Remember the fable of stone soup? A traveler comes to a town famous for the miserliness of its inhabitants. He tells them he has the secret of making soup from a stone. They are very excited about this money-saving possibility and gather around him as he places a stone in a vat of boiling water. He mentions that the one thing that makes stone soup even more delicious is an onion. Someone happily contributes one. And then he says perhaps if he had some carrots, and maybe a few chunks of beef. Before too long, everyone in the town has added an ingredient, he removes the stone, and they realize they’ve re-created the recipe for stew.
That is where we are with cryptocurrency. When it first began, the attraction was its freedom from regulation and oversight. That is unlike a bank account, which cannot be opened until you show proof of your identity and address and which is monitored so, for example, if you want to withdraw more than $10,000 in cash, the bank will file a report with the government to alert the authorities to possible money laundering or terrorism. The idea of money that is not issued by or traceable by any government had some appeal to many people, possibly some engaging in criminal activity but also some who just saw government oversight as intrusive or oppressive. Instead of the guarantees that come with an American dollar or a British pound or a Euro, cryptocurrency promised privacy, security, and freedom from any government oversight.
That was the stone in the stone soup of cryptocurrency as it grew from a few techies who could master the calculations required for “mining” digital money. But then, just as watery soup was not palatable without some meat and vegetables, crypto holders began to miss some of the protections of the government-issued currency. The very protections of crypto began to backfire.
Stefan Thomas lost $265 million in bitcoin because he forgot his password. The system only allowed ten tries and there are no “reset your password” or “Who was your first grade teacher?” security questions to retrieve it. He was not alone. The New York Times reported:
Of the existing 18.5 million Bitcoin, around 20 percent — currently worth around $140 billion — appear to be in lost or otherwise stranded wallets, according to the cryptocurrency data firm Chainalysis. Wallet Recovery Services, a business that helps find lost digital keys, said it had gotten 70 requests a day from people who wanted help recovering their riches, three times the number of a month ago.
Gerald Cotton, the man behind QuadrigaCX , once Canada’s largest cryptocurrency exchange, died without leaving any record of the passcodes to release about $250 million in other people’s assets in his exchange. The privacy protections were so robust they protected crypto holders from getting access to their money.
Another touted advantage that turned out to have some drawbacks was the fluctuation of value. And so, a group of crypto providers brought in a bushel-full of new ingredients that pushed crypto closer to government-issued money: “stablecoins” or tethered crypto, tied to the very system it is designed to replace. “Not knowing what the value of your tokens will be tomorrow can feel very uncomfortable,” says stablecoin provider Stellar, overlooking the fact that this was once touted as the advantage of digital currency. These providers promise that $1 in crypto will be tied to….$1 in US dollars or Euros or pounds, which it was originally supposed to replace. The best of both worlds, right? Not exactly. They are better at promising than proving. Or delivering.
Tether, which is the biggest stablecoin, with over $80 billion circulating, and which was the idea of a former child actor in the “Mighty Ducks” franchise, just made a lot of “well, not really” answers to questions like, “Can you show us the assets you say back your dollar-denominated promise?” and “If you promised my dollar of Tether would always equal a US dollar, why is it now just worth 95 cents?” Tether “de-pegged” from its $1 promise on May 7, 2022, leading to $10 billion in withdrawals and helping to trigger a drop in the overall crypto market of 25 percent. This Today in Tabs story is hilarious (unless you are a crypto investor) and a must-read. A scarier must-read is the Business Week cover story, which describes an emergency meeting of the Secretary of the Treasury, the chairs of the Securities and Exchange Commission and the Federal Reserve, and other top finance officials to determine if “Tether had gotten so large that it threatened to put the U.S. financial system at risk. It was as if a playground snowball fight had escalated so wildly that the Joint Chiefs of Staff were being called in to avert a nuclear war.”
There are two possibilities here. The high risk possibility is that Tether is telling the truth about its assets, making an enormous section of our financial system vulnerable to its fluctuations. The less high risk is that they are lying, in which case a smaller section of our financial system is at risk. It would be great to know which it is but hey, the great advantage of crypto is that, unlike banks, the government does not have the authority to see what does and does not back up their claims.
But there is some good news. Despite the essential promise of the crypto industry that customers’ digital wallets were secure and could not be breached by thieves or the government, that turned out not to be entirely true. In February, the Justice Department announced the arrest of a couple charged with conspiracy to launder $4.5 billion in stolen cryptocurrency. So (allegedly) thieves stole billions from digital wallets and the feds, before the arrest, went to court, got a warrant, and seized the funds. Think of this as (1) proving that crypto is not as safe or free from government oversight as it claims and (2) adding the chunks of meat to the stone soup.
The libertarian dream is collapsing as participants realize the government has a role to play because markets do not run on money; they run on confidence in the system. That is why the 1929 stock market crash, the Enron-era accounting failures, the sub-prime financial meltdown led to legislative reforms founded in transparency and accountability that kept the US markets vibrant and relatively stable. Those are the qualities cryptocurrency initially claimed they did not need. Now even they recognize they cannot create a sustainable business model without it, even begging, without any sense of irony, for government intervention. “It’s an important moment for the crypto industry,” Paolo Ardino, chief technology officer of Tether (USDT), the most traded cryptocurrency, told Yahoo Finance between stints at the World Economic Forum and Coinmarketcap’s “The Capital” conference. “One that will definitely expedite regulations — and not just for stablecoins.”
by Nell Minow, originally published on Medium