"As governments supportive of cryptocurrencies prepare to take power + crypto investors cheer with delight, this bears some resemblance to the internet bubble of the late 1990s."
Last week, after Donald Trump announced the nomination of crypto advocate Paul Atkins as chairman of the U.S. Securities and Exchange Commission (SEC), the price of Bitcoin surpassed $100,000, and crypto enthusiasts cheered with delight. The mood in the crypto market reminds me of the internet bubble and its inevitable bursting, which I documented in a book over 20 years ago.
At the time, some long-term market participants and observers, including myself, were equally excited, equally predicting that prices would continue to rise, even higher, and equally uneasy.
It is certain that crypto investors, crypto entrepreneurs, and crypto-supporting donors have ample reason to be excited, as they donated hundreds of millions of dollars to crypto-friendly politicians before the November election. Investments in Trump's victory and the defeat of some famous crypto skeptics (including Ohio Democratic Senator Sherrod Brown) have already paid off.
The SEC is the leading investor protection agency in the U.S., and under the leadership of Gary Gensler, the agency has cracked down hard on an industry that Gensler described as "rife with fraud and scams," filing lawsuits against multiple crypto companies, including the crypto exchange Coinbase and the digital payments network Ripple.
However, under the leadership of Paul Atkins, the agency's ongoing lawsuits and other cases may be shelved. Paul Atkins is a conservative lawyer who served as an SEC commissioner during the George W. Bush administration and is currently the co-chair of the crypto lobbying group Token Alliance.
Overall, the SEC seems poised to take a more friendly stance toward issuers of crypto assets like currencies and tokens - a prospect that worries the industry's critics. Dennis Kelleher, president of the Washington financial reform group Better Markets, told me: "For crypto assets, the basic rules protecting investors that have been in place for decades will be greatly weakened, allowing the industry to expand with little regulation or accountability." "It will be like the 1920s - caveat emptor."
Crypto industry executives hailed Atkins' selection as a milestone. Michael Novogratz, founder and CEO of crypto firm Galaxy Digital, told Reuters: "We are witnessing a paradigm shift," "Bitcoin and the entire digital asset ecosystem are about to enter the financial mainstream."
In the late 1990s, the key paradigm shift that fueled the internet bubble was the rise of e-commerce, which gave birth to startups that went public on the Nasdaq, such as Amazon, eBay, Pets.com, and Webvan.
Speculative digital assets, including Bitcoin, Dogecoin (a cryptocurrency promoted by Elon Musk), and crypto tokens issued by the Trump family's new World Liberty Financial, cannot be directly compared to the startups of the 1990s, many of which had the potential to generate huge profits, even if many ultimately went to zero. (Amazon is now worth about $2.4 trillion. Webvan, the online grocery chain that promised lightning-fast delivery, raised $375 million in its 1999 IPO and filed for bankruptcy in 2001.)
But regardless of the speculative object, when I wrote about the internet stock bubble, I concluded that large-scale speculative events depend on a "four-horsemen":
- Exciting new technology that captivates investors;
- Effective means for them to communicate;
- Active participation by the financial industry;
- And a supportive policy environment.
For crypto assets, the invention of Bitcoin and blockchain (a secure and decentralized digital ledger) and the rise of social media meet the first two requirements, but Wall Street and policymakers remain skeptical of the industry, factors that have so far confined crypto investment to a minority pursuit. In the crypto bubble burst of 2022-23, Bitcoin prices fell more than 70%, and some major crypto companies, including Sam Bankman-Fried's FTX, collapsed, with the overall stock market and U.S. economy largely unscathed.
With Trump's election, it seems all four conditions are now in place, laying the groundwork for a broader bubble to attract more participants. Blockchain technology is still evolving, with its proponents still claiming it is about to disrupt the banking system, fundamentally change the international payments system, or generate other transformative impacts. On Musk's X, crypto enthusiasts have a massive social media platform they can use to hype crypto assets and attack skeptics. But the key development is that policy and Wall Street are now also aligned with the crypto world.
Under Atkins' leadership, the SEC may shift its stance on the core legal question of whether crypto assets are securities like stocks and bonds, which would mean they must fully comply with the nation's securities laws, or whether they are more like physical commodities like gold and silver, which are subject to less regulation, partly because they are seen as fungible items that are easier to identify and value. (If you buy a gold bar, you know what you're buying.)
During Gensler's tenure, the SEC has viewed many crypto assets as securities, subjecting their issuers to extensive registration and disclosure requirements. The agency accused Coinbase of operating an unregistered securities exchange and accused Ripple of organizing an unregistered securities offering when selling its XRP cryptocurrency. Both companies denied the allegations. Earlier this year, a federal judge ruled that most of the case against Coinbase could proceed, widely interpreted as a victory for the SEC. But Ripple's lawsuit ultimately ended with a ruling that the company's sales of XRP to retail investors on digital exchanges did not violate securities laws, which Ripple hailed as an important win.
Looking ahead, the international law firm WilmerHale said in a recent client alert that during a second Trump administration, the SEC "may propose tailored rules that account for the differences between crypto assets and traditional securities," which is precisely what the crypto industry wants. Meanwhile, on Capitol Hill, Republicans can pass legislation that would at least partially exempt many crypto issuers from SEC oversight by expanding the jurisdiction of the smaller and less well-funded Commodity Futures Trading Commission (CFTC). Earlier this year, the House passed a Republican-backed bill that would authorize the CFTC to regulate digital assets as commodities, as long as the underlying blockchain is decentralized. Gensler opposed the bill, saying it would weaken investor protections and allow crypto issuers to self-certify their products as digital commodities rather than securities. Given the Republicans' Senate majority, similar legislation may be introduced and sent to the president's desk.
The incoming crypto advocate has already promised to turn the U.S. into the "crypto capital of the world." Crypto enthusiasts will look forward to Trump fulfilling his campaign pledge to establish a "national Bitcoin reserve." Last week, Trump appointed Musk's partner, venture capitalist David Sacks, as his "White House AI and crypto czar," further energizing crypto enthusiasts.
In theory, the Federal Reserve could dampen the crypto craze by restricting financial leverage, raising interest rates, or doing both. But such measures are unpopular when speculative activity keeps surging and asset prices keep soaring.
In the late 1990s, then-Federal Reserve Chairman Alan Greenspan, after initially warning of "irrational exuberance," stood by and watched the Nasdaq plummet. (The tech stock index doubled in value from January 1998 to March 2000.) Currently, the Federal Reserve's intervention to suppress the potential of cryptocurrencies seems minimal. The central bank is taking action to lower interest rates rather than raise them, and last week, Fed Chairman Jerome Powell compared Bitcoin to gold, treating it as an investment asset - a position many in the crypto community have advocated.
Finally, Wall Street is starting to embrace cryptocurrencies. After losing a key lawsuit in 2023, the SEC approved the launch of a Bitcoin exchange-traded fund (ETF) in early 2023, which tracks the value of the cryptocurrency, allowing retail investors to purchase it. Major financial firms like BlackRock, Fidelity, and Franklin Templeton have already offered these products, while Charles Schwab offers a "crypto-themed ETF," an index fund designed to track the prices of multiple cryptocurrencies and companies. Since the election, the value of Bitcoin ETFs has risen about 45%, which will certainly spur other financial firms to launch similar products.
Considering all these factors, it is not surprising that the rise in the value of cryptocurrencies or some observers feel anxious. Eswar Prasad, an economist at Cornell University and author of "The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance," says he is concerned that recent developments may lead many ordinary Americans to view cryptocurrencies as a safe investment, rather than an extremely volatile and speculative one.
Eswar Prasad told me: "The U.S. government seems poised to approve a range of crypto products and to tacitly endorse crypto as an asset class. This could really exacerbate the crypto bubble. And if something happens to burst that bubble, we may end up with a very bad outcome."
How bad? That may depend on the degree of interconnectedness between cryptocurrencies and the rest of the financial system, as the internet bubble engulfed hundreds of startups and the stocks of many large companies. After the 2000 bubble burst, many startups went under, and the Nasdaq index fell more than 70%; the economy entered a relatively mild recession that lasted less than a year. In the late 2000s, the bursting of the real estate bubble had more disastrous effects, as it turned out the banking system was heavily dependent on subprime mortgage assets. When the value of these assets evaporated, it nearly destroyed the entire financial system, plunging the economy into one of the worst recessions since the 1930s.
So far, federal bank regulators have worked to keep cryptocurrencies confined to their own world, encouraging banks to be cautious in handling cryptocurrency business and preventing them from holding any cryptocurrency assets on their balance sheets. The Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency wrote in a joint statement last year: "It is important that risks that cannot be mitigated or controlled from the crypto-asset sector do not migrate to the banking system." Powell reiterated the Federal Reserve's goal in last week's comments of not letting any interaction between cryptocurrencies and banks threaten the banking system.
But Dennis Kelleher reminds me that recent history is not entirely reassuring. During the 2022-23 cryptocurrency bubble burst, coinciding with soaring interest rates, three banks with ties to the cryptocurrency industry collapsed: Silvergate, Silicon Valley, and Signature. Kelleher predicts that Trump will appoint bank regulators in a more laissez-faire manner and adds, "You're going to see crypto just flood into the cracks of the financial system... I think the bell has already started tolling for the next financial crisis with the election of a second Trump administration."
The worst-case scenario is a full-blown financial collapse, which I've seen many times in the 1990s, where people go crazy speculating on something, and it often ends up in a bubble. Prasad believes cryptocurrencies could experience a similar situation, and the government may tacitly or even actively support such speculation. When I asked the economist if he could think of a historical analogy, he pointed to the Chinese government's encouragement of citizens to invest in real estate, which, as we all know, does not seem to have had a good outcome.
