Remarks by Governor Waller on Digital Assets

Thanks to the conference organizers for inviting me to participate today. It’s great to be back at a Global Interdependence Center conference. Given recent events in crypto, it is certainly timely to have a day of discussions related to digital assets.¹

Before I dive into today’s talks, which will touch on different parts of the crypto ecosystem, I want to clearly define some concepts to make sure we’re all talking about the same things. I think of the crypto ecosystem as consisting of three parts:

• a crypto-asset, which generally refers to any digital asset implemented using cryptographic techniques that is traded;
• a database management protocol used to record transactions, often referred to as the blockchain, which includes both permissioned and permissionless distributed ledger technologies; and
• technology that directly facilitates the trading of cryptoassets; this includes smart contracts and tokenization as a form of privacy.

The latter two parts can facilitate the trading of cryptoassets, but also have much wider applications.

First, let’s consider distributed ledger technology. The technology is simply a database management protocol that has different permissions regarding who can write to the database and who can read the database. Although this technology is fundamental to creating cryptoassets, there is nothing in this technology that limits it to only be used in the crypto ecosystem. Indeed, distributed ledger technology is being explored to potentially solve a wide range of data management problems.

Next, there are various technologies associated with crypto-assets. One is the use of smart contracts in peer-to-peer trading. Smart contracts can also be used in conjunction with a centralized data management protocol to automate the execution of certain transactions in non-crypto assets. For example, over time they can be used to speed up the clearance and settlement of securities transactions. Another new technology is tokenization. In any trade in assets, there is the question of how much personal information you have to provide in order to execute the trade. For example, some personal information is required to protect against the possibility of anonymous trading, which can promote money laundering. Tokenization, when combined with data vaults to securely store personal information, can be used to trade objects in a way that protects one’s identity from being exploited for profit. While these technological developments are still in their infancy, they have potential applications beyond the crypto ecosystem that could lead to significant productivity improvements in other industries.

This leaves us with the crypto assets themselves. The question is, why would anyone have such an asset? What is the value of such an asset? The answer is not new or unique, but rather is based on economic relationships that result in objects having value. One reason objects have value is because of their inherent properties. For example, the value of corn comes in part from the fact that it can be used for food or fuel, or in some cases for Thanksgiving centerpieces. Intuition suggests that if an object has no intrinsic value, the price of that object should be zero – why pay for something that has no intrinsic value? Shockingly, it turns out that objects can be valued far beyond what their inherent properties would suggest. Since Paul Samuelson’s seminal work in 1958 on the equalization of intertemporal consumption, economists have known that an intrinsically useless item can be traded at a positive price.² Such an object’s value is driven solely by belief. If I believe that someone will pay a positive price for this object in the future, I may be willing to pay a positive price now, carry it over time, and sell it when I need to consume other goods and services. Samuelson referred to this concept as “the social procurement of money.”

While an intrinsically useless object can be traded at a positive price, we also know that there is always a second equilibrium price for this object, which is zero. What if one day the belief changes and I no longer believe that someone will pay me for this object in the future? Then I obviously shouldn’t pay anything for it today, so the price goes to zero.

There are many inherently useless items that still have value. Think things like baseball cards and celebrity autographs, which are pieces of cardboard and paper with pictures or scribbles on them. Based on their basic properties, these things have little or no intrinsic value, but can still be in demand and fetch staggering prices. What happens if one day nobody wants to collect baseball cards? As valuable as they are today, they wouldn’t be worth much, if anything.

This brings us to crypto assets. To me, a crypto asset is nothing more than a speculative asset, like a baseball card. If people believe that others will buy it from them in the future at a positive price, it will trade at a positive price today. If not, the price will go to zero. If people want to hold such an asset, then go for it. I wouldn’t, but I don’t collect baseball cards either. But if you buy crypto assets and the price goes to zero at some point, please don’t be surprised and don’t expect the taxpayers to socialize your losses.

The result of this is that cryptoassets are risky and many of the firms that trade in them are in their infancy. That has come to the fore in the past year as several prominent crypto-related firms have filed for bankruptcy, including payment platforms, exchanges, crypto lenders and hedge funds. The decline in crypto asset values ​​and associated business failures have left many investors in the crypto industry hurt. As I mentioned in a speech last summer, surveys conducted indicated that somewhere between 12 and 20 percent of American adults have owned, traded, or used crypto assets.³ As losses mount, the debate turns to whether there should be better investor protection in place. But even institutional investors, with significant resources to conduct investment due diligence, have felt the pain of the so-called crypto winter. For example, it has been reported that at least 15 public pension funds, which manage public employee pension funds, had investments in the now bankrupt crypto-asset exchange, FTX.⁴

While I don’t care if people take on risky investments or engage in risky business ventures, banks and other financial intermediaries must engage in any activity they do in a safe and sound manner. I support sound innovation in the financial system, while being concerned that banks are engaging in activities that increase the risk of fraud and fraud, legal uncertainty, and the proliferation of inaccurate and misleading financial disclosures. As with any customer in any industry, a bank engaging with crypto customers will need to be very clear on their customers’ business models, risk management systems and corporate governance structures to ensure that the bank is not left stranded if there is a crypto meltdown. And banks considering engaging in crypto-asset-related activities face a critical task of meeting the “know your customer” and “anti-money laundering” requirements, which they are by no means allowed to ignore.

So far, the ripple effects to other parts of the financial system from the stress in the crypto industry have been minimal. The lack of spillovers to date may be due in part to the relatively limited number of interconnections between the crypto ecosystem and the banking system. While it is crucial that we ensure that the risks to financial stability associated with crypto assets are reduced, it is important that we keep the different parts of the crypto ecosystem distinct in our minds as the debate about and how to regulate crypto continues. Doing so will ensure that we do not unduly limit the development and potential future use of the positive features of the crypto ecosystem.

With that, I’d like to answer a few questions.

1. The views expressed here are my own and do not necessarily reflect the views of my colleagues on the Board of Governors of the Federal Reserve System. Return to text

2. Paul Samuelson, “An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money,” Journal of Political Economy, vol. LXVI (December 1958): 467–482. Return to text

3. Christopher J. Waller, “Risk in the Crypto Markets” (comments at the SNB-CIF Conference on Cryptoassets and Financial Innovation, Zurich, Switzerland, June 3, 2022). Return to text

4. “Have Pensions Lost Money on FTX?,” Equable.org, 1 Dec. 2022. Return to text