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Crypto Is Failing as Money. Regulators Can Save It.

Cryptocurrency has so far failed to sweep away government-issued money, or to bring about the broader revolution that its most ardent enthusiasts envision. But what if the underlying technology could be harnessed to transform traditional fiat currencies — for example, by making them much easier and cheaper for more people around the world to use?

This goal might be attainable — with help from the governments that crypto was meant to sideline.

Ordinary money leaves a lot to be desired. Most people keep it at large banks, which have sometimes used subterfuge and even outright fraud to tax their customers — and which have proven troublingly fragile in crises. Moving money can take days, particularly if it must wend its way through the antiquated and hackable network of correspondent banks that handles international transfers. For those who don’t have bank accounts — including millions of Americans, disproportionately Black and Latino — things are worse. Check cashers, ATMs, card issuers and money transmitters all charge burdensome fees.  

Bitcoin, the original cryptocurrency, was designed to bypass all this. Anyone with an internet connection could set up a pseudonymous account, controlled with a private key. Users could send digital tokens anywhere, at any time, thanks to a voluntary network of computers that recorded transactions on a public ledger known as a blockchain. High-powered cryptography and decentralization protected against abuse and malfunction. The technology inspired hope not only for a more equitable sort of finance, but also for greater stability: The demise of one or more big global banks would do much less damage if payments could proceed without them.

Bitcoin has spawned an entire movement, but it has so far failed as money. Pure cryptocurrencies are far too volatile to be useful except for speculation, illicit trade and the occasional financing of activists in oppressive regimes. The computing power required for the Bitcoin blockchain makes it slow and expensive for smaller transactions, not to mention environmentally damaging. People are afraid to lose the keys to their crypto (about a fifth of all Bitcoin is estimated to have been lost in this way), so they entrust them to wallet apps and other platforms that often get hacked. Most crypto “believers” engage through the same types of intermediaries — exchanges, PayPal, specialized ATMs, opaque trust companies — that the technology was intended to replace. Many of these businesses are less safe and more expensive than traditional banks. Their rapid growth threatens more financial instability.

That said, all is not lost. Despite everything, crypto innovation may yet deliver a better payment system.

Consider stablecoins. They deal with volatility by tying their value to fiat currencies — implicitly recognizing the biggest defect of pure cryptocurrencies. They can run on blockchains that work more efficiently than Bitcoin and have a smaller carbon footprint. At the moment, they’re mainly used by crypto speculators to park funds while deciding what to bet on next, or to earn interest in unregulated lending pools. But as a unique form of electronic cash, they have the potential to make transfers easy, instantaneous and cheap. The Facebook-initiated Diem Association, for example, wants to use them to enable payments on mobile apps such as Facebook Messenger and WhatsApp. Ultimately, the infrastructure they use could even provide the rails on which government-issued digital currencies could travel.

Another initiative, known as Lightning, seeks to address Bitcoin’s throughput and energy issues by establishing side channels through which multiple payments can be made, with only the final balance recorded on the blockchain. The system has allowed one application, Strike, to use Bitcoin as a utility for remittances between the U.S. and El Salvador. Users’ money can enter as dollars in one country and emerge as dollars in the other, spending practically no time in volatile crypto.

Innovations like these have promise — but they also pose risks that regulators need to address.

•  They could trigger runs. Stablecoins redeemable for fiat currencies at fixed rates, and fiat-currency balances in apps such as Strike, need to be securely backed. Often, they aren’t. A recent Bloomberg Businessweek exploration of Tether, the most popular stablecoin with about $70 billion outstanding, found a company “quilted out of red flags.” The lack of clarity — or a lack of funds — could one day spook holders, precipitating a crash as everyone rushes for the exits.

Regulators should insist on backing in the form of high-quality assets, and ideally in fiat currency. In the U.S., this can be achieved by requiring payment apps and stablecoin issuers to invest only in bank deposits that are in turn held at the Federal Reserve, or by creating a narrowly defined banking license allowing them to open reserve accounts directly with the Fed.

•  They could undermine traditional banks. If people could safely keep their money in stablecoins and payment apps, they might stop depositing it at banks, depriving the latter of the resources to make loans. The resulting credit contraction could tank the economy.

A recent analysis by the Bank of England suggests that such concerns are overblown. People will likely be slow, its authors say, to adopt new forms of digital money, allowing time for the system to adapt. Still, regulators should err on the side of caution, by forbidding stablecoins and payment apps to pay interest, or by reducing the interest they receive on their deposits at the Fed. Such restrictions could be relaxed later, once officials can assess any threat to banking and credit.

•  They could crash or get hacked. It’s one thing for Facebook’s apps to go dark for a day; it would be another if the company were running a global payment system. The newer protocols aren’t yet proven — as the recent outage of the Solana blockchain demonstrated. Lightning has known vulnerabilities.

Regulators should require enough equity capital to absorb surprise losses and set standards for security and governance — for example, by testing resilience and identifying who’s in charge of handling emergencies. If a company can’t show it would act responsibly, it shouldn’t be allowed to run a payment system. Also, systems should be interoperable, so that a dollar in one can easily be converted into a dollar in another.

•  They could abet crime. Crypto platforms usually identify users only with an alphanumeric address. This has made them useful for ransomware developers, tax cheats and other criminals — and raised concerns that they could undermine international sanctions and anti-money-laundering laws.