Money Reimagined: Bitcoin’s Warning for Central Banks

Bitcoin’s rising price reflects declining faith in the existing financial system. Will central bankers like Christine Lagarde take notice?

(Illustration: Moe Na/CoinDesk)

Jan 15, 2021 at 5:42 p.m. UTCUpdated Jan 15, 2021 at 6:17 p.m. UTC

Money Reimagined: Bitcoin’s Warning for Central Banks

Another week, another lifetime lived:

The U.S. President impeached, again. Worldwide COVID-19 deaths close in on 2 million. Bitcoin surges to a record high above $42,000, promptly plunges to almost below $30,000 and then begins a late-week rally above $36,000.

Meanwhile, the crypto community has been grappling with some contentious regulatory proposals that would strengthen U.S. monitoring of global digital currency transactions.

That’s the topic of this week’s “Money Reimagined” podcast episode. We talk to Christopher Giancarlo, the former chairman of the Commodities Futures Trading Commission, and Marvin Ammori, a famed digital civil rights lawyer who’s now chief legal counsel at Uniswap, about how the crypto industry and regulators can better collaborate on rules that enable constructive innovation.

Have a listen after reading this week’s newsletter.

What does it mean when the most powerful woman in finance scolds you?

Christine Lagarde: “For those who had assumed [bitcoin] might turn into a currency, terribly sorry, but it’s an asset. And it’s a highly speculative asset which has conducted some funny business and some interesting and totally reprehensible money laundering activity.”
Did the European Central Bank President just give bitcoin a time-out? Or is punishment still coming? During those remarks in an online Reuters event on Wednesday, Lagarde called for crypto regulation “at the global level.”
Bitcoin is a disruptive force that demands attention. So such comments aren’t necessarily bad. They suggest the stewards of the global monetary system now realize they can no longer ignore it as a mere curiosity of zero. A soaring price is putting Bitcoin on central banks’ radars.
The question is whether high-level monetary authorities such as Lagarde truly understand why they should take it seriously. Do they get that it’s sending a message about the failures of their system, one that has made the owners of financial assets fabulously wealthy in a year that hundreds of millions have suffered unprecedented hardship?
Lagarde has actually been a well-informed supporter of crypto innovation, both as head of the International Monetary Fund and now at the ECB. (She’s spearheading the digital euro.)
So, why now trot out old, nuance-less critiques of bitcoin that, while arguably true, are mostly irrelevant?

A wide cross-section of bitcoiners welcome clear, internationally consistent regulation to dissuade bad guys and make crypto safe for good guys. But if your priority is attacking money laundering – rather than, say, boosting financial inclusion – then please first go after the trillions of dollars in “funny business” facilitated by mainstream finance’s bankers and lawyers.
Yes, bitcoin is “speculative” (though our chart below might suggest it has become less so.) And, yes, it’s “volatile, an “asset” and a poor unit of account/medium of exchange. But very few informed market participants expect anything more. They are betting on it to become “digital gold,” a future hedge against monetary dysfunction. Until a wide enough investor base believes in that, it will stay volatile and will be generally useless for buying groceries.
Lagarde has surely heard all that. So why the rant?
Perhaps, just as crypto people join forces when regulators come after their industry, she, too, is siding with her community: international financial policymakers. Much of what Lagarde said sounded like solidarity with the U.S. Treasury Department’s hardline proposal that crypto exchanges be required to track the identities of self-custodial wallets.
Or, as Bloomberg’s Brian Chappatta suggested this week, do central bankers like Lagarde see the soaring price of bitcoin, and perhaps also Tesla, as symptoms of a wider bubble in capital markets that will require a tighter monetary response?
Maybe. But let’s be clear: Bitcoin is still nowhere near big enough to encompass actual systemic risk.
Yes, its market capitalization, about $650 billion, has suddenly become higher than Facebook’s and is just shy of Tesla’s. But it’s nothing like, say, the $55 trillion credit default swap market of 2008, whose complex interconnections with bond markets meant that when defaults accelerated, they fueled that year’s global financial crisis. If bitcoin investors lose money, it won’t lead to meaningful knock-on effects in other markets.
So, instead, might it be that Lagarde and Co. are starting, just slightly, to get a hint that bitcoin’s price says something about public confidence?
If we view owning bitcoin as a short position against the financial system, then its surging price – alternatively, the plunging price of fiat – along with its increased attention from institutional investors, reflects waning faith in that system. Will financial authorities take the right message from it?
Short-sellers are often maligned. But one value they bring to society is that the price movements they generate are a signal that something needs fixing.
So, policymakers: Yes, you should regulate bitcoin. But even more urgently, fix the legacy financial system.

Speculative? It’s all relative

Last week, we brought you a chart showing how data from the Bitcoin blockchain described how the current bull market has been driven by large investors, unlike the “Mom and Pop” rally of December 2017. (The number showed a recent rise in the number of large addresses that hold more than 1,000 BTC, whereas that measure was falling three years ago.)

This week, we use exchange data to suggest another difference in investor type, this time between the new, incoming large investors – thought to be large, sophisticated institutions such as hedge funds – and the more established crypto-native players. While the latter are more sophisticated than the naive retail newbies of 2017, they tend to be individuals or crypto startups.

We looked at open interest in bitcoin derivatives on six of the biggest exchanges, which reflects the amount of money invested in options, futures and other such instruments that hasn’t been converted into the underlying asset, in this case bitcoin itself. Then we compared that to the volumes traded in the underlying spot market for bitcoin, creating a percentage that we treat as an admittedly imperfect proxy for how much leveraged speculation is going on.

Then we split these results between the four online crypto exchanges that are outside U.S. regulation and which allow for significantly higher leveraged bets – OKEx, Huobi, BitMex and Binance – and two long-established U.S.-regulated exchanges that follow the more traditional, low-leverage models on which they were founded: the Chicago Mercantile Exchange and Bakkt, which belongs to the Intercontinental Exchange, the owner of the New York Stock Exchange. The idea is that the crypto natives typically play in the first and the institutions in the second.

From the chart that CoinDesk’s Shuai Hao pulled together, which uses a seven-day moving average for open interest, you’ll note that although speculative bets in the CME and Bakkt futures rose steadily over the spring and summer, it was nothing like the build-up that occurred in the crypto-native exchanges.

Then, after criminal charges were brought against the BitMex founders, a sharp pullback occurred. And although the crypto-native speculators came back for a bit, they haven’t sustained it, closing out their positions as bitcoin started to soar in December, presumably at a profit. Meanwhile, the institutions, the big money players who’ve been pouring cash into long positions in the spot market, have kept a comparatively steady hand.

As the price quadrupled in four months, the bitcoin market appears to have been driven by a moderately low level of derivatives-based speculation and leverage, at least compared to the summer. All things considered, that should mean less volatility. That seems hard to square with the past week’s rally-plunge-rebound. But it might explain why the early-week sell-off was so short-lived.

The conversation: Platform or publisher?

Perhaps the biggest immediate fallout from last week’s insurgence of Donald Trump’s supporters into the Capitol came from Twitter’s and Facebook’s moves to suspend the outgoing president’s accounts and those of some of those supporters in what some have dubbed Silicon Valley’s own impeachment process. Inevitably, they drew support from many who saw Trump as an instigator of violence but also sweeping criticism from others, who complained of these platforms’ unique power to curtail speech.

It’s a complicated debate, one that animates the call for decentralization within the crypto and blockchain community, where people are trying to build a new, censorship-resistant architecture for the internet and for digital money. Twitter and Facebook – and Amazon, which joined in by kicking right-wing-friendly social media site Parler of Amazon Web Services’ servers – are private companies. They aren’t subject to the government’s First Amendment free speech standards. Yet, because of their massive size and the dependency of their users, and because they have proprietary control over users’ data and an algorithmic capacity to curate what they view, these de facto public forums have a monopoly power that can shape society.

Ironically, some of the best discussion occurred on Twitter.

CEO Jack Dorsey published a thoughtful lament that his company, as a private entity, is forced to make these difficult decisions. He said he’d rather a less centralized internet, which is why he has a “passion for Bitcoin,” describing it as “a foundational internet technology that is not controlled or influenced by any single individual or entity.”

Chess grandmaster Garry Kasparov, whose experiences under the totalitarian regime of the Soviet Union have made him an articulate voice for freedom, emphasized the need to distinguish private power from state power.

But it was former presidential candidate and now New York mayoral wannabe Andrew Yang who nailed it. Moving beyond the contentious issue of Trump’s account, he focused on the broken state of the media economy, on how it rewards people for disseminating destructive disinformation. He skewers the business models of the big tech companies, calling them “essentially quasi-governments unto themselves,” where “their decisions are driven by maximizing ad revenue, user engagement and profit growth … not the set of incentives you want when deciding what millions regard as truth.”

Relevant Reads: A crypto-savvy SEC

Reports emerged this week that President-elect Joe Biden would nominate former Commodities Futures Trading Commission Chairman Gary Gensler to head the Securities Exchange Commission. This news that someone with such deep knowledge of this industry (Gensler has taught courses on cryptocurrency and blockchain at MIT for several years) was widely welcomed by a crypto community, which has been whipsawed of late by big shifts in the regulatory environment. Our coverage reflected that.

(Disclosure: I worked with Gensler at MIT before joining CoinDesk, including co-authoring an economic paper with him and other colleagues from MIT Sloan School of Management and the MIT Media Lab’s Digital Currency Initiative. It’s true what they say: Gary gets it.)

CoinDesk initially picked up Reuters’ scoop on the story. Kevin Reynolds’ account noted that Gensler had testified before Congress on cryptocurrencies and, in his course on cryptocurrencies and blockchains, had called the technology “a catalyst for change in the world of finance and the broader economy.”
In his “The Breakdown” show on the CoinDesk podcast network, Nathaniel Whittemore optimistically described Gensler as “a partner we can work with” who “is going to try to get the space in line with the regulatory mainstream” but who “also appreciates what makes it different, where the opportunities lie.”
OpEd contributor Jeff Bandman, a former CFTC official, wrote that Gensler will start the job “shovel ready.” He predicted that his wariness of incumbents having too much power could create opportunities for crypto innovators and that the SEC would now finally move to approve a bitcoin exchange-traded fund.

Money Reimagined: Bitcoin’s Warning for Central Banks

Speculative? It’s all relative

The conversation: Platform or publisher?

Relevant Reads: A crypto-savvy SEC

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