• Fri. Dec 1st, 2023

A crypto truce emerges amid fraud and revolution

A crypto truce emerges amid fraud and revolution

I see a growing middle-of-the-road regulatory consensus on cryptocurrencies. Crypto is a Ponzi scheme to defraud investors and empower criminals, on the one hand, it splits the difference between “crypto will solve ancient economic problems and usher in an era of prosperity and freedom.” It envisions a future where domestic crypto plays well within the traditional financial regulatory system.

Last week, four senior International Monetary Fund executives published an outline for international regulation of crypto on the IMF blog that does a good job of summarizing this view. It proposes four principles for crypto regulation: one good, one bad, and two ugly.

(1) The defense against the substitution of sovereign currencies is the maintenance of strong, credible and reliable domestic institutions.

Good – A refreshing blast of sensible fair play. When the competition is threatening, raise your game. Maintain your market share by providing customers with the best product, not by whining to regulators to impress your competitors. Bitcoin was created by Satoshi Nakamoto in response to the financial crisis of 2008, when traditional financial institutions seemed to be in danger of collapse and financial regulation seemed to be part of the problem and not part of the solution. Confidence in sovereign credit, central bank competence and respect for the rule of law was low.

Crypto has benefited where sovereign managed fiat currencies have been mismanaged and financial repression intensified. Commercial successes were areas where traditional financial institutions charged exorbitant fees and offered poor customer service. Crypto has changed Gresham’s Law – good money drives out bad.

(2) In order to protect national sovereignty, it is important not to assign official currency or legal tender status to crypto-assets. Doing so… would create economic risks to government finances and threaten economic stability or rapid inflation.

Bad – Direct contravention of (1). What the authors want to protect is not sovereignty, but government revenue.

Since the invention of money, the government has made huge profits from seigniorage. In ancient times, this was maximized by devaluing the coinage, cutting the amount of precious metal in the coins, and forcing citizens to accept them at their old values. This was made easier by the fiat currency system introduced by the Nixon shock of 1971. The government creates money at close to zero cost, spends it on real goods and services, and only a fraction of that money comes back to the government in taxes or fees. A central bank holding non-government interest-paying assets can also create seigniorage by financing it through zero-interest accounting entries on its balance sheet and other indirect means.

Governments protect their seigniorage by using favorable legal and tax status for currencies issued by sovereigns and other assets. If these benefits are extended to cryptocurrencies, the government’s revenue will decrease.

If crypto is better than government currencies, it would be better to replace lost seigniorage revenue with taxes rather than protect an inefficient monopoly that hurts consumers – not outlaw email and instant messaging to protect the post office.

(3) To address the volatility of crypto-related capital flows, policymakers should integrate them into existing regimes and laws governing capital flows.

Dirty – Manipulating capital flows (usually by either prohibiting foreigners from buying domestic assets, or preventing foreigners from taking assets out of the country) is a euphemism for economic repression. For example, the movie The Good, the Bad and the Ugly is a spaghetti western. When the film was made in 1966, Italy “restricted” capital flows by not allowing people to take lira out of the country. Foreign companies with lira profits could not bring them home. The solution was to use the lira to finance American films made in Italy that had worldwide appeal. Foreign companies returned their lira profits in the form of global movie ticket sales.

If there was crypto in 1966 there would be no need to make movies. Foreign companies could sell their goods in Italy for GBUcoin (the good-bad-dirty coin) and move their profits with little disruption. Italy could try to regulate the buying and selling of GBUcoin, but since the crypto allows under the guise of global peer-to-peer transactions, enforcement will be difficult.

Managing capital flows is scary economics, and there is no way to implement capital flow management rules in crypto without destroying its advantages.

(4) Finally, tax policies should ensure unambiguous treatment of crypto assets, and administrators should strengthen compliance efforts.

The ugly – You can’t have a straightjacket upgrade with pre-set treatments. Long before crypto, tax collectors struggled with the theoretical distinctions between casual human exchanges — gifts, you-grill-the-meat-and-I-salad, hitchhiking, pick-up basketball games, etc. — and taxable events. In practice, it is usually taxable if currency is involved, if not, it may in theory be taxable but in most cases the authorities will not attempt to collect (not legal advice, there are many exceptions!).

Many crypto projects cannot adapt to the commercial exchange/human exchange dichotomy. Lines are blurred between customers, suppliers, employees and investors. Projects link financial and non-financial humanitarian incentives.

In the future, we may be able to monitor the crypto ecosystem and find good ways to generate government revenue from it. This is a reasonable goal for a forward-looking regulator. But this principle is ugly because it wants to “ensure” taxes today and threatens to “reinforce compliance” as if it were a fight against evil tax evaders rather than a genuine exploration of better human cooperation.

The good news is that the main impact of crypto to date has been (1) – governments and banks have improved their services to compete with crypto. Bad (2), ugly (3) and (4) are too difficult and don’t go far.

The authors of this IMF blog post have precisely identified the challenges for regulators — protecting government revenues and mitigating disruptions from volatile capital flows — and they have proposed solutions that are now impossible.

I am personally optimistic about crypto regulation. I don’t mean that I or anyone else knows how to do it right. I mean there is good communication between innovators and regulators. They may not see eye to eye, but there is more common ground than there was a few years ago, and a greater willingness to entertain unconventional approaches. With good will and luck, a Pax Bitcoinus may be in our future.

More from Bloomberg Commentary:

• Spot Bitcoin ETFs are coming. Beware of Risk: Nir Kaiser

• Matt Levine’s Money Stuff: Ripple Is a Security, It’s Not

• Some Bad Boring Monkey Won’t Crash the NFT Market: Aaron Brown

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Aaron Brown is a former Managing Director and Head of Financial Markets Research at AQR Capital Management. Author of “The Poker Face of Wall Street.” He is also an active crypto investor and has venture capital investments and advisory relationships with crypto companies.

More stories like this one are available at bloomberg.com/opinion

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