The prospective appointment of Janet Yellen as U.S. Treasury Secretary and Gary Gensler to head up the U.S. Securities and Exchange Commission all point towards the regulation of cryptocurrencies, and the institutionalization of cryptocurrency markets.
Detective Joseph Blake looked down at the slumped over body of Peter “Petey” Romano.
Lying in a pool of his own blood, Petey and several capos had just been gunned down by a rival gang as they stepped out of the Green Mill Cocktail Lounge in downtown Chicago.
A notorious mob hangout during Prohibition, the Green Mill was also known as the “Green Mile” — after the color of the strip of walkway that death row inmates would walk their final steps on towards the electric chair.
The Green Mill was often a place where scores were settled and frequent shootings that would take place at the bar — hence the moniker “Green Mile.”
As Prohibition got into full swing in the United States in the 1920s, the ban on the sale and consumption of alcohol fueled a rise in underground black markets as Americans clamored for a tipple to cope with living in America.
And with those black markets came the rise of the Mafia, which has been romanticized in both literature and film ever since.
But with the Mafia came increasing lawlessness and cycles of escalating violence, as rival gangs duked it out for supremacy and control over the lucrative trade in alcohol.
And while the lifting of Prohibition in 1933 put a serious dent into one of the Mafia’s key revenue streams, it did lead to a more civilized management of alcohol consumption, the rise of many iconic America distilleries and breweries, and the birth of a lucrative tax-paying sector of the economy.
Today, nobody in the United States even thinks about, let alone suggests a return to Prohibition.
Despite the fact that alcohol is one of the most addictive substances on earth, it’s regulation has ensured its continued existence.
Regulation is Recognition
At its core, regulation is a form of recognition — that alcohol has the legal right to exist and more importantly, that it has the legal recognition to be consumed.
Which is why investors shouldn’t dread the possible arrival of more comprehensive regulation for cryptocurrencies, they should embrace it.
Because with regulation of cryptocurrencies, comes the potential of a much wider audience than previously addressable.
As Bitcoin’s price quadrupled over the past few months, to hit a high of around US$41,900 in early January, Bitcoin was once again thrust into the limelight, less than three years after it hit an all-time-high and crashed a spectacular 80% soon after.
Bitcoin has since fallen through the US$30,000 level, reminding investors just how volatile the asset class is, yet nothing about Bitcoin’s fundamental technology has changed.
As an immutable decentralized ledger, Bitcoin still produces no earnings, pays no dividend or interest, and is backed primarily by how much someone else is willing to pay for it.
But something happened last year that may have changed Bitcoin in a pivotal way — more than just a few people believed in its value.
Bending Towards Bitcoin
Whilst it probably didn’t happen overnight, 2020 marked a turning point when Wall Street started to bet on Bitcoin.
From billionaire hedge fund managers such as Paul Tudor Jones and Stanley Druckenmiller, to the Acting U.S. Comptroller of the Currency giving the greenlight to U.S. banks to accept fiat currency deposits to back stablecoins, a perceptible shift in attitudes towards cryptocurrencies was evident.
And although that shift was far from tectonic, these wizards of Wall Street helped fuel the narrative of Bitcoin’s role as a potential inflation hedge, coming in the wake of policymakers’ aggressive fiscal and monetary intervention to prop up a living-dead economy during the coronavirus pandemic.
Funds catering to cryptocurrencies have naturally flourished in the past few months, as they did during the Bitcoin rally of 2017, but with a proper regulatory framework, many of them will persist.
Grayscale Bitcoin Trust, one of the only means by which institutional investors can participate in Bitcoin, saw inflows of US$4.7 billion in 2020, an amount which Bloomberg Intelligence reports is more than 99% of other exchange-traded product inflows listed in the U.S.
It’s Not About Inflation
Although Bitcoin has been touted as an “inflation trade,” Wall Street’s interest in Bitcoin may be more of a “speculation trade.”
Consumer price increases have been muted for years, despite fiscal measures and over a decade of rock-bottom interest rates.
Instead, asset inflation has been seen in real estate, stocks, IPOs and other risk assets.
Qualitatively of course, pandemic stimulus differs from the post-2008 financial crisis measures, because this time, much of the money has flowed directly to Americans.
And while many in the cryptocurrency space have long hoped that institutional investors would add to fund flows into the space, that doesn’t necessarily translate into a higher price for Bitcoin.
For many on Wall Street, cryptocurrencies are an opportunity, albeit a risky one, to generate outsize returns in a world where risks abound and yields are scarce.
As stocks have rallied, they are throwing the risk-reward ratio off balance and near-zero yields have investors starved for choice.
Hedge funds and other money managers, who suffered massive outflows in the decade following the 2008 financial crisis have had to work harder to beat benchmarks and prove themselves to investors to stay in business.
Any edge, even a cryptocurrency one counts, and it doesn’t matter where you’re placing your bets, as long as you win.
Can I bring a Plus One?
And that’s where regulators come in.
This past week, Janet Yellen, U.S. President Joe Biden’s pick for Treasury Secretary, expressed concern about cryptocurrencies like Bitcoin and suggested that lawmakers “curtail” the use of cryptocurrencies.
Those comments sent Bitcoin crashing below the psychologically-important US$30,000 level of support, a level from which it has since rapidly rebounded.
But why does the cryptocurrency industry fear regulation if it wants to invite institutional investors in?
It’s often heard in cryptocurrency circles that regulation is a bad thing, but not necessarily for the reasons one may think.
Since one of the features of cryptocurrencies is that they require no permission for participation, regulation also has the potential to stifle innovation.
Because there is no bank to act as a gatekeeper to determine your access to financial services on the blockchain, and no insurance firm to determine the premiums that you pay, cryptocurrencies have democratized access to financial services, warts and all.
The blockchain is fair in the sense that it will approve your transfer of cryptocurrencies (provided you pay the requisite amount of transfer fees) whether you’ve had good credit, bad credit or indeed, deserve no credit.
But all that may be set to change as U.S. President-elect Joe Biden’s pick to lead the U.S. Securities and Exchange Commission (“SEC”), Gary Gensler, could be seen as ushering in an era of greater federal oversight over the US$1 trillion cryptocurrency market.
Gensler is no cryptocurrency noob and until recently taught cryptocurrencies and blockchain technology at the venerable Massachusetts Institute of Technology, had previously chaired the Commodity Futures Trading Commission and was also a former partner at Goldman Sachs.
Known for pushing back at banks and corporations in favor of greater investor protections, the runaway cryptocurrency markets might just have a new sheriff in town.
Revealed in talks and editorials over the last decade, Gensler has ben a strong advocate for a U.S.-wide method to register and monitor cryptocurrency exchanges instead of leaving oversight at the state level.
If appointed as Chairman of the SEC, Gensler’s rolling out of more comprehensive and federal-level oversight of U.S. cryptocurrency exchanges could have implications for America’s biggest cryptocurrency exchange Coinbase, which has plans to go public.
And if outgoing SEC Chairman Jay Clayton was seen as wielding a sword against initial coin offerings or ICOs, Gensler is likely to use a sledgehammer to go after thousands of ICOs that he believes are nothing more than unregistered securities.
In an interview with Bloomberg in 2018, Gensler noted,
“If it (cryptocurrencies) gets broad adoption, if we really think the crypto world is going to be part of the future, it needs to come inside of public policy envelope.”
“That means we need to guard against illicit activity. And yes, we need to protect investors. The crypto exchanges, big exchanges like Coinbase, need to come within the SEC or the CFTC.”
But while Gensler believes that greater oversight could lead to more mainstream adoption of cryptocurrencies, it also favors incumbents more than upstarts because there are always parasites benefiting from regulation.
Regulation often provides the means with which businesspeople can use their influence and connections to leverage the government to derive profits.
Often disguised as protective regulations, these “regulated entities” are in effect nothing more than members’ only franchises and cabals which could lead to regulatory capture, and potentially cancel the benefits that cryptocurrencies were intended to create, or erode many of the efficiencies that are inherent in the blockchain.
Decentralization was specifically intended to avoid those circumstances.
But if you want institutional investors, that’s the price for entry.
Is it any wonder then why Goldman Sachs is now considering starting up its own digital asset trading desk?
The prospect of one of their own at the helm of the SEC may be just too irresistible to pass up.
Which is why institutional investors are coming for cryptocurrencies, and they’re bringing their regulations and regulators with them.
Be careful what you wish for, you just might get it.