket of SEC sceptics, because I think the SEC has an important role to play. So to the extent crypto is used for capital formation, there’s no question in my mind, at least in the US. No question.
I’m only critical of the SEC for not enforcing their law, and not having at the same time created a pathway forward. That’s what I tried to do for the CFTC. And I’m very proud of the fact that we not only prosecuted unregistered crypto commodities, but we also created a path forward. It was actually a more difficult path forward. We called for heightened scrutiny for crypto to get registered.
But to the extent crypto is used for capital formation, that’s the SEC’s job and they’ve got to step up to the challenge. I’m not I’m not trying to play intramural football between them and the CFTC. I’ve always recognised their role.
SK: But capital formation is a very common use of the technology at the moment, right?
CG: Well take a look at Bitcoin, for example, you know, there’s no there, there. There’s no enterprise to be funded. So we declared it to be under CFTC jurisdiction as a commodity in 2015. So, there are other forms of crypto that are for the purposes of creating smart contracts or the ability to create networks of functioning enterprises that are not necessarily funding. But sometimes you need to raise funds to get something up and running.
SK: What does crypto under-regulation look like, and what does crypto over-regulation look like?
CG: Well, first of all, I’m a regulator. We need good regulation, we need smart regulation. Both the securities laws and the commodities laws were written in the 1930s. They’re written for an analogue world. I think they’ve served well, from a US point of view. My advocacy in the US is for us to write custom, bespoke legislation for this and assigned to the SEC tasks that they’re suitable for: investor protection, and capital formation. Assign to the CFTC tasks that they’re suitable for. Make sure that innovation is part of it. And I think if we get the regulation, right, innovators will innovate to it.
SK: The type of regulation you are in favour of – had it been in place last year, when cryptos crashed, how would this last year have played out differently?
CG: Well, first of all, I don’t believe it’s the job of regulation to prevent crashes unless fraud and manipulation is involved.
SK: There has been a bit of that.
CG: Yes. And one could criticise the SEC for perhaps not having done a better job with Celsius or Voyager. But I think the crypto winter, so-called crypto winter, is driven by a lack of regulatory clarity. But also other things. I mean, I think it’s also driven by the promise that had gotten ahead of the reality, right? The dotcom crash happened, not because people didn’t want to buy pet supplies online, but because they didn’t want to do it using a dial-up modem and waiting three weeks for delivery, right? And they also didn’t want to pay the wild valuation of pets.com. Because the promise had gotten ahead. I think the same thing happened here. There were I think 300 million users of the internet in 2000. By 2010, that became 2 billion. So the dotcom crash didn’t stop innovation. Now there are five and a half billion people online. And I don’t think this crypto winter will stop crypto either.
SK: You truly have a CFTC mindset — you’re not thinking about it from a customer or retail perspective. In the year we’ve had, retail investors have lost a lot of money. And it’s a uniquely crypto story. Are you saying that’s just a fundamental feature of crypto – it is going to crash occasionally, but that’s not a regulatory problem?
CG: Any more than a stock market crash is the fault of SEC regulation, right? It’s not just a crypto crash right now. We’re seeing equity value devastation across the board.
Quite frankly, it’s pretty interesting. If you look at the last few weeks, Bitcoin has held up pretty well, compared to most foreign currencies. So, again, I don’t think it is. I think the regulator’s job is to protect investors and to set up sensible regulatory structures. But it’s not the regulator’s job to defend the status quo. It’s not the regulator’s job to say ‘we like the financial system that exists today, and therefore we’re going to set up barriers to any changes in it’. That’s not something that’s in their mandate.
SK: That gets out my other question – what is over-regulation? Now there’s a bunch of regulators circling cryptos – the SEC, the CFTC, the EU commission. Any of them could be clumsy in how they implement their regulation. How might this go wrong?
CG: So I’m glad you use the word clumsy because I’ve actually always looked at regulation, not from a quantitative but from a qualitative approach.
I’ve always pushed back against the idea that there’s either too much or too little regulation. It’s irrelevant how much there is what really is irrelevant is, what’s the quality of it? Is it really fit for purpose?
And so if to the extent I have any of the CFTC mindset is, I believe that regulation has also got to further innovation. I think if we can get a good bespoke regulatory framework for crypto, that both focuses on its use for fraud and manipulation, and its use for all the traditional Ponzi scheme behaviour.
The goal has got to be for the regulators to stay one step behind [the bad guys], not five steps behind them. And so regulators need to be properly funded. They need to understand the technology. But what they can’t do is say, because this new technology gives the bad guys new opportunities, we’re going to stifle it.
SK: On that point about Ponzi schemes. I think it’s fair to say, for the vast majority of investors in crypto, the attraction is that the price is going to go up. Rather than that, they are going to fund some new smart contract or some form of technology.
CG: Is that any different than investing in Tesla?
SK: Well, yes, because Tesla generates cash flows, and it has factories, and it’s doing things in the world. Obviously, psychology is an element of every investment. But with crypto – the entire crypto industry, which was worth 2.8 trillion – doesn’t produce much of a tangible output. To the extent that there isn’t tangible output… then surely whatever is left is a Ponzi Scheme?
CG: That’s a value judgement. And I guess people are free to make value judgments. I don’t think it’s the job of the regulator to sit back and say, “we like this one. So we’re gonna let it go forward. But we don’t like that, well, we don’t see the value proposition there. So we’re going to stop that.” We have the self-certification process. As long as a venture meets core principles, we can’t interfere with it.
And I think there’d be plenty of people that would argue with you that a new crypto is going to change the world, and it’s going to bring sunshine and lollipops to you know, everything. And the same people might not feel Tesla is going to bring sunshine. Those value judgments, I’ll leave to the marketplace. My feeling is let the marketplace sort that out. It’s not the job of an unelected bureaucrat to insert their value judgement as to where people can put their money.
SK: Central bank digital currencies (CBDCs) are interesting. I can see why central banks want to do them. Because they’re at risk of having their milkshake drunk.
CG: You know what’s interesting – you say you’re familiar with the milkshake effect. The dollar strength right now, right? The milkshake effect is in full swing right now. Right? The other five major reserve currencies are all seeing devaluation against the dollar. But what’s really interesting is you haven’t seen that against Bitcoin in the last few weeks, as the yuan, the won, the euro, and the pound have all dropped against the dollar. Bitcoin has actually held stable to a very narrow band.
So you might ask yourself. If crypto is many things, right, but to the extent, it’s a currency, why hasn’t it suffered from the milkshake effect? Now, there are a lot of reasons. I mean, it had a big period of depreciation months ago, so maybe its had all the depreciation it can take. But if you look at the last, say, 30 days, less 45 days when all the major reserve currencies have been milkshaked against the dollar.
SK: In all the tumult, Bitcoin got pushed to the back of my mind. It’s hard to remember everything at once!
CG: First of all, I’m an evangelist for the innovation of technology, but not for any crypto. I made it a point: I don’t hold crypto. So that way, when I speak about it, I speak about it from a neutral position. But I do think that Bitcoin travels in a different world than fiat currencies, because of its program scarcity, because it can’t be depreciated. After all, there’s a set number that can ever be produced. And so when you’ve got all these fiat currencies in the dollar, 40 per cent of dollars in circulation created in the last four years, you get these depreciating currencies, perhaps Bitcoin may be seen by some as a stable instrument at a time of depreciation in value.
SK: In 2022, you would need to be an optimist for Bitcoin to be your flight to safety trade.
CG: Perhaps it is. If you look at human history, throughout almost all of human history, except for the last 50 years, humans have pegged currency to some commodity, usually gold. And it was only since 1973, that the world basically said well peg it to a fiat currency, that’s not pegged to gold, and that’s the dollar. But throughout most of history, it’s been a currency. Well, when we declared Bitcoin to be a commodity, in 20 15, we didn’t think about the fact that it could be someday in time the world goes back to a commodity, whether it’s Bitcoin or some other digital commodity that has programmable stability, that you can’t undo the programming because it’s now written into the world’s network of computers.
SK: Back to the CBDCs. The problem with CBDCs is that they’re too good. They offer instantaneous transactions, with zero friction, and zero counterparty risk. Basically a perfect deposit account. The problem is, in a world of CDBCs, why use a bank? What happens to the banks and the financial system?
CG: I don’t know if you’ve ever driven a Tesla. What’s interesting about Tesla is it’s a good example of going from an analogue to a digital system. Because the acceleration is so extraordinary. But the deceleration is the same. Because the acceleration is so great, they’ve actually had to build a braking system to it. So when you take your foot off the gas, it actually applies a brake, otherwise, you’ll be jolted into the seatbelt from the deceleration, right?
My point is, wherever you go from an analogue to digital thing, the tolerances become so tight that sometimes you actually need to build in some latency. So for example, in financial markets, CBDC will allow us to go to what’s called the atomic settlement of security. When you go to a digital system, you can immediately take out all those three days and go to a trade-by-trade settlement. But that may be too fast for us. So in fact, we may build in latency one or two hours maybe and today, not because we have because the technology has to but because humans have to. So my point about CBDC is, absolutely they are going it is so powerful, that they are going to build in some human slowdown, late latency into it.
SK: The risk is that the product is so good, you don’t use your bank.
CG: So they may put limitations on how much people can hold in CBDC because they want people to still put money on deposits.
SK: So the CBDC is going to be great… but we’re going to have to pour some grit into it just to make sure it’s not too great, so the banks can compete… then the question becomes ‘sorry, why are we doing this again?’
CG: So in my book, I talked about seven reasons why I think within 10 years, almost every major economy will adopt a central bank digital currency. The first is the data generation from it is just extraordinary. Then there’s the infrastructure modernization improvement. It costs the world 2-3 per cent of the world’s GDP, just to move money around the world – just to move it, not to generate a return on it. And in the area of remittances, people pay 6 or 7 per cent to send money from a developed economy to an underdeveloped economy. So the modernization of infrastructure will take away an enormous amount of friction.
SK: How has the last year changed your views on crypto?
CG: What’s interesting right now? The Western governments are not covering themselves in glory in the current financial crisis. You’ve got central banks that were slow to turn off the tap, turn off quantitative easing and start monetary tightening. And now as they’re turning to it, you see the politicians say, ‘Well, wait a minute, we don’t want inflation. But we also don’t want hard times’.
My feeling is let the marketplace sort that out. It’s not the job of an unelected bureaucrat to insert their value judgement as to where people they can put their money.
And meanwhile, you can’t stop innovation. And if anything, my views are becoming I believe even more so. That this notion of using the internet for good or bad I don’t know whether the outcome of this is good. I’m not an optimist about whether it’s going to be better for humankind or worse. But I am convinced that this innovation is not going to be stopped. It’s naive to think the internet, which totally changed the way we hail a cab, the way we view a film, the way we communicate, is not going to do the same thing to banking and finance and money. It is.
And one of the reasons why it seems like every other utterance out of the central bankers is about crypto. At a time when we’ve got huge crises, you would think they’re talking about interest rates. And yet they’re focused, I think the reason is, they hear the footsteps of this new technology, central bankers have long enjoyed a monopoly over wholesale payments, suddenly there are 16 trillion in transactions using stablecoins. So I think that the central bankers are very worried about this new technology, overwhelming the status quo. And they’re struggling to manage the status quo. So as my views change, my views have only become more convinced that this innovation is going to change everything we know about finance. And I hope that’s for the better. But I’m not certain, because technology is value-neutral. And then a lot will come down to how well the regulators do their job.
