Is the Great Crypto Debate Different This Time?

Cryptocurrencies will displace fiat.

The banks even central banks will be disintermediated. Volatility and risk will rule the day.

And, if people dont get the access to bitcoin or other crypto alternatives they want, there will be rioting in the streets.

Or perhaps there will be an orderly transition toward a coexistence between sovereign money and cryptos. The traditional banking system will evolve, embracing the blockchain and a wave of innovation that will be as sweeping as anything seen in the past three decades.

Circle CEO Jeremy Allaire and Kenneth Rogoff, professor of Economics and the Thomas D. Cabot professor of Public Policy at Harvard University (and co-author of the bestselling book This Time is Different: Eight Centuries of Financial Folly), told Karen Webster that fears of systemic risk as cryptos take root around the globe are not as great as some might fear.

Which is not to say that the environment is risk-free. But regulation will be necessary, along with early warning systems that will raise flags to make sure this time really is different.

The conversation came against a backdrop in which venture capital firms have poured tens of billions of dollars into crypto-related ventures so far this year, with more than 540 deals in 2021 so far. Beyond those VC firms, payment heavyweights such as J.P. Morgan, Citi, Visa, Mastercard, PayPal and others, have been investing in and building out the crypto ecosystem.

What the VCs Want

The investors want to spur, be part of and earn return on investment (ROI) from what Allaire said is an infrastructure development that rivals the development of the web itself or the advent of smartphones.

At a high level, he said, cryptocurrencies are a generalized technology effectively a new operating system, with layers that are being built for the internet. The value of the public internet is really profound and allows for an incredibly diverse range of applications.

Of the investors, said Allaire, Theyre trying to grab the tiger by its tail, so to speak, and get in on a frothy market. The promise they are chasing might be likened to the 10x effect, in which things can be transformed and made leagues better with disruption thrown into the mix.

Crypto holds that promise for economies as whole, according to Allaire. The banks, at least for now, are trying to give high-net-worth clients a range of ways to purchase synthetic derivatives of bitcoin, while the innovation lies with the smaller, non-traditional players within financial services.

Scale can come quickly amid the innovation. Allaire said that with the blockchain networks in place, USDC stablecoins can transact at roughly 50,000 transactions per second, with 400-millisecond finality, and transactions cost a fraction of a cent.

Its on a linear growth path, explained Allaire. Storing value, moving value and integrating that into different forms of financial contracts can become a commodity, a free service on the internet, like data and content.

Drilling down a bit, these crypto developers, the exchanges, the issuers and the blockchain firms are still grappling with growing pains that mark the initial stages of any new industry.

Said Rogoff: Its kind of the Wild West, and theyre all under the umbrella of cryptocurrencies, but theyre completely different animals.

Circle stands out as a firm that has been focused on issuing stablecoins, specifically the USDC, but has expressed its intent to become a regulated bank. It is now targeting a new business model as a pre-emptive strike in anticipating where the regulatory framework is headed.

Financial stability board members around the world have said that global stablecoins, according to Allaire, look, feel and smell more like large-scale banking and payment system activities, and ought to be dealt with that way.

Circles USDC has grown from $4 billion in circulation a few years ago to $33 billion today and its on its way to hundreds of billions of dollars in circulation, Allaire projected.

As for the banking application, he said, We do not intend to operate a fractional reserve lending business. We want to take these dollar deposits. We want to hold them in full reserve. We want to work with the federal government to determine the right reserve liquidity kind of covenants.

Winners Take All

The winners in the game will be firms that learn to be what Rogoff termed as regulation-friendly.

No matter where you look, that regulation is coming, as policymakers eye the potential for crypto to scale to billions of users and for immense amounts of value to be transferred across lending and payments activities.

For now, there may be worries about a systemic crisis, at least from some observers. Indeed, Rogoffs celebrated 2009 book, This Time Its Different, chronicles centuries worth of financial crises that shook nations to their economic cores. But in one important way, when it comes to cryptocurrencies, some things really are different.

One reason that cryptos are worth so much (even considering the volatility), according to Rogoff: Interest rates are roughly zero, and investors and speculators are chasing returns.

I dont really see how crypto could cause a systemic crisis because its not regulated yet, he said. Its not like a banking system failing if bitcoin fell to $1,000 tomorrow, it would really be like a stock falling. From a systemic point of view, this would really just be a shrug.

Policymakers are justifiably concerned about how to regulate the industry, which firms will become big enough to be termed systemic and what the inherent risks would be, he said. Allaire said that current and future concerns would center around money laundering and tax evasion.

It is the specter of cheating governments out of their due that might spark regulation in earnest, Rogoff said. Theres just no way policymakers can indefinitely sit on their hands as a vehicle develops if its being used for sharply reducing government revenues.

Driving out currencies that have been around for centuries is utterly naive, said Rogoff, who co-authored the G30 paper that examined digital currencies consisting of bitcoin and its brethren,

There is a giant financial infrastructure out there, which is very efficient in some ways, but very inefficient in other ways, he said. And theres always change. And this is a very big one.

Nations such as El Salvador may experiment with bitcoin, but the idea that individuals and enterprises can sidestep that giant financial structure is folly.

As Rogoff put it: If youre playing a game with the government where it can keep changing the rules until it wins, youre going to lose.

Thats not to say there wont be friction as cryptocurrencies evolve, said Allaire. After all, even where autocratic governments are in place, theres been access to the internet (albeit with censorship). Governments could say that cryptos are illegal, said Allaire, but people are clever and will find their ways to VPNs.

You might actually have civil conflict that starts to emerge because people and entities want to participate in a different economic system internet digital currency will topple some forms of monetary sovereignty, said Allaire.

Eventually, he predicted, governments will capitulate and hold non-sovereign and digital currencies on their balance sheets.

Rogoff countered that if that were to happen a very big if it would happen with much smaller nations, where there is limited state capacity to control things. As an example, he pointed to Venezuela, where sanctions have been imposed by other nations and where theres at least some appetite to circumvent those sanctions (and in some cases, support the development of underground economies).

Looking Ahead

In order for cryptos to coexist and become an inherent part of the financial services ecosystem, Allaire said the evolution must include interoperability with Federal Reserve account infrastructure, the Feds payment rails and the international financial infrastructure.

Were examined by governments all the time, he said. We are audited by major accounting firms and their self-governance as well. Self-governance around technology standards, information, security, cybersecurity compliance and transparency is really critical.

Rogoff said central banks around the globe are looking at central bank digital currencies (CBDCs) and the question remains: How far do we want to take it? How does the public feel about having the central bank be in total control of whats private and not private or would you like there to be an intermediary between you and the government?

For now, the innovation is coming out of the private sector, while Rogoff said the policymakers must tackle what they think the world of digital currencies should look like.

As Allaire said, The smart money, if you will, is really focused on seeing this as an internet infrastructure build that will generate very significant value and new types of companies and business models over the next five to 10 years.

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