In April, Fidelity became the first major retirement plan provider to allow everyday people to invest in Bitcoin with their retirement accounts. This move, according to Anthony Lee Zhang, assistant professor of finance at the University of Chicago’s Booth School of Business, signaled a major shift in how traditional financial institutions view cryptocurrency. In the past, crypto investors tended to be people on the fringes of traditional finance. But this cycle, everyone was getting in.
Then, crypto crashed. From April to May, nearly $1 trillion of value in the crypto sector vanished. Bitcoin dropped to below $20,000 for the first time in years. The crash raises a big question: Is crypto simply too risky for regular people to be investing their life savings in?
On Sunday’s episode of What Next: TBD, I spoke with Zhang about the future of crypto investment and the potential for regulation. Our conversation has been edited and condensed for clarity.
Sonari Glinton: Can you help me to quantify how much of the investment world is in stocks and bonds versus in crypto?
Anthony Lee Zhang: So, crypto, even at its peak, was a sizable fraction of overall financial markets. It was not by any means the majority. The market cap of the S&P 500, I checked this a couple months ago, was up at like $20 trillion. I believe stocks, private bonds, and government bonds have roughly equal-ish size, so think of each as being $20 trillion. And at its peak, crypto, if you add up most of the coins together, was about $2 or $3 trillion. The crypto market cap is something like 10 percent of the aggregate cap of the stock market. So it’s huge, considering the fact that this entire asset class did not exist until fairly recently, but still small in size compared to regular, other assets that people invested in for a long time.
How is the crypto market different from the regular market, when it comes to how people respond to it?
Everyone has slightly different views on this. My particular view is that fundamentally, crypto and blockchain technologies are substitutes for lawyers. In the past, if you wanted to write a contract, you would write basically “I promise to give you $20 in a month” or something like that. This technology lets people in the world who previously didn’t have access to promise enforcement technologies write promises. All of finance consists of promises. What blockchain does is it changes the technology for promise enforcement, and that makes a real difference in finance. I do think this technology really has something to it that’s different. I don’t think the market totally shares my view.
When I was doing research about this, I found the panics of 1819, 1837, 1857. These are all market crashes back when stocks and futures markets were new. History has a whole list of things that get hyped and hyped, and then the hype ends, and we do what comes most naturally: We’re humans, and humans panic.
Exactly. And I think the hype cycles are funny and you get the sense, it’s like, “I’m looking at this. I’m not totally sure what everyone’s excited about, but everyone else is so excited, there must be something there.” And there’s a confirmation bias effect. I think in this blockchain wave, with the kind of companies that were rising, you see similar kinds of speculative mania. Everyone tried to rebrand into blockchain, just because attaching yourself to the rocket ship got you tons of funding attention. Because nobody had any clue really, or a lot of people had no real clue what this technology was supposed to do.
And some of the places that blockchain technology ended up being used were pretty ridiculous, right?
Music, NFTs, real estate, supply chain, health care, medical records, stuff like that. Everyone was trying to say, “We’re going to do blockchain. That’s going to revolutionize our industry.” I think it’s very similar to the ’01 one tech bubble in the sense that there was a huge amount of mania, a ton of money wanted in, and a lot of the money didn’t really have a great sense what the tech was, what was special about it, and what applications of it made sense and what didn’t.
The investor in crypto is different from the say, middle-aged guy at Fidelity or Edward Jones. How does that affect the marketplace and what it does?
With crypto, there were no barriers to access. Precisely because it was so easy to just go in and buy this stuff, you talk to people you run into—Uber drivers, your barber, so on—and all of them know about this stuff to a varying degree. Some of them are running simple strategies, just buying Bitcoin and stuff. Some of them are running pretty complicated yield farming strategies.
You can think of it as like ’08, with these super complicated, actually risky, but nontransparent things. But anyone could buy the mortgage-backed securities, not just institutions, and the layers of protection between you and the risky investments is even cut smaller, precisely because crypto was so effective at disintermediating all the layers of funds and pensions that usually invest in those assets on your behalf. So, I think that’s why it went this way.
I wonder if the recent crypto crash will scare off investors who are less risk averse. Will we see people back away from crypto?
It feels to me like we’re going to get less of this, at least for a bit of time going forwards. But what lesson would you have learned from the past two years of investing? Just by watching the markets? The lesson you would’ve learned is: The more risk you take, the more you get. From COVID onwards, markets just went one direction, every trade that should not have worked, worked. You buy tech stocks, they go up like crazy. You buy GameStop, when the fundamentals really don’t seem to justify it, it goes up like crazy.
It was very difficult to teach my class in these times, because I would basically tell them, “Look, you got to ignore everything that happened in the past year when we talk about this class, because none of this advice works in the past year. Everything which really should not work, is working spectacularly well over the past year.” Finally, we are vindicated, the stuff that isn’t supposed to work, stops working after a while. And I think, in terms of narratives, investors watching the failure of these strategies may hopefully convince you, “Look, this doesn’t always work, to just load up a ton on risk, these things don’t always pay off.”
What do you think it’s going to take for crypto to genuinely become mainstream? For say, my mother to give my niece a Bitcoin instead of a savings bond? How do we get to that, and should we?
I think Bitcoin is special. A case in which it eventually has value is what they call the digital gold thesis. People hold gold not necessarily because they value it in and of itself, but because everyone else thinks it has value. And there’s also a finite amount of gold in the world as well, so you want to hold this thing because you’re guaranteed, because of its scarcity and the consensus of everyone that it has value. The thesis is that Bitcoin has properties like gold. There’s a finite amount of Bitcoin. You’ll never print more than the Bitcoin algorithm says you’re allowed to print. And then if everyone agrees it has value, then it’ll continue to have value.
So where could this thesis go? In this cycle, it looked like you were seeing more people seemingly buy into this thesis. You were seeing institutions, family offices, investments funds, various kinds of entities, basically start saying, “Hey, we want to allocate a bit to Bitcoin.” If this trend continued, if you started having central banks say, “Hey, we hold U.S. dollars because they’re somewhat safe. We hold some gold. Why don’t we hold some Bitcoin also? And that backs up the value of our fiat currencies.” You could imagine a world where basically many of the entities in the world hold part of their portfolios in Bitcoin. And that dramatically expands demand for Bitcoin and can support higher prices of Bitcoin. That’s the bull case for Bitcoin. The weird thing here is, we do not have a historical case, I believe, in which an asset with no fundamental value has, purely through consensus, acquired value for any long period of time.
Can you see that scenario actually happening with Bitcoin?
The argument seems to me cohesive enough. There’s a first time for everything. It doesn’t seem impossible to me that this could happen.
Right now, crypto is hardly regulated and a lot of shenanigans going on in the market are because there isn’t a body that oversees or regulates. What are some of the basic reforms that could be put in place? Is there a body out there—a government, organizations—that are poised to step in and play the role of sheriff?
So, the SEC has done a fair amount in trying to regulate this space and has also exerted some pressure, in that crypto has been edging carefully to try and avoid what is the SEC’s jurisdiction. That has limited some of the excesses that the crypto firms have done. One simple example is the SEC has jurisdiction over anything that is a security. Crypto firms have basically been very reluctant to print tokens that have cash flow rights, because of the fact that this, they believe, puts them under jurisdiction of the SEC.
So there is regulatory pressure being exerted on crypto firms, and the SEC has done a bunch in going after crypto firms, in requesting information. Crypto has moved so fast that regulators took some time to just understand what was even going on here. I think regulators, unfortunately, do a lot of learning from hindsight, and they’re going to do some of that here.
They’ll regulate it when they fully understand it?
Better too late than never, I guess. Right?
Future Tense is a partnership of Slate, New America, and Arizona State University that examines emerging technologies, public policy, and society.