Does Crypto Investment Need to Be Regulated?

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Sonari GLINTON: Cryptocurrency has arrived this April. Fidelity became the first major retirement plan provider to allow everyday people to invest in Bitcoin with their retirement accounts.

Speaker 2: The fact that a regulated, traditional, high status financial institution is telling you, Hey, buy some of the stuff, right? Gives it some of the stamp of approval that is not present in one of these traditionally like kind of sketchy sounding crypto exchanges.

Sonari GLINTON: That’s Anthony Lee Zion. He teaches finance at the University of Chicago’s Booth School of Business. He says this move by Fidelity signaled a major shift in how traditional financial institutions view cryptocurrency.

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Speaker 2: The past cycles, I think, somewhat more involved kinds of people that were more on the fringes of traditional finance. Right. And this cycle you see everyone getting in.

Sonari GLINTON: And then crypto crashed.

Speaker 3: What we do know is that even for those diehard Bitcoin supporters who were used to volatility, the last 74 hours were a very rough ride.

Sonari GLINTON: In just one month from April to May, nearly $1 trillion of value in the crypto sector just vanished. Bitcoin dropped to below $20,000 for the first time in years. Now, volatility is nothing new to cryptocurrency markets, but with many more regular investors putting their life savings into crypto over the last few years, a lot of people will end up getting hurt by this crash.

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Sonari GLINTON: Now investors are worried that we’ve entered a crypto winter. That’s when crypto values fall and stay low for a long period of time. Has the bubble finally burst for cryptocurrency, or is the future of money just delayed? According to one argument, there is a four year cycle just built into cryptocurrencies and we’re just getting to the ugly part. An answer could come from traditional financial investors. Fidelity, one of the largest financial services firms, doesn’t seem to think crypto winter is here. They’ve doubled the size of their digital asset when signaling they think institutional crypto trading is going to increase despite the downturn in the market. Anthony, though, is not so sure.

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Speaker 2: I don’t know if this crash is going to due to this wave of institutional adoption. It could be like following this crash, like this crash delegitimizes this whole thing. The whole trend reverses. And maybe we should expect that it hinges on the question of whether, in fact, these big traditional investors, in fact, are less fickle than Silicon Valley hipsters, basically.

Sonari GLINTON: The real question is, are the crypto markets too risky to allow regular people to put their life savings in?

Speaker 2: Some stuff is like too risky for regular people. You kind of want to keep people out of investing in this thing. I think that sort of especially with this crash and people having lost a lot like regulars, they end up saying like, look, we don’t want people to put themselves in this position again where basically they put all their money in lost this.

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Sonari GLINTON: Two day on the show. How does the crypto market compare to traditional markets and what does that mean for the future of crypto, big investors and our economy? I’m Sonari GLINTON, filling in for Lizzie O’Leary. And this is what next TBD, a show about technology, power and how the future will be determined. Stick around.

Sonari GLINTON: It’s gotten a lot easier to invest in crypto and its share of the investment market has grown. But just how much of the market is tied up in crypto don’t mean to quantify how much of the SEI investment world is in stocks and bonds and say in crypto.

Speaker 2: So crypto, even at its peak, was not was a sizable fraction of overall financial markets. It was not by any means the majority. So then I think the numbers are approximately the market cap of the S&P 500. I checked this a couple of months ago, is up at like 20 trillion, I believe stocks and bonds, stocks, bonds and government bonds have roughly equal ish size. So think of it as being 20 trillion, right? And that is t crypto is something like if you add up basically most of the coins together, you get a number like two or 3 trillion. Now it’s below like 1 trillion, right? So you have something like crypto market cap is something like 10% battery cap in the stock market. So huge compared to just considering the fact that this entire asset class did not exist basically until fairly recently, but still sort of small in size compared to sort of regular like other assets that people invest in for a long time.

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Sonari GLINTON: All right. To be overly simple. Crypto and blockchain are relatively recent technologies that allow for decentralized recordkeeping and verification of transactions. The hope of blockchain is to get around a lot of the impediments of traditional markets. Every few years, there’s like a technology that everybody says is going to change everything, right? Cryptocurrency may be different, but the people who invest it, they’re still people. So what I’m wondering is how is the crypto market different from, say, the regular market when it comes to how people say respond to it?

Speaker 2: Everyone has slightly different views on this. I think like I have a particular view on what crypto enables, which is that sort of crypto. Fundamentally, crypto and blockchain technologies are in a sense substitutes for in fact lawyers. And then so my core thesis about what the core contribution of blockchains are is that basically in the past, if you wanted to write a contract, you would write a piece of paper and you would write basically like, I promise, I promise Sonari to basically give you like say $5 in like a month or something like that, right? I think there’s a real difference in this technology. And then it lets us it lets people in the world who previously didn’t have access to basically promise enforcement technologies to write promises. All of finance fundamentally consists of promises. What blockchain does is it changes the technology for promise enforcement, and that makes a real difference in finance.

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Speaker 2: I do think this technology really has something to it that’s different now. I think like if you look at the market, I don’t think the market totally shares my view. So you sort of see in every tech wave, I totally agree with what you said, that this speculative mania arises where everyone thinks this technology sort of is going to be revolutionary. The vast majority of people have no real clue what the revolution actually is. Right. And then the sentiment that this is going to change the world, I have no idea how, but I want some part of it leads to this mania of people just like assuming that the answer is known by someone else. Right?

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Sonari GLINTON: When I was doing research about this, I found the panic of 18, 19, 1837, 1857. These are all market crashes back when stocks and futures markets were new. And history has a whole list of things that get hype and hype, and then the hype sort of ends. And we do what comes most natural where humans and humans panic.

Speaker 2: No, 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 you kind of have this confirmation bias effect of wanting to see something there. It’s actually quite similar, I think, to the oh one tech bubble where basically sort of everyone was excited about tech. Nobody was super sure what everyone is excited about. So you got this thing where you take like arbitrary businesses and start gluing tech onto them because like tech plus x must be a good thing for every x. And you could raise spectacular amounts of money as long as you try to do tech for like something. Right. And I think in this blockchain wave and you see the kind of companies that were raising, you see similar kinds of like speculative mania, just like everyone tried to rebrand into blockchain just because sort of attaching yourself to basically the rocket ship like got you tons of funding attention, so on and so forth because nobody had any clue really, or a lot of people had no real clue what this technology was supposed to do.

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Sonari GLINTON: And some of the places that blockchain technology ended up being used were pretty ridiculous.

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Speaker 2: Music, NFT, um, real estate, supply chain, so on and so forth. Health care and medical records, stuff like that. Everyone was trying to say, We’re going to do a blockchain that’s going to revolutionize our industry, right? I want like say in particular, which of these I think work and which of these don’t. But a couple of these I’m like from my knowledge of the tech, I’m pretty confident blockchain has no relevant application to this particular stream of work. Right. But I think it’s very similar to the though in fact, although in the sense that there was a huge amount of mania, a ton of money wanted in and nobody really had a great so like 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 did I think?

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Sonari GLINTON: You know, when I think of this, there’s a possibly apocryphal tale that one of the first heads of the FCC, Joe Kennedy, was talking to a was was talking to his cab driver. And his cab driver gave him a stock tip and he like was like Arcel. I mean, that’s apocryphal story. But, you know, my videographer friend who never thought is, you know, getting in the Crypto, you know, by barbers literally talking about it, but that the investor in crypto is different from the, say, middle age guy at Fidelity or Edward Jones or one of those places. I’m wondering how the nature of the difference between the investor, how does that affect, you know, the marketplace and what it does?

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Speaker 2: I think like crypto, precisely because there are no barriers to access, precisely because it was so easy to just go in and buy this stuff. Right. Like a lot of it anecdotally, it seems like a lot. Yeah. I mean, as you say, like you talked to sort of I mean, like sort of people you run into.

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Sonari GLINTON: Barber survivors.

Speaker 2: On all the know about this stuff to varying degrees. Some of them are running several stages of buying Bitcoin. And so some of them are running like pretty complicated because you’re driving a ton strategy. Right. And so the thing is, I think you can think of it as like oh eight with these like super complicated, actually, risky but non-transparent things, but anyone could buy them. Yes. There’s not just institutions. And the layers of protection between you and the risky investment is even smaller, precisely because crypto is so effective at disintermediated. All the layers of like funds and pensions and whatever that usually invest in those assets on your behalf. So I think that’s kind of a difference that like why it went this way.

Sonari GLINTON: I wonder if the recent crypto crash will scare off investors who are less risk averse. I like what we see people back away from crypto.

Speaker 2: It feels to me like we’re going to get less of this, at least for a bit of time going forwards. What lesson would you have learned from the past two years of investing just by watching the markets? Right. Like the lesson you would have learned is like the more risk you take, the more you get for the past. I mean, ignoring the past year. But basically from like COVID onwards, markets just like went one direction. Every trade that should not have worked for you. Like by Techstars, they like go up like crazy. You buy a GameStop when the fundamentals really don’t seem to justify. It goes up like crazy, right? So the lesson you learn from all this is basically that sort of in the short run, like everything that shouldn’t work is working.

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Speaker 2: Right. I think you have market conditions that really explain, like why so many people get into this belief that basically the old guys are wrong. The way to win is to sort of take ridiculously risky bets. It was very difficult to teach my class in these times because I basically tell my class like, look, you got to ignore everything that happened in the past year when we talk about this class. Right, because none of this advice works. In the past year, everything which is like really did not work is working spectacularly well over the past year. Finally, we are vindicated. The stuff that doesn’t is supposed to work. It stops working after a while. Right. And I think sort of in terms of narratives, like I think investors are watching, the failure of these strategies finally may sort of hopefully convince you. But this doesn’t always work to just like load up on risk. Like risk doesn’t like these things don’t always pay off.

Sonari GLINTON: What do you think it’s going to take for crypto to genuinely become mainstream for, say, my mother to get my niece a Bitcoin instead of a savings bond? How do we get to that and should we.

Speaker 2: Think bitcoin is kind of special a case in which it eventually has value? Right. Is that basically what they call the digital gold thesis? Right. Like the thesis is basically like people hold gold, not necessarily because they value in and of itself, but because everyone else thinks it has value. Right. And there’s also a finite amount of gold in the world as there is still if you want to hold this thing because you’re guaranteed, basically because of its scarcity and the consensus of everyone that it has value. And then so the question basically the thesis is like Bitcoin has properties like gold. There’s a finite amount of Bitcoin. You’ll never sort of print more than the Bitcoin algorithm says you’re allowed of print. Right. And then if everyone. Agrees it has value. They’ll continue to evaluate.

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Speaker 2: Right. And then so where could this thesis go? In this cycle, it looked like you are seeing more people seemingly buy into this thesis. You are seeing institutions, family offices, investment funds, various kind of entities basically start saying, hey, we want to allocate a bit to Bitcoin, right? And then sort of. If this trend continued, if you started having like central banks say, hey, we like U.S. dollars because there’s some would say if we hold them gold. Why don’t we hold some Bitcoin also? And that sort of backs up the value of our fiat currencies, right. You can imagine a world where basically, like many of the entities in the world, hold part of their portfolios and Bitcoin and that dramatically expands, I think, the demand for Bitcoin and can support sort of higher prices of Bitcoin and can support sort of. That’s, I think the whole case for Bitcoin. I think the weird thing here is like we do not have a historical case, I believe, in which a asset with no fundamental value has purely through consensus acquired value for any long period of time. I cannot think of one example of this.

Sonari GLINTON: Anthony says, Just because it hasn’t happened doesn’t mean it can’t or won’t happen.

Speaker 2: However, the argument seems to be cohesive enough that sort of there’s a first time for everything. It doesn’t seem impossible to me that this could happen. So the bull case, I think for Bitcoin, like in the long run, the world in which like this is fairly widely adopted is a world in which purely through consensus, everyone is like, I’m going to hold a bunch of this because like gold, it has value, everyone agrees it has value. And sort of I want in holding parts of the market, parts of valuable assets in the market to hold part of my portfolio. Yeah.

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Sonari GLINTON: We know right now crypto is hardly regulated and a lot of the shenanigans going on in the market are because there is anybody that oversees or regulates, you know, what are some of the basic reforms that could be put in place? And is there a body out there, you know, government organizations that are poised to step in and play the role of share?

Speaker 2: So the FCC has done, I think, quite a bit and I think a fair amount in trying to regulate this station, I think has also exerted some pressure in that Crypto has been like edging carefully to try and avoid what is the FCC jurisdiction. And I think that is sort of limited some of the excesses that the crypto firms have have have done right.

Speaker 2: And so, for example, one simple example is the FCC has jurisdiction over anything which is a security. Crypto firms have basically been very reluctant to print tokens that have cash flow rights, basically because of the fact that this, they believe, puts them under the jurisdiction of the FCC. So that’s like one example of basically there is regulatory pressure being exerted on Crypto firms. And the FCC has done a bunch in basically going after crypto firms and basically requesting information. So I think there is some regulation going on. I think that like one barrier here is that crypto has moved so fast. I think is one thing that it’s like. Regulars, I think, took some time to just understand what was even going on here.

Sonari GLINTON: You know, I know a lot of middle aged, you know, financial advisers and planners, and I know they don’t fully understand crypto. And you seem to be saying that as the average finance guy or gal comes to understand the markets, regulators are going to see where the holes are and create regulations that work. Like what happened after the 29 stock market crash that gave us the FCC and other regulations.

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Speaker 2: I think, like regulators, unfortunately, do a lot of learning from hindsight and they’re going to do some of that. I think here.

Sonari GLINTON: They’ll regulated when they fully understand it better.

Speaker 2: Too late than never, I guess.

Sonari GLINTON: So thank you for taking the time to talk to me. I really appreciate.

Speaker 2: It. I know. Thanks a lot for having me.

Sonari GLINTON: Anthony Lee Zang is an assistant professor of finance at the University of Chicago’s Booth School of Business. Well, that is it for the show today. TBD is produced by Evan Campbell. Our show is edited by Jonathan Fisher. Joanne Levine is the executive producer for What next? Alicia montgomery is vice president of Audio for Slate. TBD is part of the larger what next family? TBD is also a part of Future Tense Partnership of Slate, Arizona State University and New America. I’m Sonari GLINTON, filling in for Lizzie O’Leary. Thank you for listening.