Letting crypto loose is a mistake banks will watch happen

President-elect Donald Trump made a bit of a gamble when he decided to throw his weight behind cryptocurrency during the 2024 election. Crypto — a marketplace/casino built around the promise of still-emergent blockchain technology — has attracted a base of users, investors and supporters whose interests are primed to embrace the kind of radical, disruptive change that Trump has envisioned for the federal government, and so it would make sense that a modest investment of supportive overture could pay off in the form of votes. 

There’s no real way of knowing whether or to what degree crypto policy tipped the scales in the 2024 election — it’s a big issue for a relatively small number of people, but it was also a relatively close election. But that isn’t really important; what matters is that Trump loves crypto and crypto loves him back. He has promised to make the U.S. a leader in crypto and pass regulations enabling the asset class to become more mainstream, even calling for a national Bitcoin reserve. Even these nascent gestures have rallied crypto markets, sending Bitcoin and Dogecoin prices surging after his election. The message of an open regulatory field for crypto in the years to come has been sent and received.

If we are poised to enter into a world where crypto is more fully integrated into the financial mainstream, it’s worth asking whether that integration is a net positive. But before we get there, let’s consider what the component parts of a more integrated crypto are. As of right now, it isn’t very simple to use crypto for everyday retail transactions, nor is crypto very easy to acquire and exchange for garden-variety dollars. 

Part of that is because banks tend not to deal in crypto, and that is because regulators have been slow in designing rules of the road, and what rules have been issued are politically wobbly and hard to base a business around. Custodia Bank explicitly built its business model on top of dealing in crypto and has sued the Federal Reserve to obtain a master account, allowing it to access the payment rails that undergird the U.S. financial system. The incoming administration would be relatively free to loosen the rules that already exist around crypto custody and over time would likely obtain the votes necessary on the Fed board to change its stance toward master accounts as well. 

Let’s now consider what crypto does and what it is for. The fundamental innovation of the crypto market is that it uses a blockchain — a dispersed ledger that records each transaction permanently — to execute and record transactions. That means everything is everywhere all at once, and theoretically this would create the kind of certainty in the technology that we currently have in the full faith and credit of the United States. 

The most practical feature of crypto as it exists now is that there are no rules. I am not free to send my dollars anywhere in the world I like; I cannot buy drugs or a nuclear weapon with my dollars, or send those dollars to a terrorist organization or an enemy state of my choosing. But you can do those things more easily with Bitcoin, which has created an odious use case for what promises to be a revolutionary technology.

Perhaps the most important thing that crypto does is increase in value as more people obtain it, which is an attractive feature for both institutional and retail investors. To date the mainstream pickup of crypto has been limited by regulatory reticence and aversion to risk — the FTX debacle wasn’t that long ago, after all. But if the next administration eliminates the regulatory roadblocks, institutions and people will follow — just look at what happened to the price of Bitcoin when the Securities and Exchange Commission approved the first Bitcoin exchange-traded funds earlier this year. What is more, there are always new coins being created and offered with the promise of being worth more tomorrow than they’re worth today, a pitch that can be reinforced by the idle observation that crypto values have gone up just in the last few months.

The combination of a lightly regulated market and rising values creates the ideal conditions for an asset bubble, and if increased uptake of crypto as a medium of exchange has the effect of diminishing the Federal Reserve — whose job is, in part, to maintain price stability — then policymakers would have an especially difficult time mitigating the inflation of the bubble on its way up and cleaning up the mess when it inevitably pops. The idea of regulators stepping in to bail out crypto in 2022 was absurd, but maybe it won’t be so absurd in 2026 or 2030. 

This publication being named American Banker, it is reasonable to assume that I’m coming in on the side of the financial establishment because banks are at the core of that establishment, and that assumption would not be entirely wrong. I personally think that the financial establishment has some pretty notable and obvious flaws, but a century or two of tinkering has allowed the core competencies of our financial system to function reasonably well. 

I’m skeptical of any purported revolution because revolutions tend to replace the old establishment with a worse one, especially when they’re not given careful thought. I might also be wrong — the incoming administration appointees might take a look at the same landscape that the current ones do and reach similar conclusions, or the crypto market might evolve and diminish the illicit elements that I think most people object to. But if the underlying value of crypto is that it makes early movers rich, that is a soft foundation on which to build a pillar of the financial system. We’ll just have to see whether it can bear weight.

This post was originally published on here