The surprising effectiveness of crypto regulation

Stephen Diehl is a programmer and co-author of the book Popping the Crypto Bubble.

Not so long ago you couldn’t ride the London Underground without being bombarded with pushy advertisements saying “now is the time to buy bitcoin” or enticements for the latest dog-themed crypto coin.

In hindsight, the outcome was pretty predictable. Spasms of euphoric speculative excesses and promises that “this time is different” have been an inescapable part of society for centuries. However, what was genuinely different this time was how many of our institutions correctly recognised and successfully pre-empted many of the worst excesses of this bubble.

Those of us who have watched the crypto frenzy with horror have been wracked with anxiety over what the inevitable collapse might entail. And yet when it finally arrived it was not with a bang but with a whimper. The reaction of the broader financial system was pretty much a shrug.

However, the reason for this controlled implosion is not purely accidental and owes a great deal to the vigilance of regulators, the press, and civil servants.

Unbeknown to many, a parallel thoughtful discussion about crypto happens every day. Far from the din of social media, a more sober policy debate is unfolding in law review journals, symposia, and policy white-papers as agencies grapple with the technology’s genuinely novel and strange implications.

And there are many schools of thought for and against the vast array of policy proposals — including banning crypto, letting crypto burn, regulating crypto as gambling, using existing financial regulatory capacities to regulate crypto without additional legislation, and proposals for entirely new bespoke legislation.

However, extending the protection and the privilege of legitimacy-inferring regulation must be conditioned on an adequate answer to the existential question of crypto: What is its purpose?

Outside of crypto circles, few people find the circular and self-referential explanation that “the purpose of crypto is to trade more crypto” particularly satisfying. Until we have a better answer, the traditional financial system should remain ringfenced from this experiment, so that it’s turbulence can never grow beyond being a storm in a teacup. Thankfully, that’s what we’ve essentially done in the US and UK.

In the US, the actions by the Federal Reserve, IRS, OCC, and the Department of Justice have been surprisingly effective at curtailing the crypto industry’s growth. The SEC stymied the initial coin offering bubble, brought over 130 enforcement actions against crypto entities, and has yet to lose a single one. The Fed and FDIC have firmly restricted the interactions between banks and crypto markets. Even at the peak of crypto mania last year, the entire “value” of bitcoin was a mere drop in the bucket of US capital markets; less than that of a single listed company such as Microsoft.

In the UK, despite the government’s fitful flirtations with the industry, crypto exchanges have never gained a foothold, and have struggled to acquire licence for financial services. The FCA and Bank of England consistently warned the public that they should be prepared to lose all their money in crypto (unfortunately a painful reality that many victims have discovered first-hand). The UK Treasury never minted the NFT it once promised. The crypto industry never became intertwined with the City, and remains systemically irrelevant to the British economy.

Our regulators and agencies did the right thing, despite the remarkable level of speculative fervour, the unpopularity of scepticism and the biddability of politicians. And credit is due to the foresight and thankless work done by thousands of civil servants who quietly insulated our financial systems from crypto shocks through action or strategic inaction.

The alternative history, where we had prematurely extended the regulatory remit around crypto, could have led to far more catastrophic outcomes. In other words, this time actually was different — our institutions worked.