Paul Krugman: Cryptocurrencies: A Postmodern Pyramid Scheme | Business

When the Federal Reserve speaks, it does so in its own language. A concise phrase or a catchy metaphor can very easily become a headline that provokes big movements in the market and a public reaction. That is why technical language and euphemisms are usually the best choice.

Given this, the bluntness of a recent speech on crypto regulation by Lael Brainard, the institution’s vice president, is almost shocking. It is true that Brainard did not go as far as Jim Chanos, the famous bearish investor who called cryptocurrencies “predatory junk”, but he was close. The heading with which she began her intervention was “distinguishing between responsible innovation and circumvention of the rules”, and the vice president made serious insinuations that the crypto universe moves by the latter. Traditional banking is regulated for a reason; By circumventing regulations, it said, cryptocurrencies have created an environment subject to banking panics, not to mention “thefts, hacks, and ransomware attacks,” in addition to “money laundering and terrorist financing.” .

Otherwise, all good.

The thing is, most of Brainard’s litany has been apparent to independent observers for some time. So why haven’t we heard serious calls for regulation so far? Cryptocurrencies have been around since 2009, and in all this time they have never come to play a significant role in real-world transactions. El Salvador’s much-vaunted attempt to convert bitcoin into its national currency has ended in disaster. So how did the virtual currency come to represent nearly three trillion dollars at its peak? (Now, two-thirds of that value is gone.) Why was nothing done to put limits on stablecoins, supposedly pegged to the US dollar but clearly subject to all the risks of unregulated banking, and now experiencing a series of cascading crashes reminiscent of the wave of bank failures that helped make the Great Depression great?

My answer is that while the cryptocurrency industry has never succeeded in creating products that are useful in the real economy, it has been spectacularly successful in commercializing them, creating an image that is both cutting-edge and respectable. This has been achieved, in particular, by cultivating the friendship of prominent individuals and institutions. I am not referring here to the positive reception of cryptocurrencies among libertarians and types of the Make America Great Again, nor to embarrassing episodes like the ad starring Matt Damon. What strikes me, rather, is the extent to which they have earned a reputation for respectability by associating themselves with high-status institutions and individuals.

Let’s say, for example, that you use a digital payment app like Venmo, which has been widely proven useful for real-world transactions (it can even be used to shop at street fruit stalls). Well, if you go to the home page of Venmo, you will find an invitation to use the application to “start your journey in the world of cryptocurrencies”. In the application itself, a “Crypto” tab appears right after “Home” and “Cards”. That must mean that the coins in question are serious business.

Suppose you want to learn about virtual currency. Many famous universities offer programs, usually online courses.

Suppose you want to know who advises the major players in the cryptocurrency industry. Well, the board of directors of Digital Currency Group, one of the biggest players, includes a co-chairman of the board of directors of the Brookings Institution and has a former secretary of the Treasury as an adviser. With this aura of approval from the elite, how many people were willing to believe that the digital emperor had no clothes? Moreover, how many would have been willing to accept strict regulatory control?

Why would these elite people and institutions support a sector that, as Brainard made clear, is highly dubious? I don’t think there was any corruption (unlike in the cryptocurrency industry itself, which is riddled with scammers). In fact, I know from my own experience that you can cash a check doing what looks like honest work, only to find out later that the people who signed it were fraudsters.

Still, it is clear that there have been and continue to be financial rewards. I don’t know how much money Venmo makes from people buying and selling cryptocurrencies on its platform, but it sure doesn’t offer the service out of sheer disinterest. If one wants to do, for example, a course on blockchain at the Massachusetts Institute of Technology, it will cost you $3,500.

In my opinion, cryptocurrencies have become a kind of postmodern pyramid scheme. The industry lured investors with a combination of tech-babble and libertarian bullshit, and used some of that money to buy the false image of respectability, which lured even more investors. And for a while, though the risks multiplied, it became, in effect, too big to regulate.

One way to interpret Brainard’s speech is that he was saying that the cryptocurrency crash provides an opportunity, a time when effective regulation has become politically possible. And he urges us to seize this moment before the crypto universe ceases to be a simple casino and becomes a threat to financial stability.

It is very good advice. I hope the Federal Reserve and other policy makers follow suit.

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