Written by: Annie Lowrey
Translated by: Block unicorn
Dennis Kelleher, president of the non-profit organization Better Markets, told me, "The countdown to the next catastrophic collapse has already begun."
In recent weeks, I've heard this or similar views from economists, traders, congressional staff, and government officials. The incoming Trump administration has promised to support cryptocurrency-friendly regulations and may ease the strict restrictions on Wall Street institutions.
They believe this will usher in an unprecedented era of American prosperity, maintaining the United States' position as a leader in global capital markets and the core of the global investment ecosystem. "My vision is to make America dominant in the future," Donald Trump said at a Bitcoin conference in July. "I am formulating plans to ensure that America becomes the global cryptocurrency capital and the world's Bitcoin superpower."
Financial experts expect things to play out differently. First, there will be prosperity, perhaps a major boom, with the prices of Bitcoin, Ethereum, and other cryptocurrencies soaring; financial companies will reap huge profits; and American investors will bask in newfound wealth. Second, there will be a downturn, perhaps a major depression, with company failures, a demand for government intervention to stabilize the market, and many Americans facing foreclosure and bankruptcy.
I have written articles about Bitcoin for over a decade and reported on the last financial crisis and its long-lasting aftereffects, so I have some understanding of the causes that can lead to both prosperity and collapse. Crypto assets are often extremely volatile, far more so than real estate, commodities, stocks, and bonds. With Washington's encouragement, more Americans are investing in cryptocurrencies. As money flows in, prices will rise. When prices fall, individuals and institutions will take a severe hit, and this is inevitable.
Experts I spoke with did not refute this view. But they told me that if this is indeed the case, America and the world should count themselves fortunate. The danger is not only that regulations supporting cryptocurrencies may expose millions of Americans to scams and market volatility. The real danger is that this will lead to an increase in leverage across the entire financial system. This will exacerbate opacity, making it harder for investors to determine the risks of financial products and price them accordingly. Moreover, this will happen alongside the Trump administration's cuts to regulation and regulatory agencies.
Cryptocurrencies will become more prevalent, while traditional financial markets will resemble cryptocurrency markets—more chaotic, more opaque, more unpredictable, and potentially leading to trillions of dollars in consequences that will last for years.
"I worry that the next three or four years will look quite good," Eswar Prasad, an economist at Cornell University and former IMF official, told me. "The real challenge will be what follows, when we will have to clean up the mess caused by all the speculative frenzy triggered by this administration’s policies."
For years, Washington has 'waged an unprecedented war against cryptocurrencies and Bitcoin,' Trump told cryptocurrency entrepreneurs this summer. 'They are targeting your banks. They are cutting off your financial services... They are preventing ordinary Americans from transferring money to your exchanges. They are defaming you as criminals.' He added, 'I have encountered this as well because I said the election was rigged.'
Trump is not wrong; cryptocurrencies do exist in an independent parallel financial universe. Many crypto companies cannot or choose not to comply with U.S. financial regulations, making it difficult for ordinary investors to use their services. (The world's largest cryptocurrency exchange, Binance, even refuses to disclose which jurisdiction it is registered in, directing U.S. customers to a branch in the U.S.) Companies like Morgan Stanley and Wells Fargo tend to offer very few crypto products and invest little in cryptocurrencies and related businesses. The problem is not that banks do not want to participate, but that regulatory rules prevent them from doing so, and regulators have explicitly warned them not to.
This situation limits the amount of money flowing into cryptocurrencies. But this practice is wise: it prevents company failures and wild price fluctuations from disrupting the traditional financial system. Kelleher points out that cryptocurrencies lost $2 trillion of their $3 trillion market value in 2022. 'If any other asset experienced such a massive financial collapse, it would inevitably trigger contagion. But it did not happen because you have parallel systems that are almost entirely disconnected.'
Upcoming regulatory measures will tightly integrate these systems. Admittedly, no one knows exactly what laws Congress will pass or what laws Trump will sign. However, the Financial Innovation and Technology for the 21st Century Act (FIT21) provides us with a good reference. This law stalled in the Senate after passing in the House last year, and it has become the focus of crypto advocates gathering massive lobbying funds, including $170 million for the 2024 elections. This law is essentially a wishlist for the industry.
FIT21 designates the Commodity Futures Trading Commission (CFTC) as the regulator for most crypto assets and companies, rather than the SEC, and requires the CFTC to collect far less information about the structure and trading of crypto products than securities firms provide to the SEC.
In addition to the loose rules, financial experts also anticipate that enforcement will be lax. The CFTC primarily regulates financial products that companies use for hedging and trade among traders, rather than those sold to individual investors. The CFTC's budget is about one-fifth that of the SEC, with staff only one-seventh that of the SEC. Overall, Washington is expected to relax restrictions, allowing traditional banks to incorporate cryptocurrencies into their books and allowing crypto companies to access the U.S. financial infrastructure.
According to Prasad, this regulation would be a 'dream' for cryptocurrencies.
Trump and his family have personally invested in cryptocurrencies, and the presidential candidate has proposed the idea of establishing a 'strategic' Bitcoin reserve to counter the influence of certain countries. (In reality, this means using tens of billions of taxpayer dollars to absorb speculative assets with no strategic interest.) How many party members from certain countries would invest in cryptocurrencies because Trump did? How many young people would put money into Bitcoin because Trump's son Eric said its price would soar to $1 million, or because the Secretary of Commerce said it is the future and put money into Bitcoin?
Any measures being considered by Congress or the White House will not reduce the inherent risks. Cryptocurrency investors will still be vulnerable to hacks, ransomware, and theft. The research group Chainalysis recorded $24.2 billion in illicit transactions just in 2023. If the U.S. government invests in cryptocurrencies, nations like Iran and North Korea will have increased motives to intervene in the market. Imagine China launching a 51% attack on the Bitcoin blockchain, taking over and controlling every transaction. This scenario is a security nightmare.
Any measures being considered by Congress or the White House will not reduce the inherent risks of cryptocurrencies. Cryptocurrency investors will still be vulnerable to hacks, ransomware, and theft. The research firm Chainalysis recorded $24.2 billion in illicit transactions in just 2023. If the U.S. government invests in cryptocurrencies, countries like Iran and North Korea will have much greater incentives to intervene in the market. Imagine a country launching a 51% attack on the Bitcoin blockchain, taking over and controlling every transaction. This would be a security nightmare.
Americans will also face more scams and fraud. The Securities and Exchange Commission (SEC) has taken enforcement actions against dozens of Ponzi schemes, charlatans, and frauds, including the $32 billion fake exchange FTX and some shoddy token companies. No one expects the CFTC to have enough power to do the same. Moreover, FIT21 leaves many loopholes for various dirty profit-making activities. Crypto companies may legally operate exchanges, buy and sell assets themselves, and execute orders for clients, despite conflicts of interest, but still be legal.
Simple volatility is the biggest risk facing retail investors. Prasad emphasizes that cryptocurrencies, tokens, and other coins are 'purely speculative.' 'The only thing that can support their value is investor sentiment.' At least gold has industrial uses. Or, if you bet on the price of tulip bulbs, at least you might get a flower.
But in the world of cryptocurrencies, you might end up with nothing, or even incur losses. Many cryptocurrency traders borrow money to speculate. When leveraged traders incur losses in their investments, their lenders—typically exchanges—will demand collateral. To provide collateral, investors might have to cash out their 401(k) accounts. They may have to sell Bitcoin during market downturns. If they cannot raise cash, the company holding their accounts may liquidate or seize their assets.
A report released last month by the Office of Financial Research, a government think tank, clearly pointed out how dangerous this situation could be: some low-income families 'are using cryptocurrency gains to secure new mortgages.' When cryptocurrency prices fall, the homes of these families will be at risk.
Many individual investors seem unaware of these dangers. The Federal Deposit Insurance Corporation (FDIC) had to remind the public that crypto assets are not protected by it. The Financial Stability Oversight Council (FSOC) also expressed concern that people are unaware that crypto companies are not subject to the same regulations as banks. However, how serious is it if Trump also invests in it?
However, regulators and economists are primarily concerned not with the harm this new era will inflict on individual households. They worry that the chaos in the cryptocurrency market could disrupt the traditional financial system—leading to a credit collapse and forcing government intervention, much like in 2008.
Once, Wall Street viewed it as fool's gold, but now it sees it as a gold mine. Ray Dalio of Bridgewater Associates called cryptocurrency a 'bubble' a decade ago; now he considers it 'an extremely great invention.' Larry Fink of BlackRock once referred to Bitcoin as 'an index for money laundering'; today, he sees it as 'a legitimate financial tool'—his company has begun offering this tool to clients, albeit indirectly.
At the beginning of 2024, the SEC began allowing fund managers to sell certain cryptocurrency investments. BlackRock launched a Bitcoin exchange-traded fund (ETF) in November; a public pension fund has already invested retirees' hard-earned money into it. Barclays, Citigroup, JPMorgan, and Goldman Sachs are also trading in cryptocurrencies. Tens of billions of dollars in traditional financial capital are flowing into decentralized finance markets, and with regulatory easing, more funds will flow in the future.
Will there be any problems? If Wall Street firms accurately assess the risks of these high-risk assets, then there will be no problem. If they do not assess correctly, everything could go wrong.
Even the most seemingly solid instruments are fraught with danger. For example, stablecoins are crypto assets pegged to the dollar: one stablecoin equals one dollar, making them a medium of exchange unlike Bitcoin and Ethereum. Stablecoin companies typically maintain their peg by holding ultra-safe assets (such as cash and government bonds) equal to each stablecoin issued.
It is said that in the spring of 2022, the widely used stablecoin TerraUSD collapsed, its price dropping to just 23 cents. The company used algorithms to maintain TerraUSD's price stability; as long as enough people withdrew funds, the stablecoin would lose its peg. Tether, the largest crypto asset by trading volume globally, claims it is fully backed by secure deposits. However, in 2021, the U.S. government found that this was not true; furthermore, the Treasury was considering sanctions against the company behind Tether for allegedly serving as a funding channel for 'North Korea's nuclear weapons program, Mexican drug cartels, Russian arms companies, Middle Eastern terrorist organizations, and manufacturers of fentanyl chemicals in certain countries,' as reported by the Wall Street Journal. ("It is outrageous to imply that Tether somehow assists criminals or evades sanctions," the company responded.)
If Tether or another major stablecoin encounters problems, financial chaos could quickly spread beyond the cryptocurrency market. Worried investors will sell stablecoins, leading to a 'self-fulfilling panic redemption,' as three scholars simulated this possibility. The issuers of stablecoins will sell government bonds and other safe assets to meet redemptions; the price drop of safe assets will affect thousands of non-crypto companies. These economists estimated at the end of 2021 that the risk of Tether experiencing a run was 2.5%—which is not stable!
Other disasters are also easy to imagine: bank failures, exchange collapses, massive Ponzi scheme bankruptcies. However, the biggest risk of cryptocurrencies is not so much related to cryptocurrencies themselves.
If Congress passes FIT21 or a similar bill, it will create a new asset class called 'digital commodities'—essentially, any financial asset managed on a decentralized blockchain. Digital commodities will not be regulated by the SEC, and 'decentralized finance' companies will also be outside its regulatory scope. Under the FIT21 act, any company or individual can self-certify a financial product as a digital commodity, and the SEC only has 60 days to raise objections.
This loophole is large enough for an investment bank to exploit.
Wall Street has begun discussing 'tokenization', which involves placing assets into programmable digital ledgers. The nominal reason is capital efficiency: tokenization can make the flow of funds easier. Another reason is regulatory arbitrage: blockchain-based investments will no longer be subject to SEC jurisdiction, potentially facing fewer disclosure, reporting, accounting, tax, consumer protection, anti-money laundering, and capital requirements. Risks will accumulate in the system; the government will have limited means to control companies.
Gary Gensler, the soon-to-be former chairman of the SEC and the industry's number one enemy, believes that crypto regulation could ultimately disrupt "the broader $100 trillion capital markets." "It could encourage non-compliant entities to choose the regulatory regime they want to be subject to."
We have seen a similar plot not long ago. In 2000, President Clinton signed the Commodity Futures Modernization Act as he was nearing the end of his term. This law imposed strict limits on exchange-traded derivatives, but did not regulate over-the-counter derivatives. As a result, Wall Street manufactured trillions of dollars in financial products, many of which were backed by mortgage income streams and traded over the counter. These products bundled subprime loans with prime loans, masking the true risks of certain financial instruments. Subsequently, consumers bore a heavy burden under the pressures of rising interest rates, stagnant wage growth, and climbing unemployment rates. Mortgage default rates rose, and home prices fell, first in the Sun Belt and then spread nationwide. Investors fell into panic. No one even knew what those credit default swaps and mortgage-backed securities contained. No one could determine the value of anything. Uncertainty, opacity, leverage, and mispricing contributed to the global financial crisis, ultimately leading to the Great Depression.
Today's cryptocurrency market is poised to become the derivatives market of the future. If Congress and the Trump administration do nothing—still treating the SEC as the primary regulator of cryptocurrencies, requiring crypto companies to follow existing rules—then chaos will continue to be isolated. There is no reasonable justification for treating digital assets differently from securities. By the simple standard that the government has used for over a century, almost all crypto assets should be considered securities. However, Washington is creating loopholes instead of enacting laws.
As cryptocurrency proponents like to say, 'hold on, don't let go.' Jamie Dimon of JPMorgan said at a conference in Peru last year, 'Many bankers are dancing in the streets.' Maybe they should. Bankers will never be left holding the bag.
