Does the Senate Reg Bill Scratch The Itch?

We want transparency and accountability, and we want to have consumer protections. Influential crypto insiders hailed this proposal as a great starting point, a reception that suggests it might be perceived as relatively friendly to the people it's supposed to be regulating in the digital asset community. Hillary Allen, a law professor at American University, is among those who think that the proposed legislation just doesn't go far enough, especially

when it comes to consumer protection. She joins me now, Professor Allen, thank you so much for joining us today. It's a pleasure to be here. Thank you for having me. You have I think if ever, somebody were to invent a profile for somebody who feels, you know, like the right person to comment on financial regulation, it does seem

to be the one that you have. You have written a book about fintech, You are a professor who sort of studies these things professionally or academically at least, and you've had some pretty incisive commentary in the past couple of months about your concerns over you know, financial stability and the threats that crypto appears to pose to financial stability. Can you say a little bit more about this proposed legislation from these senators and like what your first, second,

and maybe third reactions have been to it. I used to work for a law firm partner who if your work was really arable, he wouldn't try to salvage anything from it. He would just start and send it back with something at the top saying start over. And that was my initial reaction to this bill. There's not a lot in here to salvage. The second reaction was, you know, what are the politics going on behind this? It's very curious. I've never seen an industry so happy with proposed legislation

that's intended to regulate them. It's almost like champagne corks

were popping all over the crypto industry. So those are sort of my broad brush reactions, and then it got into sort of the nitty gritty of the problems, and they're varied from taking jurisdiction away from the sec over things that already fit the definition of securities, to putting stable coins in the banking environment and potentially implicitly putting deposit insurance and government guarantees behind stable coins, to creating

regulatory sandboxes that would sort of reverse pre empt federal legislation intended to protect investors and the stability of our

financial system. It's a lot of problems. Well, you've named three very specific things that I'd love for us to break down a little bit, and let's let's start from depositary insurance and your concerns about that, because you know, this is something that's often held up as all right, if I'm a consumer, if I have money in a bank, I don't personally qualify for a two and fifty deposit insurance. I do not have any bank balances that are that

are that high. But you know the idea is if my bank were to go under I would at least be protected up to a certain amount, and there's no comparable protection for folks who may have their assets in crypto. Why is the way it's constructed that protection is constructed in this bill? Why is that a concern for you? Well, first of all, you know, I do want to say that my heart goes out to the people who are losing their money. You know, Celsius has just suspended redemptions

and a lot of people are losing their shirts. And I'm seeing comments on Twitter saying things like, but this is insured, right, and people don't understand that they don't have any guarantee or insurance, and that is heartbreaking for the individuals. But what we need to think about is sort of the big picture when we ensure something. And

there are downsides to deposit insurance. So when deposit insurance was introduced in the nineteen thirties after a series of banking panics, there were a lot of economists who were worried about it because it can incentivize some bad behavior on behalf of the banks, because they know that people won't be paying attention, they won't be watching their deposits, and so you know, the banks can take more risks knowing that they can pocket the upside and the downside

will be covered by the deposit insurance. So in the end, notwithstanding those concerns, they decided to implement deposit insurance anyway, and I think that was the right decision because of the importance of banks to how our broader economy functions. But if we're talking about stable coins, people keep talking about these being used for payments. They're not used for payments for every day goods and services. They're not very

useful for payments for every day goods and services. Where they're being used is to speculate in the decentralized finance space, which or defy um, which is a fancy way of saying that they have created on the blockchain equivalence of a lot of financial products and services that we already have. But because they're on the blockchain, they're operating in an unregulated way. So if we are ensuring stable coins, if we're putting government guarantees behind stable coins, were essentially ensuring

people speculative activity in the defy space. And that's not you know, building products and services. That's not employing people in the same way that we think of you know, traditional economic growth, so very loath to put deposit insurance behind this very speculative space. So if I'm hearing you correctly, it's less the idea that insurance equal bad and more the idea that insurance equal risk reward for an activity that, as you're describing it, doesn't seem to qualify to you

as like economically valuable exactly. That's a great way of putting it. You're essentially giving people a safety net to gamble um in a way that doesn't create productive use for the rest of the economy. Are there other instances in this bill? You know, because you you name a couple of other things where that's where your reaction is coming from, that these are creating incentives that may sow

the seeds of whatever the next crisis is. Absolutely, and I've written about this at length, there are so many parallels between what we're seeing in crypto now and what we saw on the lead up to two thousand and eight. The news from Wall Street has shaken the American people's faith in our economy. The situation where Lehman Brothers and other financial institutions is the latest in a wave of prices that have generated enormous uncertainty about the future of

our financial markets. To be clear, I don't think an implosion of the crypto markets right now would cause a broader global financial crisis, but that's really about size and integration with the broader system, rather than it being safer. What we're seeing with crypto is, you know, we're seeing just a far reaching complexity that people can't process, and that makes panics more likely. It makes systems more fragile when you can't see the interconnections of the different parts

of the system. We're seeing new ways of creating leverage because people can create tokens out of thin air and then use them as collateral for loans. We're seeing this rigidity, this smart contracts, which are really just computer programs but

they run on the blockchain and they automate transactions. We're seeing that rigidity parallel what we saw with mortgage backed securities in the lead up to two thousan eight, where you know, there aren't the opportunity it needs to renegotiate these deals when they're bad for both the consumers and for the system as a whole. And we've seen you know, a bunch of runs on stable claims in the last few weeks that look a lot like the runs that we saw on money market mutual funds in the past.

But to your point, these runs don't seem to have that sort of systemic e contagious effect that folks were worried about in two thousand and eight. Yet, right, So that's the thing. So you know, there's um you know, it's a balancing act. You know, you don't want to rush and put government backing behind all of this stuff now because it won't have the systemic effect I think,

and it's current iteration. The thing that concerns me most is that as this stuff starts to get integrated with the traditional financial system, which is happening, then we start seeing the tentacles of this stuff spreading into the traditional finance broader economy, and then we're getting to a place where a bailout might be necessary. So proactively to prevent that from happening, I think the most important thing that can happen right now is to set up a separation

between banking and crypto instead of encouraging their integration. Interesting We'll be right back with American University law professor Hillary Allen for more analysis of the pros and cons of this big bipartisan piece of proposed crypto regulation. One thing you did mention. You said this on Twitter and one of your threads that you haven't paying attention to is this idea of taxation as it relates to crypto. Can

you talk a little bit more about that? Sure, So, taxation for any lawyer is terrifying if they're not a tax lawyer. Um, it's it's the one thing that you know, I teach business law, and I say your one job is to make friends with the tax lawyers so that you have someone to call when tax issues come up. And so the taxation around oundum crypto assets is you know, it is a very important issue that a lot of the people who are talking about crypto sort of deal

with as an add on. So, the taxation experts that I have talked to said that this carves out a incredible it is an incredible sort of carve out and give away for um crypto that doesn't exist in other asset classes. And so that ties into this broader picture of why are we giving crypto more favorable treatment on every level than the existing laws accord, Why are we treating crypto securities as different and deserving of a lighter touch regime than regular securities. Why are we giving more

preferential treatment to taxation on crypto? And I think it keeps coming back to this issue that I think if the most charitable reading of all of this is that there are a lot politicians that and policymakers who don't want to be seen as anti innovation. When I came to Washington, I found out that very few, if any, members of the Senate had an awareness of how big bitcoin and other digital assets were becoming, and that there was a vacuum of both interest and knowledge about this topic.

And yet it was becoming more and more apparent that a framework for regulation was going to be needed. What this bill really says to me is that policymakers are not looking behind the curtain to see what's really going on here. So a lot of the technology that is being trumpeted as being so innovative is really, according to many tech experts, not particularly good. It doesn't scale well, it's slow, it's expensive, a lot of its environmentally castle well.

You have compared smart contracts, for example, which is just you know, as you said, contracts that exist on the blockchain to mortgage backed securities. You have compared various elements of defied to credit default swaps and somebody who used to cover both of those things a long time ago. I find those analogies very interesting because the big argument that their proponents made was this is about better risk mitigation. This is about using bleeding edge technology to solve you know,

novel problems. And when it blew up, they were like, except under these very specific circumstances, when everything goes wrong at the same time, yep, yep, that's always it. I mean, especially if you're someone like me who pays a lot of attention to financial crises and systemic risks. It's all about the tail events. It's all about the low probability who could have seen this happening, very high consequence events

that are not as rare as people think they are. Um, you know, I grew up in Australia and all the Swans they are so yes. Indeed, famously refusing the title of the book, black Swan exactly what we And this is a comment that I've made a lot that It's just it surprises me how short memories are that that these these lessons that we should have learned from the

two eight crisis. We have not learned and I think part of the reason why people haven't learned them is because what used to be is just sort of a question of um financial complexity now has this overlay of technological complexity. So to really dissect this and see why none of this is going to work in those tail events, you need to understand both the finance and the tech and those are two very um complicated areas, and so

what you need are both kinds of expertise. And that's why I think it's particularly valuable that um uh, Well, it started out with I think twenty three leading technologists, but then the letter was signed by over fifteen hundred other technologists around the world. In a letter to Congress, it was said recently they articulated the technological flaws here, and I'm contributing my expertise on the financial flaws of this.

And when you put them together, you see that this is an inherently flawed system that isn't fit for purpose. This being crypto from your perspective, like the whole thing,

the whole really the whole thing, um. And so what I would really like to see from policy makers is not a bill like this that accepts at face value the claims of innovation and financial inclusion, but actually interrogates those a little before giving away the store on things like securities, regulation and tax And I think the financial inclusion narrative is particularly pernicious here because we keep hearing that this will you know, this will help the emb

bank to people who haven't well. I mean, Jay z and Jack Dorsey just set up a center for educating kids in Brooklyn about the benefits of bitcoin. Nothing could possibly go wrong, nothing could possibly go wrong. It's just heartbreaking.

But you know this is rhetoric we've heard before. So in the lead up to two eight, sub prime mortgages were going to be the thing that helped bring people who had been previously excluded from the housing market into the housing market, and in the end it was predatory inclusion. People lost their homes, lost their money, et cetera, and it was the sort of the building blocks for a

much broader systemic crisis. Right now, as I mentioned, I don't think the crypto assets are yet the building blocks for systemic crisis because we don't have the integration with the mainstream financial system yet. But it's still predatory inclusion to my mind, So if you invested in bitcoin after December of twenty you would have lost all your money by now. And so you know that's that's everybody who's invested for the first time, which to be a lot

of people right there. There have been multiple surveys. I was just looking at a couple of these right before talking to you today, that between half and seventy depending on how you slice it of people who currently own bitcoin invested between now and all of them are underwater, every single one of them. And when you when you start a statistic like that, it really emphasizes that the people who got in early on a lot of this crypto stuff are going to make a lot of money,

and it's highly concentrated. This is, you know, the people who have been in here since before, there aren't that many of them, and a lot of them are very very concentrated in terms of wealth. And then the newer arrivals, the people who come in basically since the end of any twenty um, had smaller investments, but had you know, we're not is able to absorb losses, and as I said, every single one of them is underwater. Well, on that note, Professor Allen. I would like to thank you very much

for joining me today. You've certainly given all listeners quite a lot to think about, and I will make sure that they know where to find you on the internet. Thanks so much pleasure. You can find Professor Hillary Allen on Twitter at prof Hillary Allen. That's Hillary with one L H I L A R Y on the next episode of Bloomberg Crypto. I'm part of a generation that grew up with the Internet, with social networks that long predated Facebook or Twitter, and with online identities that sometimes

felt more authentic than my offline self. Experimenting with who you are online, especially if those identities are really different from how you present in the analog world, it's not a new concept, so it's no surprise that folks are using newish technologies like crypto on the blockchain to play with their self expression. Some folks are even using blockchain enabled structures to monetize these experiments with identity, including their

gender presentation. For more on crypto and identity, Bloomberg reports that Emily Nicole and doctoral candidate and researcher Florence Smith Nichols will join me on the next episode of Bloomberg Crypto. I'm Stacy Marie Ishmael, and this is Bloomberg Crypto, a daily podcast from Bloomberg and I Heeart Radio. For more shows from I Heart Radio, visit the I Heart Radio app,

Apple Podcasts, or wherever you get your podcasts. Email your questions, comments, or suggestions for the show to Crypto at Bloomberg dot net and you'll find us on Twitter at Crypto. The supervising producer of this episode is Vicky very Galina. Associate producer is Thy Butler. Just to wonder at is our engineer. Original music by Leo Sdrin. Bloomberg's head of Podcasts is francescality As