Crypto’s Red Flags, and the Need for Regulation
July 21, 2022
By Emily DiVito, Joseph Miller
Cryptocurrencies come with a lot of hype, but the fanfare belies the risks. Persuaded by clever and now-ubiquitous crypto ads and celebrity endorsers—from actors Matt Damon and Reese Witherspoon to basketball stars Steph Curry and LeBron James—many individuals and families view crypto as a sound and sure investment open to everyone. However, crypto’s dangers are many, and embedded within its very design. And after a tumultuous year for crypto, investors and policymakers are asking questions about the long-term stability of the market.
With any product or service where many people are investing lots—sometimes most—of their money in risky assets, the federal government has a responsibility to prevent fraud, abuse, and the resulting economic precarity faced when overhyped markets crash. Crypto needs just such regulation. But in order to effectively regulate crypto in the public interest, we need to be clear-eyed about the range of threats it poses—to individuals, families, and the macroeconomy as a whole.
Crypto’s most fundamental flaw is that it is, by design, almost entirely speculative. In other words, its value is derived from how much interest other people have in it at any given time. While the specific price point of more traditional assets, like gold or real estate, is influenced by fluctuations in supply and demand, there is typically a tangible, valuable thing (or, in the case of the US dollar, the full backing of the federal government) attached to it, no matter its market value at any given time.
Not so with crypto. Crypto is extremely—and inherently—volatile, and especially vulnerable to boom-and-bust cycles, which, in turn, makes its everyday investors vulnerable to frequent and dramatic losses. And while crypto’s backers tout it as a potential money substitute, it is solely created and sold by private actors, whose incentive does not lie in the public interest but rather in personal (and quick) profits.
The sheer number of red flags in the crypto market shouldn’t downplay just how pernicious each alone is. Some of crypto’s most problematic features, all of which should be top of mind in future regulatory frameworks, include its
- Disproportionate threat to the economic stability and wealth-building of Black and brown people;
- Systemic risk to the larger US financial system and macroeconomy, including by jeopardizing retirement account security;
- Exacerbation of climate and energy crises; and
- Refuge for bad actors and intentional fraudsters.
Disproportionate threat to the economic stability and wealth-building of Black and brown people
One of crypto’s particularly damaging features is how aggressively its backers and spokespeople trumpet its benefits for Black and brown communities, putting those communities at greater risk for significant future losses. As Darrick Hamilton explains, because Black and brown communities have been locked—or pushed—out of the traditional finance and banking sectors and so have a harder time finding opportunities to make safe investments, crypto’s promised quick gains seem like an attractive option. And in contrast to more traditional methods of wealth-building like home ownership, crypto has a lower bar to entry: In theory, there is no minimum investment required. For Black and brown communities, who still face a persistent racial wealth gap and hiring/job discrimination, crypto is tempting.
The result is disproportionate crypto-holding by Black and brown investors: 24 percent of crypto owners are Latino and 8 percent are Black, when Latino and Black households hold only 2.8 percent and 2.9 percent of overall wealth in the US, respectively. Being disproportionately exposed to this speculative asset makes Black and brown individuals and families disproportionately vulnerable to crypto’s frequent crashes.
Systemic risk to the larger US financial system and macroeconomy, including by jeopardizing retirement account security
Crypto still represents a marginal slice of the economy. The more it integrates into more traditional financial sectors, however, the greater risk it poses to US macroeconomic stability. As an example, with the recent proliferation of pro-crypto ads and assurances that it’s a sound bet, more and more retirement accounts and pension funds have begun to invest in it. Just this past April, Fidelity, the largest 401k manager in the country, announced it would allow its customers to invest their funds in crypto, a move the Labor Department cautioned against. Should retirement accounts hold more crypto, the next inevitable crash will bring with it a crash in the retirement security of millions.
The potentially widespread risk crypto poses also underscores the importance of comprehensive, early regulatory action, which would allow policymakers and regulators to better insulate consumers and other financial sectors from future crypto crashes. In the 1990s, accommodative regulatory policy helped fuel an explosion in risky financial products that eventually led to the 2008 financial crisis.
Exacerbation of climate and energy crises
Much crypto, and the mining processes through which transactions are recorded and certain coins are entered into circulation, requires a significant amount of computing power using massive amounts of energy. For example, Bitcoin’s annual energy consumption is comparable to that of entire countries as large as Argentina. Thus, some environmental models are predicting that crypto could be a significant contributor to climate change.
Crypto’s concentrated use of scarce energy is driving up costs for all families, even those who haven’t directly invested—by as much as $1 billion per year across the US in higher electricity bills. And, in Texas, where recent summer heat waves wreaked havoc on their insufficient energy grid, area crypto investors had to power down, freeing up a full percent of the state’s energy grid and allowing the state’s residents and families to avoid widespread blackouts.
Refuge for bad actors and intentional fraudsters
Part of the inescapable problem with crypto—and the shadowy, anonymous spaces in which it thrives—is that it necessarily attracts bad actors with bad intentions. Crypto’s volatility obfuscates some of its most egregious swindles. In “rug pulls” or “pump and dump” operations, a scammer leverages crypto’s wild fluctuations for his own gain—artificially inflating the value of a coin before disappearing with the funds and leaving everyday investors in the lurch with a worthless asset. The Federal Trade Commission found consumers lost over $1 billion dollars to crypto fraud since January 2021—nearly 60 times more than in 2018. Further, the anonymity crypto provides on its digital interfaces makes it a popular tool for illicit activities, like money laundering and drug trafficking.
Partly because of crypto’s novelty, lawmakers on both sides of the aisle have heralded it as the future of finance. Regardless of where the future of finance truly lies, there is still a clear need for significant regulation now to protect people—especially Black and brown people, those nearing retirement, and/or those who are otherwise economically vulnerable—and to shield the US financial system and planet from crypto’s built-in volatility and abuses.
Only by confronting crypto’s dangers directly and effectively can we regulate in the public interest. As such, even crypto’s staunch advocates should welcome regulation as a way to stop rampant fraud and crime and provide a stabilizing force that could bring in skeptics and facilitate productive innovation.
Stay tuned for more in our ongoing crypto blog series, which will include a close look at some of the shortcomings in the proposed regulations being debated in Congress and how we can and should use existing policy prescriptions to solve the economic ills that crypto claims—but fails—to address.