The surprising effectiveness of crypto regulation

Stephen Diehl is a programmer and co-author of the book Pops the crypto bubble.

Not so long ago, you couldn’t ride the London Underground without being bombarded with pushy ads saying “now’s the time to buy bitcoin” or lures for the latest dog-themed cryptocurrency.

In retrospect, the outcome was quite predictable. Spasms of euphoric speculative excesses and promises that “this time is different” have been an inevitable part of society for centuries. What was really different this time, however, was how many of our institutions correctly recognized and preempted many of the worst excesses of this bubble.

Those of us who have watched the crypto frenzy with horror have been plagued with anxiety about what the inevitable collapse might entail. And yet when it finally came, it wasn’t with a bang, but with a whimper. The reaction of the wider financial system was largely a shrug.

However, the reason for this controlled implosion is not purely random and owes much to the vigilance of regulators, the press and civil servants.

Unknown to many, a parallel thoughtful discussion about crypto happens every day. Far from the din of social media, a more sober policy debate is unfolding in law review journals, symposia and policy white papers as agencies wrestle with the technology’s genuinely new and strange implications.

And there are many schools of thought for and against the wide range of policy proposals – including banning crypto, letting crypto burn, regulating crypto as gambling, using existing financial regulatory capacity to regulate crypto without additional legislation, and proposals for entirely new bespoke legislation.

However, extending the protection and privilege of legitimacy-ending regulation must be contingent upon an adequate answer to the existential question of crypto: What is its purpose?

Outside of crypto circles, few find the circular and self-referential explanation that “the purpose of crypto is to trade more crypto” particularly satisfying. Until we have a better answer, the traditional financial system should remain fenced off from this experiment so that its turbulence can never grow beyond being a tempest in a teacup. Fortunately, that is essentially what we have done in the US and UK.

In the US, the actions of the Federal Reserve, the IRS, the OCC and the Department of Justice have been surprisingly effective in limiting the growth of the crypto industry. The SEC stopped the initial coin offering bubble, took over 130 enforcement actions against crypto entities, and has yet to lose a single one. The Fed and FDIC have strictly limited the interactions between banks and crypto markets. Even at the height of cryptomania last year, the entire “value” of bitcoin was just a drop in the bucket for US capital markets; less than a single publicly traded company like Microsoft.

In the UK, crypto exchanges have never gained a foothold, despite the government’s uneasy flirtations with the industry, and have struggled to obtain a financial services licence. The FCA and the Bank of England consistently warned the public that they should be prepared to lose all their money in crypto (sadly a painful reality that many victims have discovered first-hand). The British Treasury never minted the NFT it once promised. The crypto industry never became intertwined with the city, and remains systemically irrelevant to the UK economy.

Our regulators and agencies did the right thing, despite the remarkable level of speculative fervor, the unpopularity of skepticism, and the marketability of politicians. And credit is due to the foresight and thankless work of thousands of civil servants who quietly insulated our financial systems from crypto shock through action or strategic inaction.

The alternative story, where we had prematurely expanded the regulatory task around crypto, could have led to far more disastrous outcomes. In other words, this time actually our different — our institutions worked.