The Case for Regulating, Not Banning, Crypto

American University professor Hilary Allen, who recently wrote an article titled “The Case for Banning Crypto" in the influential publication Foreign Affairs, is part of a very small cohort of “crypto banners” working toward that end. In addition to engaging the media, Allen and her peers are pushing the argument that crypto does more harm than good while speaking with federal agencies. She is testifying before the congressional hearing on "the future of digital assets" Thursday afternoon.

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The case for banning crypto is a pipe dream. It won't happen. By Allen’s own admission, blockchain is a general purpose “database” technology that supports a trillion-dollar industry employing thousands globally. Nonetheless, the efforts to ban, rather than regulate, crypto have only backfired and harmed Americans.

Banning crypto is simply the wrong policy – the crypto industry instead could and should be effectively regulated.

A complete ban of crypto is an unattainable distraction by the industry’s naysayers, as Congress, the courts and the international community have already rejected the idea. Indeed, many in Congress support embracing and regulating crypto. This includes the Republican House leadership and heads of the most relevant economic committees – the House Financial Services Committee and House Committee on Agriculture. They work alongside progressive Democrats such as Reps. Richie Torres (D-N.Y.) and Ro Khanna (D-Calif.).

Additionally, multiple U.S. senators have been willing to introduce bipartisan legislation on this issue, such as Sens. Kirstin Gillibrand (D-N.Y.) and Cynthia Lummis (R-Wyo.). These officials could block any attempts to quash crypto, because the number seeking to regulate crypto significantly outnumber those calling for an outright ban. Similarly, the White House has written that it seeks to work with Congress to regulate, not ban, crypto.

The courts are the next insurmountable obstacle. As Allen knows, Congress simply won’t agree with her, and so she cheers on the efforts of allies at administrative agencies such as the U.S. Securities Exchange Commission and banking regulators. But the courts would gut these efforts.

Over the past several years, the Supreme Court has reined in agencies operating beyond congressional mandate. First, agencies cannot make “decisions of vast economic and political significance” unless Congress has said “clearly” that “it wishes to assign” that power “to an agency.” This is known as the "major questions" doctrine, and was recently invoked in West Virginia v. Environmental Protection Agency in 2022.

Banning crypto – an industry that supports tens of thousands of American jobs – is a major economic question requiring Congress, not just the SEC or banking regulators, to answer.

Additionally, the SEC has failed to engage in any kind of rulemaking on crypto, and instead has resorted to bringing individual enforcement actions. The SEC’s authority here, by its own admission, is “transaction by transaction,” not technology by technology, and so a ban on crypto via enforcement action would require the SEC to prove that each digital asset is a security and even that each transaction is a security offering, one by one, in court.

See also: It's Not Just Fraud That Chilled Crypto Regulation

Since there are already thousands of tokens, it would likely take 400 years to get through these lawsuits against all existing tokens, according to the math of SEC Commissioner Hester Peirce. The SEC has been in litigation against just one company, Ripple, for over two years. This kind of extended litigation could be the reason for the SEC’s $411 million shortfall last year, a number that would surely only rise were the SEC to continue its futile efforts to pick off the industry one by one. So reality again gets in the way.

Finally, crypto is global and other countries won't agree to ban crypto. Indeed, several nations are vying to be the capital of crypto, seeing the benefits of embracing – and regulating – a nascent industry. Those nations include the U.K., Singapore, Japan and France, along with the entire European Union, which passed a comprehensive and thoughtful Markets in Crypto Assets Regulation framework last week.

U.S. efforts to ban crypto will make it only easier for these jurisdictions to compete for American talent. Moreover, even if crypto companies leave the United States for greener regulatory pastures, it is unlikely that crypto would be “banned” for U.S. consumers seeking to access those platforms. Both FTX and Binance, two “foreign” crypto exchanges that ostensibly geofenced U.S. users had a large number of U.S. users using virtual private networks, shell companies and other methods.

“Banning” crypto in the United States means that foreign companies reimport even more – and less controllable – risk back into the United States. The International Monetary Fund has asserted that “comprehensive regulations are preferred to blanket bans,” because blanket bans may “stifle innovation,” “drive illicit activities underground,” “be costly to enforce” and motivate users to access “illegal markets.”

There has been a real cost to the obsession to ban crypto by figures like Allen and Sen. Elizabeth Warren (D-Mass.).

Their misguided focus caused them to miss the real risks in the financial system that led to the collapse of three banks within a week (Silvergate, Silicon Valley Bank and Signature Bank). According to Nellie Liang, the Under Secretary of the Treasury for Domestic Finance, crypto didn't play a direct role in any of those bank failures.

Yet the bank failures threatened the faith in the nation's banking system and could have destabilized the global economy in a way that none of the cryptocurrency failures could. The Senate Banking Committee, where Elizabeth Warren sits and which has jurisdiction on this issue, held 33 hearings last year. Four were on crypto, although the nation’s systemic-risk watchdog concluded crypto doesn't pose a systemic risk. Not one hearing was held on the banking system’s safety and soundness or the specific risks that banks pose.

Beyond missing the eventually realized risk of bank collapses, crypto banners also failed to protect Americans from the main bad actors in the cryptocurrency sector itself. Allen cheers on SEC Chairman Gary Gensler, but most of the largest crypto scams and failures harming Americans have happened during his watch, not those of his predecessors.

Gensler has been a remarkably ineffective “cop on the beat.” For example, Gensler missed the collapse of the now infamous exchange FTX. The banking regulators and the SEC, cheered on by Allen, have exhibited a clear pattern of misallocating resources away from real risks like banking collapses and crypto scammers, and focusing their limited resources on attacking the crypto industry as a whole, including its safest actors.

So the crypto banners are chasing a pipe dream and harming Americans. But are they right in theory? Do the harms of crypto clearly outweigh the benefits?

No, the benefits of crypto outweigh the harms (which could have been prevented by to good regulation). Further, the financial harms caused by crypto are overstated and not unique to the industry.

Allen writes: “The root of the problem is that cryptocurrency assets can be created at no cost and without limit, and an unlimited supply of assets makes a system more vulnerable to booms and busts.” This sentence captures the essence of Allen’s argument, and it's worth unpacking the weakness of her assumptions and arguments. Crypto’s root problem, according to Allen, is what economists call “zero marginal costs” – the idea that the cost to produce each additional unit of a good or service typically approaches zero.

This type of cost structure isn't unique to crypto and is well-understood in economic literature. Many assets can be created at no cost without limit, including most software, broadcast radio or TV reception, digital books, digital articles (such as this one), digital songs and even emails in a marketing campaign. This prevalent cost structure evidently doesn't lead inexorably to booms and busts.

Investment assets, including the shares of publicly traded companies, may be created at “no cost” and “without limit.” Any company, following the usual corporate governance that crypto companies usually follow, can decide to issue a nearly infinite number of shares without cost. Every startup in America could decide tomorrow to issue billions more shares, and that would likely not lead to economic calamity, because the booms and busts turn on people being willing to buy those shares.

Finally, an overwhelming majority of the volume and value in cryptocurrency is in a handful of tokens that are created at great cost (not “no cost”) and with clear limits (not “without” them). Bitcoin (BTC), ether (ETH) and one of the top stablecoins, USDC, account for over 70% of volume.

One bitcoin costs roughly $17,700, not $0, to mine, and there isn't an unlimited supply, but instead a hard cap of 21 million tokens. Unlike with shares, no single company can increase the total number of bitcoin. Ethereum has a negative supply schedule, and so its native token, ether, decreases in supply. USDC is backed by dollars, one to one, held in regulated banks. All of these assets, which account for most of the volume in the crypto ecosystem, aren't created at no cost and without limit, and so Allen's “root” argument doesn’t apply to 70% of the market.

In short, the “root problem” of crypto Allen puts forward isn't an economic problem at all. It is common across many digital and some non-digital goods, applies to stock certificates and doesn't even apply to most of the value in the cryptocurrency industry.

Turning away from a discussion of crypto's harms, Allen dramatically undersells blockchain's benefits. She writes, “Many of the most hyped innovations, including central bank digital currencies, do not require a blockchain at all. Blockchain technology itself has extremely limited utility. The consensus mechanisms that make blockchains work are inherently less efficient and more costly than centralized alternatives.”

Once again, the assumptions do most of the work. First, central bank digital currencies aren't one of the most hyped innovations. They are unpopular in the crypto community and elsewhere. In fact, House Republicans recently introduced the CBDC Anti-Surveillance State Act, a bill that would prevent the Federal Reserve from issuing a CBDC without further congressional approval. Second, crypto users understand that there are trade-offs between efficiency and decentralization, just as there may be trade-offs between efficiency and many other qualities that are at times desirable, such as democracy or pluralistic decision making.

See also: Who Really Benefits From CBDCs? It's Not the Public

Despite innovation being constrained by continued regulatory uncertainty, crypto networks are already having a positive global impact. For example, crypto has been an inflation hedge for many struggling families holding hyperinflationary non-dollar currencies, including millions of desperate Turks, Venezuelans, Afghans, Argentinians, Ethiopians and Nigerians.

Or look to humanitarian uses: Many refugees fled with their own assets in crypto wallets and the United Nations High Commissioner for Refugees dispersed humanitarian aid to displaced Ukrainians via stablecoins, even as banks were in disarray.

Turning to creators and artists, non-fungible tokens enable people to effectively own digital art. NFTs are a roughly $15 billion market and benefit both collectors and the artists. Crypto networks are changing the internet itself – an internet that's now dominated by a few private companies.

Indeed, several crypto projects have introduced blockchain protocols designed to be open-source alternatives to the corporate giants, including for data storage, such as Filecoin. Blockchains also enable databases where users can control their own identity and data and easily port it to new social-media applications, such as a potentially decentralized Twitter, Twitter co-founder Jack Dorsey’s Blue Sky project and the Lens Protocol.

Finally, the crypto industry is ushering in a new era of trusted, open finance. Many decentralized-finance applications remove trusted intermediaries and replace them with transparent software. Decentralized exchange Uniswap, which pioneered automated-market-maker functions, enables 24/7 trading (rather than 40 hours a week).

Exchanges like Uniswap also offer transparent pricing and supply (rather than the dark pools of money flows in traditional finance), as well as instant settlement than many centralized exchanges. In fact, at least two multi-government international projects (known as Project Guardian and Project Mariana) are using variations of the Uniswap protocol for experiments in foreign-exchange trading (which a study by crypto researchers suggests may be highly efficient) and tokenized bonds.

Despite a lack of regulatory clarity in some countries including the United States, figuring out how to regulate crypto is not an insurmountable challenge. For example, the European Union passed MiCA, which is a framework requiring disclosure through white papers and exchange registrations. Additionally, several groups of bipartisan senators and congressmen have proposed comprehensive or partial frameworks.

As these efforts show, good-faith actors can come together across party lines and land on a proposal that would foster innovation and access while stamping out the real fraud, manipulation and security risks.

Calls to ban crypto – or leave it entirely unregulated – merely distract from and slow down these important efforts.