Opinion – Paul Krugman: Cryptocurrencies Are Crashing; where were the regulators?

When the Federal Reserve [banco central dos Estado Unidos] speaks, uses its own language, “Fedspeak”. A terse sentence or striking metaphor can easily turn into a headline, causing huge market moves and a public backlash.

Therefore, dry technical language and euphemisms are often the form of choice. Given this reality, the candor of a recent speech on cryptocurrency regulation by Lael Brainard, vice chairman of the Fed, is almost shocking. Granted, Brainard didn’t go as far as Jim Chanos, the famous short seller who called cryptocurrency a “predatory dump”. But she came close.

The first title of her comments was “Distinguishing Responsible Innovation from Regulatory Evasion,” and she emphatically suggested that much of the cryptographic universe is driven by the latter. Traditional banking is regulated for a reason; cryptocurrency, by circumventing those regulations, she said, created an environment prone to banking panics, not to mention “robberies, break-ins and ransom attacks” as well as “money laundering and terrorist financing.”

Other than that, everything is fine.

The fact is, most of Brainard’s litany has been obvious to independent observers for some time. So why are we only now hearing serious calls for regulation?

Cryptocurrencies have been around since 2009, and in all that time they never played a major role in real-world transactions — El Salvador’s much-heralded attempt to make bitcoin its national currency was a disaster.

So how did cryptocurrencies come to be worth nearly $3 trillion at their peak? (Two-thirds of that amount has already disappeared.) Why has nothing been done to contain stablecoins, which were supposedly pegged to the US dollar, but clearly subject to all the risks of unregulated banks, and are now undergoing a series of meltdowns that remember the wave of bank failures that helped make the Great Depression big?

My answer is that while the cryptocurrency industry has never been able to create products that are widely used in the real economy, it has had spectacular success in marketing itself, creating an image of being avant-garde and respectable. It did this particularly by cultivating important people and institutions.

I’m not talking about the adoption of cryptocurrency by libertarians and “Make America Great Again” types here, nor am I talking about embarrassing episodes like that cryptocurrency ad starring Matt Damon. What strikes me most is the extent to which cryptocurrencies have gained a reputation for respectability through association with outstanding institutions and individuals.

Suppose, for example, you use a digital payments app like Venmo, which has amply demonstrated its usefulness in real-world transactions (you can even use it to buy goods from fruit stands on the sidewalk).

Well, if you go to Venmo’s homepage, you’ll find an invitation to use the app to “start your crypto journey”; in the app itself, a “Crypto” tab appears right after “Home” and “Cards”. Surely, then, cryptocurrency must be serious business.

Suppose you want to learn about cryptocurrencies. Many famous universities offer programs, usually online subscription courses.

Suppose you want to know who advises the major players in the cryptocurrency industry. Well, the board of the Digital Currency Group, one of the biggest players, includes a co-chair of the Brookings Institution’s board of directors and a former Secretary of the Treasury as a consultant.

Given this aura of general approval, how many people would be willing to believe the Digital Emperor was naked? More precisely, how many would be willing to accept regulatory restraint?

Why were these institutions and traditional people covering what is, as Brainard made clear, a highly dubious industry? I don’t believe there was any corruption (unlike what happens in the cryptocurrency industry itself, which is swamped by fraudsters).

In fact, I know from experience that someone can make money doing what appears to be honest work and only later discover that the people who signed the check were scammers.

Still, clearly there were and are financial rewards involved. I don’t know how much Venmo makes from people buying and selling cryptocurrencies on their platform, but it’s certainly not offering the service out of pure goodwill. If you want to take, for example, the MIT online blockchain course, it will cost you $3,500.

In my view, cryptocurrency has evolved into a kind of postmodern pyramid scam. The industry has lured investors with a combination of tech blah and libertarian nonsense; it used some of that cash flow to buy the illusion of respectability, which attracted even more investors. And for a while, even as the risks multiplied, it became, in fact, too big to be regulated.

One way to read Brainard’s speech is that she was saying that the cryptocurrency crash provides an opportunity — a time when effective regulation has become politically possible. And she urges us to seize this moment, before cryptocurrency stops being a mere casino and becomes a threat to financial stability.

It’s very good advice. I hope the Fed and other policymakers will accept it.

Translated by Luiz Roberto M. Gonçalves