Author: Annie Lowrey Article Translated by: Block unicorn

Dennis Kelleher, president of the non-profit organization Better Markets, told me: "The countdown to the next catastrophic collapse has already begun."

In recent weeks, I have heard this or similar views from economists, traders, congressional staff, and government officials. The incoming Trump administration has promised to support cryptocurrency regulations and may relax strict restrictions on Wall Street institutions.

They believe this will usher in an unprecedented era of American prosperity and maintain the US's position as the leader of the global capital markets and the core of the global investment ecosystem. "My vision is to make America dominate the future," Donald Trump said at a Bitcoin conference in July. "I'm developing a plan to ensure America becomes the global hub of cryptocurrency and the world's Bitcoin superpower."

Financial experts predict the situation will be different. First, a boom, perhaps a great boom, with the prices of Bitcoin, Ethereum, and other cryptocurrencies soaring; financial firms making a killing; American investors basking in their newfound wealth. Second, a bust, perhaps a great bust, with companies going under, governments being called upon to stabilize the markets, and many Americans facing foreclosure and bankruptcy.

I have written over a dozen articles on Bitcoin and covered the last financial crisis and its lasting aftermath, so I have some understanding of the potential causes of booms and busts. Crypto assets tend to be highly volatile, far more so than real estate, commodities, stocks, and bonds. With the encouragement from Washington, more Americans will invest in cryptocurrencies. As funds pour in, prices will rise. When prices fall, individuals and institutions will be devastated, and this is inevitable.

The experts I spoke with did not dispute this view. But they told me that if things do turn out this way, the US and the world should consider themselves lucky. The danger lies not only in the cryptocurrency-friendly regulations that could expose millions of Americans to scams and market volatility. The real danger is that this will lead to a rise in leverage across the entire financial system. This will exacerbate opacity, making it harder for investors to determine and price the risks of financial products. And this is happening as the Trump administration is cutting regulations and regulatory agencies.

Cryptocurrencies will become more prevalent, and traditional financial markets will become more like cryptocurrency markets - crazier, more opaque, more unpredictable, and potentially with trillions of dollars in consequences that will last for years.

"I'm worried the next three to four years will look pretty good," Eswar Prasad, an economist at Cornell University and former IMF official, told me. "The real challenge is what comes after, when we'll have to clean up the speculative frenzy unleashed by the policies of this administration."

For years, Washington has "waged an unprecedented war on cryptocurrency and Bitcoin," Trump told cryptocurrency entrepreneurs this summer. "They're coming after your banks. They're cutting off your financial services... They're preventing ordinary Americans from sending money to your exchanges. They're slandering you as criminals." He added, "I've been through that too, because I said the election was rigged."

Trump is right that cryptocurrencies exist in a parallel financial universe independent of the US. Many crypto companies are unable or choose not to comply with US financial regulations, making it difficult for ordinary investors to use their services. (The world's largest cryptocurrency exchange, Binance, won't even disclose its jurisdiction, instead directing US customers to a US-based affiliate.) Companies like Morgan Stanley and Wells Fargo rarely offer crypto products and invest little in cryptocurrencies and related businesses. The problem is not that banks don't want to participate, but that regulations prevent them from doing so, and regulators have explicitly warned them not to.

This limits the flow of funds into cryptocurrencies. But this approach is prudent: it prevents company failures and crazy price swings from disrupting the traditional financial system. Kelleher points out that cryptocurrencies lost $2 trillion of their $3 trillion market value in 2022. "If any other asset experienced such a massive financial collapse, it would surely trigger contagion. But it didn't, because you have this parallel system that's almost completely disconnected."

The upcoming regulatory measures will tightly integrate these systems. To be sure, no one knows exactly what laws Congress will pass and what Trump will sign. But the Financial Innovation and Technology for the 21st Century Act (FIT21) provides a good reference. The bill, which passed the House last year but stalled in the Senate, is the focus of a massive lobbying effort by cryptocurrency advocates, including $170 million for the 2024 elections. It's essentially an industry wish list.

FIT21 would designate the Commodity Futures Trading Commission (CFTC) as the regulator for most crypto assets and businesses, rather than the Securities and Exchange Commission (SEC), and require the CFTC to collect far less information about the structure and trading of crypto products than securities companies provide to the SEC.

In addition to lax rules, financial experts also expect lax enforcement. The CFTC primarily oversees financial products used for hedging by businesses and traded between traders, not those sold to individual investors. The CFTC's budget is about a fifth of the SEC's, and its staff is only about a seventh of the SEC's. Overall, Washington is expected to ease restrictions, allowing traditional banks to put cryptocurrencies on their books and allowing crypto companies to access the US financial infrastructure.

According to Prasad, this regulation would be a "dream" for the cryptocurrency industry.

Trump and his family have personal investments in cryptocurrencies, and the president-elect has proposed establishing a "strategic" Bitcoin reserve to prevent the influence of a certain country. (In reality, this means using billions of dollars of taxpayer money to absorb a speculative asset with no strategic interest.) How many members of a certain country's party will invest in cryptocurrencies because of Trump's investments? And how many young people will put money into Bitcoin because Trump's son Eric says the price will skyrocket to $1 million, or because the Commerce Secretary says it's the future?

Any measures being considered by Congress or the White House will not reduce the inherent risks. Crypto investors will still be vulnerable to hacks, ransomware, and theft. Research group Chainalysis tallied $24.2 billion in illicit transactions just in 2023. If the US government invests in cryptocurrencies, the incentives for countries like Iran and North Korea to interfere in the market will increase exponentially. Imagine a 51% attack on the Bitcoin blockchain by a country, taking over and controlling every transaction. This would be a security nightmare.

Any measures being considered by Congress or the White House will not reduce the inherent risks of cryptocurrencies. Crypto investors will still be vulnerable to hacks, ransomware, and theft. Research group Chainalysis tallied $24.2 billion in illicit transactions just in 2023. If the US government invests in cryptocurrencies, the incentives for countries like Iran and North Korea to interfere in the market will increase exponentially. Imagine a 51% attack on the Bitcoin blockchain by a country, taking over and controlling every transaction. This would be a security nightmare.

Americans will also face more fraud and scams. The U.S. Securities and Exchange Commission (SEC) has taken enforcement actions against dozens of Ponzi schemes, snake oil salesmen, and fraudulent activities, including the $32 billion fake exchange FTX and some shoddy token companies. No one expects the CFTC to have the same power to do the same. And FIT21 still leaves many loopholes for all sorts of dirty profiteering. Crypto companies may legally operate exchanges, trade their own assets, and execute orders for clients, despite conflicts of interest, but it's all legal.

Simple volatility is the biggest risk for retail investors. Prasad emphasizes that cryptocurrencies, tokens, and other coins are "purely speculative." "The only thing supporting their value is investor sentiment." At least gold has industrial uses. Or, if you bet on tulip bulb prices, you might at least get a flower.

But in the crypto world, you may get nothing, or even lose. Many crypto traders borrow money to speculate. When leveraged traders lose on their investments, their lenders—often the exchanges—will demand collateral. To provide collateral, investors may have to liquidate their 401(k) accounts. They may have to sell their Bitcoin when the market is down. If they can't raise cash, the firms holding their accounts may liquidate or seize their assets.

A report last month from the Office of Financial Research, the government's think tank, explicitly warned that this could be very dangerous: Some low-income families are "using crypto gains to obtain new mortgages." When crypto prices fall, these families' homes will be at risk.

Many individual investors seem unaware of these dangers. The FDIC had to remind the public that crypto assets are not protected by its insurance. The FSOC also raised a concern that people don't realize crypto firms aren't regulated the same as banks. But how serious is this if even Trump is invested in it?

However, regulators and economists are mainly concerned not with the damage this new era will do to individual households. They worry that the chaos in the crypto markets will disrupt the traditional financial system—causing a credit crunch and forcing government intervention, like in 2008.

Once Wall Street saw it as the fool's gold, but now it sees it as a gold mine. Ray Dalio of Bridgewater, who called crypto a "bubble" a decade ago, now sees it as "a fantastic invention." Larry Fink of BlackRock, who once called Bitcoin "an index of money laundering," now sees it as a "legitimate financial instrument"—his firm has started offering it to clients, albeit indirectly.

In early 2024, the SEC will start allowing fund managers to sell certain crypto investments. BlackRock launched a Bitcoin ETF in November; a public pension fund has already invested the hard-earned money of retirees in it. Barclays, Citi, JPMorgan, and Goldman Sachs are also doing crypto trading. Billions of dollars of traditional finance are flowing into the decentralized finance market, and with relaxed regulation, more will come.

What could go wrong? If Wall Street firms correctly assess the risks of these high-risk assets, nothing. If they don't, everything could go wrong.

Even the seemingly sturdiest tools are fraught with danger. For example, stablecoins are crypto assets pegged to the dollar: one stablecoin equals one U.S. dollar, making them a medium of exchange, unlike Bitcoin and ETH. Stablecoin companies typically maintain their peg by holding ultra-safe assets (like cash and Treasuries) equal to the value of every stablecoin they issue.

Except, in the spring of 2022, the widely used stablecoin TerraUSD collapsed, its price plunging to just 23 cents. The company had used an algorithm to maintain TerraUSD's price stability; as long as enough people withdrew funds, the stablecoin would lose its peg. Tether, the world's largest crypto asset by trading volume, claims to be fully backed by safe deposits. But the U.S. government found in 2021 that this was not the case; moreover, the Treasury is considering sanctioning the company behind Tether, as it allegedly served as a conduit for "North Korean weapons programs, Mexican drug cartels, Russian arms dealers, Middle Eastern terrorist organizations, and manufacturers of fentanyl chemicals," as reported by The Wall Street Journal. ("Suggesting Tether in any way assisted criminal elements or evaded sanctions is outrageous," the company responded.)

If Tether or another major stablecoin falters, financial contagion could immediately spread beyond the crypto markets. Worried investors would dump stablecoins, triggering a "self-fulfilling panic redemption," as three scholars simulated. Stablecoin issuers would have to sell Treasuries and other safe assets to provide redemptions; the price drops of safe assets would impact thousands of non-crypto companies. These economists estimated the risk of a Tether bank run at 2.5% in late 2021—not exactly stable!

Other disasters are easy to imagine: bank failures, exchange collapses, massive Ponzi schemes going bust. But crypto's biggest risk has little to do with crypto itself.

If Congress passes FIT21 or a similar bill, it will create a new asset class called "digital commodities"—essentially any financial asset managed on a decentralized blockchain. Digital commodities would be outside the SEC's purview, and "decentralized finance" firms would also be unregulated. Under the FIT21 bill, any company or individual could self-certify a financial product as a digital commodity, and the SEC would have only 60 days to object.

This loophole is big enough for an investment bank to drive a truck through.

Wall Street has already started discussing "tokenization," putting assets into programmable digital ledgers. The ostensible reason is capital efficiency: tokenization can make capital more fluid. Another reason is regulatory arbitrage: blockchain-based investments would no longer fall under SEC jurisdiction, potentially facing fewer disclosures, reporting, accounting, taxes, consumer protections, anti-money laundering, and capital requirements. Risks will accumulate in the system; the government will have few ways to control companies.

Outgoing SEC Chair Gary Gensler, crypto's public enemy number one, believes crypto regulation could ultimately "undermine the broader $100 trillion capital markets." "It may encourage non-compliant entities to try to choose the regulatory regime they want to be under."

We've seen this script before. In 2000, as Clinton was leaving office, he signed the Commodity Futures Modernization Act. It strictly regulated derivatives traded on exchanges but left over-the-counter derivatives unregulated. So Wall Street manufactured trillions of dollars in financial products, many backed by mortgage income streams, and traded them over the counter. These products bundled subprime with prime mortgages, obscuring the true risks of some financial instruments. Then, as interest rates rose, wages stagnated, and unemployment climbed, consumers buckled under the burden. Mortgage default rates rose, home prices fell, first in the Sunbelt and then nationwide. Investors panicked. No one even knew what was in those credit default swaps and mortgage-backed securities. No one was sure of the value of anything. Uncertainty, opacity, leverage, and mispricing fueled the global financial crisis and ultimately the Great Recession.

The current cryptocurrency market is now ready to become the future derivatives market. If Congress and the Trump administration do nothing - still treating the Securities and Exchange Commission (SEC) as the primary regulator of cryptocurrencies and requiring crypto companies to comply with existing rules - the chaos will continue to be isolated. After all, there is no reasonable reason to believe that digital assets should be treated differently from securities. According to the simple standards used by the government for more than a hundred years, almost all crypto assets should be considered securities. However, Washington is creating loopholes instead of enacting laws.

As cryptocurrency supporters like to say, "Hold on, don't let go." Jamie Dimon of JPMorgan Chase said at a conference in Peru last year, "Many bankers, they're dancing in the streets." Maybe they should do so. Bankers will never be the scapegoats.