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Crypto meltdown highlights need for urgent regulatory intervention

Opaque industry is an invitation to sleazy operators to do their worst

| U.S.
What real value do vaporous cryptocurrencies have beyond vague promises?   © Reuters

David J. Farber is a distinguished professor and co-director of the Cyber Civilization Research Center at Keio University in Tokyo. Dan Gillmor, professor of practice at Arizona State University, is a senior fellow at Keio's Cyber Civilization Research Center.

You have to feel a twinge of sympathy for the people who "invested" their savings in cryptocurrencies during the past few months and who subsequently lost most or all of their money when the cryptocurrency marketplace collapsed during the past several weeks.

The words "invested" is in quotes for a reason. This bubble was a classic in the genre, and the people who are collectively losing the most money are low-information gamblers, not investors, just as they are when every economic bubble deflates.

And they were warned. Anyone paying the slightest attention had to have heard the ever-more-strident cautions, including ours, that cryptocurrencies were not what they seemed and that this "marketplace" was in large part a mirage. And, as we said in the article, "Cryptocurrencies remain a gamble best avoided," published online on Feb. 5, a rigged game.

It is no less so now, though perhaps more potential suckers understand this fact and will now steer clear. We can hope they will, anyway. But that will not restore the losses.

As happens in all bubbles, meanwhile, a smaller group of people will have made out like, well, bandits. They are the ones who cooked up the systems that turned out to be far less stable than they led others to believe, or those who joined the party early, and who sold to the newcomers before the crash.

A lot of what happened was not illegal, however immoral it may have been. Our laws encourage speculation, and that is not always a bad thing. Conventional wisdom has often disdained genuine innovation, and incumbent industries usually fear and try to contain or control innovation.

Indeed, one school of bubble-economic thought holds that these episodes have a significant positive impact. However cruelly, they disappoint the last-in batch of greater-fool speculators.

Consider, for example, what happened during and after the late 1990s tech boom centered in Silicon Valley. It was fueled initially by venture capital investors who presumably understood the extreme risks involved. The money that arrived later was from people with far less understanding, and a lot of it vaporized when the bubble burst after 2000.

One of the sectors most lavishly funded was networks, including fiber optic deployments plus equipment and services designed to handle the expected flood of new data traffic.

The traffic did come, but there had been a massive overbuilding of networks. Even after the 1990s bubble deflated, the U.S., in particular, was the beneficiary of seemingly endless capacity for network growth at suddenly much lower costs. Would the internet and the data-heavy services have expanded so quickly without that capacity? Probably not.

Throughout that era, regulation was mild to nonexistent, in keeping with the tenor of the times. While a giant rip-off was taking place, the U.S. government seemed largely indifferent.

That indifference grew during the next bubble, led by the real estate industry and its collaborators on Wall Street. Their orgy of fraud and deceit came close to wrecking the global economy, and in this case, almost nothing beneficial emerged from the burst bubble.

But even the 2005-08 bubble had more going for it, in a benefit-to-society sense, than the cryptocurrency eruption. Housing, even the beyond-shoddy new construction in U.S. exurbs, does have at least some intrinsic value. What real value do vaporous cryptocurrencies have beyond vague promises?

As we also said in February, we are not dead set against cryptocurrencies. We believe there can be valid use cases, particularly to augment more traditional financial systems. And we are still very keen on the potential for value in the endless-ledger system made possible by blockchain technology. In particular, one blockchain spinoff, the decentralized autonomous organization, or DAO, has enormous potential.

A sign of the decentralized autonomous organization on a smartphone screen: DAO has enormous potential.   © Sipa/AP

But as all of this moves ahead, it cannot succeed without at least some regulatory intervention. Opaque financial instruments that theoretically offload individual risk but create vast systemic risk are an invitation to the sleazy operators to do their worst. We need not just far stricter corporate transparency requirements but also limitations on derivatives that are designed almost solely to generate fees.

We also need a broad public education campaign promoting financial literacy. It might not help much, but even a little help is better than none. Financial history shows that manias are viral affairs.

And we need enforcement. While deliberately lax regulation fueled the early 2000s bubble, active disinterest in the enforcement of the law, such as it was, was even worse.

Not only did the rampant fraud and looting go mostly unpunished, the U.S. government actually rewarded the people who concocted the worst of it. The well-nicknamed banksters were showered with hundreds of billions of future taxpayers' dollars by a government that feared Wall Street's power and implicit threats to tank the global economy if they did not get the cash.

The 2022 cryptocurrency meltdown is not the end of this story. Innovators will keep working. And human nature changes very, very slowly. We need to constantly remind ourselves that history does hold lessons for the present and future. Look ahead, yes, but do not speculate with money you cannot afford to lose.

And remember this: When someone tells you, "It's different this time," that is almost always the signal to run in the other direction.

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