[Senate Hearing 115-453]
[From the U.S. Government Publishing Office]
S. Hrg. 115-453
EXPLORING THE CRYPTOCURRENCY AND BLOCKCHAIN ECOSYSTEM
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FIFTEENTH CONGRESS
SECOND SESSION
ON
EXPLORING THE OPPORTUNITIES AND CHALLENGES SURROUNDING THE
CRYPTOCURRENCY AND BLOCKCHAIN ECOSYSTEM
__________
OCTOBER 11, 2018
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Available at: https: //www.govinfo.gov/
___________
U.S. GOVERNMENT PUBLISHING OFFICE
34-525 PDF WASHINGTON : 2020
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
MIKE CRAPO, Idaho, Chairman
RICHARD C. SHELBY, Alabama SHERROD BROWN, Ohio
BOB CORKER, Tennessee JACK REED, Rhode Island
PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey
DEAN HELLER, Nevada JON TESTER, Montana
TIM SCOTT, South Carolina MARK R. WARNER, Virginia
BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana
DAVID PERDUE, Georgia BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana CATHERINE CORTEZ MASTO, Nevada
JERRY MORAN, Kansas DOUG JONES, Alabama
Gregg Richard, Staff Director
Mark Powden, Democratic Staff Director
Jonathan Gould, Chief Counsel
Kristine Johnson, Economist
Laura Swanson, Democratic Deputy Staff Director
Elisha Tuku, Democratic Chief Counsel
Corey Frayer, Democratic Professional Staff Member
Dawn Ratliff, Chief Clerk
Cameron Ricker, Deputy Clerk
Shelvin Simmons, IT Director
James Guiliano, Hearing Clerk
Jim Crowell, Editor
(ii)
C O N T E N T S
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THURSDAY, OCTOBER 11, 2018
Page
Opening statement of Chairman Crapo.............................. 1
Prepared statement........................................... 21
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 2
Prepared statement....................................... 21
WITNESSES
Nouriel Roubini, Ph.D., Professor of Economics, Stern School of
Business, New York University.................................. 3
Prepared statement........................................... 22
Peter Van Valkenburgh, Director of Research, Coin Center......... 5
Prepared statement........................................... 36
Responses to written questions of:
Senator Heller........................................... 103
Senator Sasse............................................ 103
Senator Cotton........................................... 108
Senator Reed............................................. 112
Senator Warner........................................... 113
Senator Cortez Masto..................................... 117
Additional Material Supplied for the Record
Letters to the Committee submitted by Chairman Crapo and Senator
Brown.......................................................... 121
(iii)
EXPLORING THE CRYPTOCURRENCY AND BLOCKCHAIN ECOSYSTEM
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THURSDAY, OCTOBER 11, 2018
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:01 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Mike Crapo, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN MIKE CRAPO
Chairman Crapo. This hearing will come to order.
Today the Committee will continue its exploration of the
opportunities and challenges surrounding the cryptocurrency and
blockchain ecosystem.
Prior to the introduction of Bitcoin and underlying
blockchain ledger in 2009, there was no similar solution to the
double-spend problem--where the same digital currency could be
spent more than once--which did not require a third-party
intermediary.
While Bitcoin, the first decentralized cryptocurrency, has
been around for nearly a decade now, cryptocurrencies have
gained particular attention in the past 2 years, due in part to
their meteoric rise and subsequent fall in value last year.
Advancements since Bitcoin's creation have expanded
blockchain's uses and given way to things like ``Initial Coin
Offerings,'' a method of crowdfunding that has become popular
in the cryptocurrency community.
While the technologies underpinning cryptocurrencies have
the ability to transform the composition of, and ability to
access, capital and the financial system, much of the recent
news about cryptocurrencies has been negative, focusing on
enforcement actions, hacks on international exchanges, and
concerns raised by various regulators and market participants.
To that end, in February of this year, the Committee held a
hearing with the SEC and CFTC to examine their oversight roles
of cryptocurrency-related products and activities under their
respective jurisdictions.
Since that hearing, the agencies have made strides to
provide further clarification on their thinking surrounding
cryptocurrency-related issues. But some regulatory and
oversight questions still remain.
The regulatory questions, price volatility, and reports of
things like pump-and-dump schemes have raised a lot of
questions
surrounding the cryptocurrency and blockchain ecosystem that
need to be better understood.
Blockchain networks have the potential to improve processes
for things like smart contracts, payments and settlement,
identity management, and even things yet undiscovered.
In order to move forward in a productive way and give these
innovations the room to flourish and develop in a safe and
sound way, we need to sort through the static and better
understand what exactly are the opportunities and challenges
facing this ecosystem.
For example, the Committee would benefit to hear about: the
use of cryptocurrencies and derivative products as a store of
value or medium of exchange or payment; the current and
potential applications of blockchain technology; and the
regulatory issues surrounding the various facets of the
ecosystem and how they can be improved.
I look forward to hearing about this and other issues from
our witnesses today.
Senator Brown.
OPENING STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Chairman Crapo, for holding this
hearing. And thanks to the two witnesses. Mr. Van Valkenburgh,
welcome, and, Dr. Roubini, welcome to the Committee.
Today's hearing happens to fall just shy of the tenth
anniversary of Bitcoin and the blockchain being introduced to
the world--October 31, 2008. We were in the midst of a global
financial crisis. You cannot blame some Americans for hoping
that an alternative banking system could be created that would
be superior to the one in shambles at that time.
Bitcoin, and other cryptocurrencies like it, promised to
make payments faster and easier and cheaper, and to eliminate
our reliance on risky financial institutions whose failures
harmed workers and families in all of our communities.
The last 10 years, unfortunately, have shown that
misconduct, fraudulent investment schemes, and cybersecurity
threats are not unique to the traditional financial system.
When a cryptocurrency goes bust or a poorly supervised exchange
fails, it is often hardworking Americans left holding the bag.
We want to see innovations in the financial system,
innovations that help Americans keep more of their money by
avoiding fees or that make it easier to borrow for a small
business startup.
But so far, despite all the energy and investment dedicated
to finding a use for the blockchain, there are few real-world
applications and an alarming number of scams.
Cryptocurrency prices have swung wildly over the last year.
Inexperienced investors who were hoping to get in on the next
big financial innovation have seen the value of these
investments fall by more than 75 percent from their peak.
Though they have raised billions of dollars from investors,
few if any Initial Coin Offerings (ICOs) have registered with
the SEC. Chair Clayton told this Committee in a February
hearing, ``Every Initial Coin Offering I have seen is a
security.''
Last month, the New York Attorney General released a report
on several cryptocurrency trading platforms that pointed to
evidence of widespread manipulation and identified several
exchanges that do not follow ``anti-money-laundering'' or
``know your customer'' requirements.
With a decade of experience, much of the irrational
exuberance around cryptocurrencies and blockchain technology
has subsided, and we have an opportunity to set more realistic
expectations for how these innovations might be used to promote
a fairer and more competitive economy.
I hope this technology will prove useful, particularly in
helping people who are unbanked or underserved by the
traditional financial system. I understand why individuals
might be interested in it. But at this point, it is easier to
see the malign impacts on society as a whole than the
constructive ones. That is why we look forward to your
testimony.
Thank you. Chairman Crapo. Thank you, Senator Brown.
Today we are fortunate to have two witnesses from different
perspectives whose in-depth knowledge of cryptocurrencies will
be an asset to the community.
First we will hear testimony from Dr. Nouriel Roubini,
Professor of Economics and International Business at NYU's
Stern School of Business. And then we will hear from Mr. Peter
Van Valkenburgh, Director of Research at Research and Advocacy
Group, Coin Center.
Dr. Roubini, you may proceed--oh, before you do, as I
always do, I remind you to please try to pay attention to the
clock and keep your initial remarks to 5 minutes. You will have
opportunities to respond and add during questions. And I remind
my colleagues of the same limitations that they have on their
questioning time.
With that, Dr. Roubini, please proceed.
STATEMENT OF NOURIEL ROUBINI, Ph.D., PROFESSOR OF ECONOMICS,
STERN SCHOOL OF BUSINESS, NEW YORK UNIVERSITY
Mr. Roubini. Thank you. Chairman Crapo, Ranking Member
Brown, and Members of the Committee, thank you for the
opportunity to testify today on the topic of the cryptocurrency
and blockchain ecosystem.
My name is Nouriel Roubini. I am a professor of economics
at New York University. I am an expert of the global economy,
of asset and credit bubbles, and of financial crises.
In summary, my views on this ecosystem are as follows:
First, crypto is the mother or father of all scams and
bubbles, a bubble that has finally gone bust this year.
Second, blockchain is the most over-hyped technology ever,
and it is no better than a glorified database.
Let me elaborate on these points.
First, a recent study showed that 81 percent of all ICOs
were scams to begin with, 11 percent of them have been failing
or are dead, and only 8 percent are still traded on exchanges.
Second, after a massive bubble in 2017, Bitcoin has fallen
by 70 percent. This year, other major cryptocurrencies have
fallen by 80 percent, and thousands of other ones have fallen
by 95 percent. This entire asset class is literally imploding
now. Just yesterday, major cryptocurrencies plunged another 10
percent in a day.
Third, these assets are not currencies. Calling them
``cryptocurrencies'' is nonsense. They are not a unit of
account. They are not a means of payment. They are not a stable
store of value. Bitcoin can do only five transactions per
second. Visa can do 25,000 per second. Nobody uses Bitcoin for
transactions apart from criminals and terrorists. Cryptomining
is also an environmental disaster as the system wastes massive
amounts of energy.
Fourth, there is a revolution in financial services, but it
has nothing to do with blockchain or crypto. It is called
``FinTech,'' and it is based on a combination of AI, big data,
and Internet of Things (IOT). And it is already being used
daily by billions of people for billions of financial
transactions. There is no blockchain in FinTech.
Fifth, the crypto-ideological utopia is a libertarian dream
of full decentralization of all human transactions--no
governments, no central banks, no corporation, no banks, no
trusted institutions. It is totally utter nonsense.
Sixth, crypto-land is now subject to the opposite and
dangerous trend: massive centralization. Mining is centralized
and controlled by oligopolies in authoritarian countries like
China and Russia. Trading has centralized 99 percent of all
transactions occurring on nonsecure, centralized exchanges that
are being hacked on a daily basis. Development is centralized
as the technological elite is police, prosecutor, and judge.
They arbitrarily change the code and ``fork'' coins into new
ones when things go wrong. And wealth is massively concentrated
in crypto-land. The Gini coefficient of inequality for Bitcoin
is worse than North Korea. It is quite an achievement.
Seventh, there is massive price manipulation in crypto-
land: widespread pump-and-dump schemes, spoofing, wash trading,
insider trading. Coins like Tether that are created by fiat and
used to manipulate upward prices. Massive criminality.
Eighth, ICOs associated with security tokens are
noncompliant securities that break all security laws. They are
mostly scams, and even the SEC created a fake website to warn
investors of such initial coin scams.
Ninth, utility tokens and widespread tokenization would
mean a return to the Stone Age of barter. Even the Flintstones
knew better than crypto as they used clam shells as their own
one currency.
Tenth and final point, corporate blockchain--so-called
enterprise DLT--are glorified databases and they have nothing
to do with blockchain. They are private rather than public.
They are permissioned rather than permission-less. They are
based on trusted authorities verifying transactions rather than
being trustless. They are not distributed on millions of
computers but, rather, on a few selected control ledgers or
databases. They do not use cryptographic games or tend to get
transactions but, rather, trusted permissioned authorities.
In summary, they claim to be blockchain, but they have
nothing to do with blockchain. And 90 percent of all
corporations experimenting with them have decided that they are
no better than traditional databases, and since they are more
costly and less efficient than databases, they will not use
them. Only 1 percent of all CIOs say that there will be any
adoption of DLT in their organizations, and 80 percent of all
CIOs have no interest in this technology.
It is no wonder as no organization, government,
corporation, or bank would ever want to put on a public,
permission-less, distributed, trustless ledger all these
transactions with customers and suppliers. It does not make
sense, and it is not going to happen. So blockchain is a lot of
hype and almost no reality, as an expert senior analyst
recently concluded.
Thank you for your interest, and I am happy to answer any
questions.
Chairman Crapo. Thank you, Dr. Roubini.
Mr. Van Valkenburgh.
STATEMENT OF PETER VAN VALKENBURGH, DIRECTOR OF RESEARCH, COIN
CENTER
Mr. Van Valkenburgh. Chairman Crapo, Ranking Member Brown,
Members of the Committee, thank you for the opportunity to
speak with you today. My name is Peter Van Valkenburgh, and I
am the Director of Research at Coin Center, an independent
nonprofit focused on the public policy issues affecting
cryptocurrency and public blockchain networks.
What is Bitcoin? Bitcoin is the world's first
cryptocurrency, and it works because of the world's first
public blockchain network.
What does Bitcoin do? It is simple. It lets you send and
receive value to and from anyone in the world using nothing
more than a computer and an internet connection.
Now, why is it revolutionary? Because unlike every other
tool for sending money over the internet, it works with the
need to trust a middleman. The lack of any corporation in
between means that Bitcoin is the world's first public digital
payments infrastructure. And by ``public,'' I simply mean
available to all and not owned by any single entity.
Now, we have public infrastructure for information, for
websites, for email. It is called the ``Internet.'' But the
only public payments infrastructure that we have is cash, as in
paper money, and it only works in face-to-face transactions.
Before Bitcoin, if you wanted to pay someone remotely over
the phone or the internet, then you could not use public
infrastructure. You would rely on a private bank to open their
books and add a ledger entry that debits you and credits the
person you are paying. And if you both do not use the same
bank, well, then there will be multiple banks and multiple
ledger entries in between.
With Bitcoin, the ledger is the public blockchain, and
anyone can add an entry to that ledger, transferring their
bitcoins to someone else. And anyone, regardless of their
nationality, race, religion, gender, sex, or creditworthiness,
can for absolutely no cost create a Bitcoin address in order to
receive payments digitally. Bitcoin is the world's first
globally accessible public money.
Is it perfect? No. Neither was email when it was invented
in 1972. Bitcoin is not the best money on every margin. It is
not yet accepted everywhere. It is not used often to quote
prices, and it is not always a stable store of value. But it is
working, and the mere fact that it works without trusted
intermediaries is amazing. It is a computer science
breakthrough, and it will be as significant for freedom,
prosperity, and human flourishing as the birth of the internet.
And Bitcoin is just the beginning. If we can replace private
payments infrastructure, then we can replace other private
choke points to human interaction as well.
Now, why should we want to build more public
infrastructure? Why should we embrace blockchains over
corporate intermediaries? Why should we tolerate their
inefficiencies and work to make them better? Why should we want
the pioneers of this technology here in the United States and
not fleeing overseas? A simple reason: Because the corporate
intermediaries providing today's critical but privately owned
infrastructure are becoming fewer, larger, and more powerful,
and their failures are increasingly grave.
So roughly half of all Americans, 143 million people, had
their Social Security numbers exposed to hackers because of a
breach at Equifax. The SWIFT network has relayed hundreds of
millions of dollars in fraudulent transactions because of
hacked member banks in Bangladesh, Vietnam, Ecuador, and
Russia. The FBI suspects now that the largest of these hacks
was perpetrated by North Korea.
Corrupt, low-level employees at an Indian bank, Punjab
National, were able to fraudulently certify SWIFT messages,
stealing $1.8 billion. It is the largest electronic bank
robbery in history. In fact, it is the largest bank robbery in
history.
In October 2016, an estimated 1.2 million internet-
connected devices were hacked and turned into a botnet that for
several hours made prominent websites unavailable across Europe
and North America, including CNN and Fox News, the New York
Times and the Wall Street Journal.
Increasingly, physical machines are being connected to the
internet to augment their capabilities. They are wired through
servers that are owned and maintained by private and trusted
intermediaries--the so-called Internet of Things. Pacemakers
from St. Jude's Hospital have been hacked, baby monitors from
TRENDnet have been hacked, and jeeps from Jeep have been hacked
to the point where they can be remotely commandeered and driven
off the road.
Now, those vulnerabilities are inescapable in systems that
have single points of failure. It does not matter if the point
of failure is a corporation or if it is a government. There
should not be a single point of failure. Similar choke points
existed before the internet. If you wanted to deliver a
message, you would have to go through one of three television
broadcasters or a handful of newspapers. Private corporations
are essential, but no critical infrastructure should rely on
one or two. The internet removed single points of failure in
communications infrastructure and ushered in a wave of
competition among new media corporations building on top of its
public rails.
Blockchains can similarly disintermediate critical payments
and IOT infrastructure. The technology is not yet ready to
answer all of those questions today, but it is our best hope.
And as with the internet in the 1990s, we need a light touch,
pro-innovation policy to ensure that these innovations flourish
in America for the benefit and security of all Americans.
Thank you, and I look forward to your questions.
Chairman Crapo. Thank you, Mr. Van Valkenburgh. And I would
like to start with you. Your testimony details three particular
areas where decentralized computing can be useful and helpful:
electronic cash, identity, and the Internet of Things. Some use
cases like Bitcoin already exist, while others are conceptual.
Cryptocurrencies like Bitcoin have experienced volatile price
fluctuation over the past year.
I am going to ask you first and then, Dr. Roubini, I will
ask you to comment on this as well. Where do you see things
going in the next year or so? Under what conditions do you see
market value stabilizing?
Mr. Van Valkenburgh. Thank you, Chairman Crapo. Much of the
ongoing volatility that we are seeing I think stems from a
struggle to find a level for something brand new. So when
tulips were first introduced to the Netherlands from Arabia and
they became very popular amongst the rich set, it was hard to
find a price, and a lot of irrational exuberance pervaded those
markets. We saw volatility in equity markets when trading joint
stock companies became a new phenomenon, the South Sea and
Mississippi bubble. And we saw volatility in the dot-com
companies when the internet was brand new. Finding a level is
very difficult.
Fortunately, we are now beginning to see institutional
investment coming online with respect to Bitcoin and eventually
other cryptocurrencies as well. We have got CFTC-regulated
Bitcoin derivatives markets, and that means that we will have,
I think, better sell side research from the institutional
investment class, and there will be the possibility for people
to take short positions and rationalize the market.
Now, key to this effort is more institutional grade
products that are regulated by the proper authorities. So we
have CFTC-related derivatives. We could use ETFs regulated by
the SEC where there is institutional-grade custody and where
there are known accounting standards and where purchasers know
where they stand.
We could also use better custodians in general. Comptroller
Otting at the Office of the Comptroller of the Currency has
revitalized the process of offering FinTech charters to new
companies offering new services that do not look like
traditional banks. A nationally chartered bank that custodies
cryptocurrency is something that I think would bring more
rationality to these markets.
Chairman Crapo. Thank you.
Dr. Roubini, would you comment on the same issue?
Mr. Roubini. Yes, cryptocurrencies are not scalable, are
centralized, they are not decentralized, and they are not
secure. Bitcoin is five transactions per second, and there is a
massive concentration of the mining among, about half of those
are the Chinese, Russian, and others' miners. So you say you do
not rely on trends at institutions. You are relying on an
oligopoly of individuals that are shady in countries that you
have no control.
There are solutions that claim that in the future are going
to be scalable, but the only way they achieve scalability, like
proof of stake, is going to lead to even more cartelization of
mining. Once you have cartelization of mining, there is no
security. If I lose my credit card or somebody steals my bank
account, I call and it is blocked. I have deposit insurance. I
have lender of last resort
support of the financial system. Yes, I pay a fee. If somebody
is hacking your crypto wealth, it is gone forever, no deposit
insurance, no lender of last resort, no solution on the
immutable hacking of your wealth. There is no security in this
space, there is no scalability in this space, and there is
massive centralization that is very risky, and it is not going
to change.
Chairman Crapo. Well, thank you. I only have about a minute
left, so as a follow-up, many of the projects or use cases for
decentralized computing, as Mr. Van Valkenburgh's testimony
refers to it, are still in the conceptual phase or are not
being widely adopted as of yet. Are there particular factors
hindering implementation or adoption of blockchain or
decentralized computing solutions? And what are the most
meaningful steps that market participants or regulators can
take to create certainty or promote a safe path forward? I
would like you each to take about 30 seconds to answer me,
please.
Mr. Van Valkenburgh. So decentralized computing-use cases
are hard challenges. As I said, email was invented in 1972, and
it took 20 years for those systems to be friendly enough for
consumers to want to use them to send messages. We have got
choke points that are vulnerable on the internet today that
could be made better with blockchains. For one, the DNS system,
which was the hack that brought the websites and made them
unavailable, the New York Times and----
Chairman Crapo. I will have to stop you there and go to Dr.
Roubini.
Mr. Roubini. Well, there is no government or corporation or
bank that is going to use a public, decentralized, permission-
less system. It will be very risky to let millions of computers
somewhere in China verify your transaction. Therefore, all
enterprise DLT is private, is permission, is based on trust. So
the idea of decentralization is never going to fly. Ask any
corporation or any bank. No one of them is going to go to a
decentralized system. It is nonsense.
Chairman Crapo. Thank you.
Senator Brown.
Senator Brown. Thank you, Mr. Chairman.
Dr. Roubini, let us assume blockchain technology and some
cryptocurrencies overcome the issues that you raise in your
testimonies. Are there applications that could be beneficial on
a broad scale to address problems in the financial sector?
Mr. Roubini. Well, I do believe that there is some
innovation. As I pointed out, if you are talking about
enterprise DLT or corporate blockchains, the systems that are
private, they are permissioned, they are not distributed, they
have trusted authority to authorize transactions, and in my
view these are just glorified databases. They are being called
``blockchain,'' but they are not, and we can improve the
efficiency of source of a transaction, financial and corporate,
by having an integration of databases to reduce the transaction
cost. But I do not think that we are going to go to a solution
that is based on a public, permission-less, and trustless
system. Nobody is going to accept it, no government, no
corporation, or no bank.
So there is lots of work we can do of improving, and as I
pointed out, the revolution in FinTech that is going to lead to
banking services to the poor and unbanked is a revolution, is a
revolutionizing payment system, credit allocation, insurance,
asset management, capital transactions. It has nothing to do
with blockchain. You have AliPay and WeChat Pay in China. We
have Venmo, Square, PayPal in the United States. We have UPI
systems in India. We have M-Pesa used by poor farmers in Kenya
and all over Africa. Billions of transactions done by billions
of people every day. That is the FinTech revolution.
What is the penetration of blockchain after a decade?
Twenty-two million users and half of them are not using it.
After a decade of the internet, with 1 billion users, the
penetration of blockchain and crypto is collapsing. You have
falling users, collapse of 80 percent of transactions, and
transaction costs as a share of transaction have gone through
the roof. It is the opposite of any successful technology in
the financial sector or the internet. It is just the opposite.
Senator Brown. Thank you.
Mr. Van Valkenburgh, it is one thing for tech billionaires
or the Winklevoss twins to be investing in a complex and poorly
regulated market, but I am concerned about families who risk
their savings. What is the profile of the average person who is
investing in this market, whether it is Bitcoin or buying into
ICOs and other unestablished technologies?
Mr. Van Valkenburgh. So the profile of your average
investor is technologically sophisticated because you have to
deal with things like private and public keys or at least
understand how the company that you are working with is
securing them if it is coin base or some other exchange. And it
is usually younger people who are interested in these new
alternatives, perhaps because they feel like the legacy
financial system has in some ways disappointed them, and they
are looking for alternatives, I think in good faith.
Now, that said, are they safe? Are they being protected?
Are there good regulations in place? Exchanges in the United
States are regulated by the Federal Government for anti-money-
laundering purposes, so FinCEN was one of the first out of the
gate. America led here, and the rest of the world needs to
catch up. FinCEN said exchanges are money services businesses,
we need KYC, we need suspicion activity reporting.
From a consumer protection standpoint, though, they are
regulated by the States. You have to get a money transmission
license in every State where you have customers, assuming the
State regulator for money transmission licensing has opined on
the question of whether cryptocurrency exchanges fit their
definition of money transmission or do not.
That regime is not entirely rational. These are natively
global payments networks, and you are going State by State to
get licenses from the proper authorities. And you are going to
have 53 or so criminal background checks. The next one is not
going to make you more or less secure for your customers.
Also, money transmission licensing regimes, they look for
custody risk, which is important to safeguard against. But they
do not deal in other investor protection concerns like
manipulation and
transparency in markets. I think it is about time that we had a
serious policy conversation in this country about whether that
State-by-State approach is reasonable and whether it is the
best way to protect consumers. Federal preemption and an
alternative Federal license for these companies, perhaps one
that also polices from market manipulation and supervises for
that, would be, I think, a wise choice that would make America
a leader and protect our consumers.
Senator Brown. Thank you.
Chairman Crapo. Senator Kennedy.
Senator Kennedy. Thank you, Mr. Chairman. Thank you,
gentlemen.
Professor--well, let me reverse this. Mr. Van Valkenburgh,
how long has cryptocurrency and blockchain technology been in
existence?
Mr. Van Valkenburgh. That is an excellent question. So
cryptocurrency and public blockchain networks have been around
since 2008, 2009, when Satoshi Nakamoto invented them. But the
blockchain that Mr. Roubini has described, the permissioned
one, that has been around since the 1980s. It is actually older
than I am. It is not a particularly innovative technology. It
is just an Excel spread sheet. I think we actually in most
cases agree on that point.
Senator Kennedy. Let me interrupt you. Let us say 10 years.
How is our world better off as a result of blockchain
technology and cryptocurrency? Briefly.
Mr. Van Valkenburgh. So right now it is mostly anecdotal,
quite frankly, because these things are not used widely, just
as email was not used widely in the 1970s and 1980s until the
1990s. We have got a long runway. But, briefly, I have one
example.
So the World Bank has found that in developing economies
women are 20 percent likely to have a financial account at a
bank, and accounts under their names are often controlled by
their male relatives. There is a woman in Afghanistan, Roya
Mahboob, who was a leading tech entrepreneur and wanted to pay
her employees, most of whom were female coders. In order to get
around this issue where she was unable to pay her female
employees or their husbands were actually confiscating their
money, she paid them using Bitcoin.
Senator Kennedy. OK. I see your point.
Professor, how do you think, if at all, the world is better
off as a result of us separating into cryptocurrency and in
blockchain technology?
Mr. Roubini. I do not think the world is better off. There
is a significant need for improving financial services, and as
I pointed out, there is a revolution in financial services
called ``FinTech'' based on AI and big data and so on, and it
is used legally by billions of people, especially digital
payment systems that are already available right now. They are
low cost, they are efficient. They are used literally by
billions of people all over the world, including billions of
people even in Africa. That is really revolutionizing. If you
are a poor farmer in Kenya, use M-Pesa. You can make a payment
system. You can buy and sell your goods. You can get micro
credit. You can do everything at very, very low cost, and these
technologies are spreading everywhere. If you go to crypto,
five transactions per second. You cannot do anything. You
cannot be scaled.
Senator Kennedy. That is what I want to ask you about. Let
us set aside the Initial Coin Offerings and Bitcoin and all
that. Let us talk about blockchain technology. You do not see
any potential there?
Mr. Roubini. As I said, the only applications that are
going to be acceptable by any private or public institutions
cannot be based on a decentralized, permission-less, trustless
system. Today there is no decentralization. The mining is
controlled by a bunch of people in China, Belarus, Georgia, and
Russia. And this is not a system that you want. There is a
whole paper by a scholar at Princeton University showing there
is a threat coming from China to Bitcoin because 75 percent of
all mining of bitcoin is in China, and they are going to start
to use it to manipulate at their own will. Therefore, do we
want to rely on a private system? Yes. Do we want to rely on
trusted permissions? Yes. Do we want to rely on a system that
is kept private and safe? Yes. But it has nothing to do with
blockchain. Blockchain means that you are relying on a
cryptographic game where hundreds of thousands of computers
verify transactions. There is no institution that is going to
ever do that. So the solutions are back to basics.
Senator Kennedy. Let me let Mr. Van Valkenburgh answer
that, too.
Mr. Van Valkenburgh. So Mr. Roubini has brought up FinTech.
He has brought up WePay and AliPay, which are innovations in
China that are bringing lots of people into the financial
system. It is important to point out that those are extremely
large databases, and every Chinese citizen ends up with their
full transaction history unencrypted in those databases, and
the Chinese government, quite openly, has said that they can
look at every financial record of every citizen in their
country because of that FinTech innovation. That is a single
point of failure in multiple regards. Those databases get
hacked. Then those transactions are public to the world. But it
is also a single point of failure in the fact that it is
effectively government control and total surveillance over the
population and every financial interaction they make in the
world. It is a tool for totalitarians.
Senator Kennedy. Thank you, gentlemen. Very interesting.
Senator Brown. [Presiding.] Senator Jones.
Senator Jones. Thank you, Senator Brown. Thank you both for
being here today. This is just an area that I am still learning
a lot, and I want to move a little bit away from the financial
markets per se, as I think most people--I am an old prosecutor,
and I am concerned as much as anything with regard to the law
enforcement aspect of this.
One thing that I learned as a prosecutor and as a lawyer is
it seems like the bad guys are always two, three, or a dozen
steps ahead of emerging technologies. I have learned as a
Senator in looking at nations like Russia and China and North
Korea that they also seem to be way ahead of the game when it
comes to cybersecurity and those issues.
So my question is just really generic for both of you, and
I will start with you, Mr. Van Valkenburgh. Talk to me a little
bit about the dangers of cryptocurrency as it pertains to law
enforcement, money laundering, human trafficking, drugs, the
whole 9 yards in which emerging technologies can be exploited
by the bad guys to really wreak havoc in our systems. Let us
talk about that a little bit, and if you could address briefly,
you know, what we can do in this early stage to try to prevent
that. And then I will go to you, Mr. Roubini. I would like to
just focus on those two as my questions.
Mr. Van Valkenburgh. Thank you, Senator Jones. You are
absolutely right. Criminals are usually the earliest adopters
of new technologies. In fact, I think if criminals are not
using your technology, your technology is not worth anything.
Senator Jones. Good point.
Mr. Van Valkenburgh. So, you know, stock car racing and
souped-up cars, ultimately NASCAR, was a phenomenon that was
born out of bootleggers outrunning the cops during Prohibition.
Technological innovation and ultimately something not so bad,
but moments of disruption and things we need to worry about.
Now, with Bitcoin I think it is actually a positive story,
especially here in the United States. As I said, FinCEN, our
financial surveillance regulator, was fast out of the gate
globally, first out of the gate to say that cryptocurrency
exchanges need to know their customers and need to do
suspicious activity reporting. So when you are getting onto the
Bitcoin network by buying bitcoins in an exchange, your name is
going to be taken down if you are buying at a U.S. exchange.
Now, what about transactions within the Bitcoin network
that are not in an exchange? Well, they are public, on the
public ledger that I have been talking about, and we have
phenomenal law enforcement in this country that I have had the
pleasure of meeting who have become extremely adept at
analyzing that big data and finding and de-anonymizing or
identifying a Bitcoin address as belonging to somebody involved
in moving the proceeds of crime. I have even talked to folks
who have said that they now prefer working cases where the
illicit funds are moving through the Bitcoin network rather
than calling up five or six international correspondent banks
that do not keep good records or have shell accounts. There is
one record to query, and it is perfect. If it was not, it would
not work.
Senator Jones. All right. Mr. Roubini?
Mr. Roubini. Senator, you are absolutely right.
Cryptocurrencies and blockchain have been used by criminals, by
terrorists, by human traffickers, by tax evaders, just to
engage in a variety of criminal activities. It is correct that,
in principle, law enforcement authorities can go after this
stuff. You know, the Silk Road was using Bitcoin for lots of
transactions. They cracked it, and then they got arrested and
prosecuted. But, of course, a system that in principle is
supposed to be anonymous--and not just anonymous at the
domestic level but globally--implies significant risk to
enforcement.
Steve Mnuchin, Secretary of the Treasury, said we cannot
allow Bitcoin and cryptocurrencies to become the next Swiss
bank
account. We have spent the last 20 years at the G-20 level to
try to crack down on offshore financial centers, and now you
have a tool that would allow anybody not to declare their
income, not to declare their wealth, not to declare their
capital gains. It is not going to be acceptable. Are we going
to really go and find a system so that everybody is registered
and everybody has to declare their income, their wealth, their
capital gains, and their taxes? We are very far away from it,
let alone other types of criminal activity.
Senator Jones. Did you want to respond real quick?
Mr. Van Valkenburgh. I did want to touch on one point.
Senator Jones. Still quick, because I have 30 seconds.
Mr. Van Valkenburgh. Steve Mnuchin's point was that the
United States has pioneered the policy here, that we have
classified exchanges as money services businesses and we
require information from them. He was saying we do not want the
rest of the world to not follow suit. His reference to Swiss
banks was basically to say, ``Hey, Switzerland, you should
follow our lead.''
Senator Jones. All right. Well, thank you both. And, you
know, just for reference, Mr. Van Valkenburgh, I am headed to
the NASCAR race in Talladega this weekend. I will make sure
they are not running moonshine around the track.
[Laughter.]
Mr. Van Valkenburgh. Not too much moonshine, Senator.
Senator Jones. Thank you.
Senator Brown. Senator Toomey.
Senator Toomey. Thank you, Senator Brown. Thanks to both of
you for being here. This is a very helpful discussion.
It seems to me ICOs have featured some incredible scams.
There are some that are very obvious. The volatility of Bitcoin
has been breathtaking.
On the other hand, central banks over time have not had the
greatest record of preserving the value of the meeting exchange
that they are responsible for. We have discussed the friction
in the payment systems that we have now, and I think FinTech is
offering fabulous new ways to minimize that friction. But there
will always be some friction, and even if they become extremely
efficient, which they are, the payment system will still be in
a fiat currency everywhere.
Dr. Roubini, you point out that bitcoin, for instance, is
not really a unit of account, it is not a medium of exchange,
and it is not a store of value. And I think that is true, but
it did strike me that those are all issues of scale. Anything
can be a currency if it is acceptable to enough people. It then
takes on those characteristics.
What I think I hear you saying is that it is simply
intrinsic to the nature of the underlying technology that it is
fundamentally not scalable, that it cannot become widely enough
used to achieve those characteristics that we normally use to
define a currency. And that is what I am trying to understand.
Why is it intrinsically--unless you disagree and that there is
a different reason, but I thought I understood you to be
suggesting that it just intrinsically cannot be scaled. Is that
right?
Mr. Roubini. Yes. Some of it is quite technical, but
Vitalik Buterin who invented the theorem called ``impossibility
trinity'' that says in blockchain you cannot have at the same
time scalability, decentralization, and security. So proof of
work that is the one that Bitcoin is based is not scalable,
only five transactions per second. You could say it is
decentralized in principle, but it is not decentralized because
80 percent of the mining is done by six oligopolies. And once a
situation of this sort is centralized, it is not secure.
Now, there are dozens of other consensus mechanisms that
people are working in order to make it scalable.
Senator Toomey. OK, let me just--I just want to explore a
couple of these things a little bit more, and let me give Mr.
Van Valkenburgh a chance to respond.
First of all, is Bitcoin forever limited to five
transactions per second, or is there any way to expand that
scale? And, second, does an oligopoly on mining really matter?
My understanding is there is ultimately a finite number of
bitcoins that can be mined. And does it matter who mines them?
Mr. Van Valkenburgh. Thank you, Senator Toomey.
First of all, five transactions per second, we can do a lot
more. There are multiple layers being built on top of Bitcoin
today that do effectively things like batch settlement. So in
just one or two transactions to the blockchain, you could have
thousands of transactions.
Now, that sounds like we are reinventing the correspondent
banking system and adding more centralized trust into it. It is
not quite that. That is because the batch settlement can be
done by a robot. Bitcoin is digitally native, so you can have
smart contracts that manipulate and batch transactions
together.
We have an M&M machine in our office. You would normally
press a button and an M&M would come out. We have rigged it to
work with lightning network payments, which are these second-
level solutions, such that you can pay per the M&M with a fee
that is about 0.002 cents, an incredibly negligible fee. If we
can run transactions like that in a test net or in early days
of a new layer, we can do all kinds of transactions per second.
On the question of Vitalik Buterin's trilemma, it is not an
impossibility theorem. It is a trilemma. It is true. It is hard
to have scale and decentralization and integrity of the data.
Vitalik himself said it is not impossible. It is just a problem
worth striving for. It is the kind of thing that American
innovators and entrepreneurs should be working on.
Senator Toomey. Very quickly, does it matter that there is
an oligopoly on the mining?
Mr. Van Valkenburgh. That is an excellent question. So it
is worth asking, once you have a lot of mining power, what harm
can you do? The Bitcoin protocol is decentralized not because
it distributes power but because it checks power. What can a
powerful person do to a weak person in the system? Bitcoin pits
ambition against ambition, like our Federalist system here in
the United States. And what I would say is you cannot do much.
You cannot change the number of bitcoins in circulation. You
would not be able to make that block and have it accepted by
the network. You cannot reallocate or move other people's funds
on the blockchain. The worst you can do is during the time when
you have leveraged massive and costly resources, you can slow
down the network and block transactions. It is a denial-of-
service attack, something that all internet systems are
vulnerable to, even the FinTech that Dr. Roubini talks about.
Senator Toomey. Thank you very much.
Senator Brown. Senator Warren.
Senator Warren. Thank you, Mr. Chair.
So virtual currencies are an interesting innovation that at
least theoretically could provide benefits to consumers. But
they also at the same time could empower scammers and
criminals, and the challenge here, I think, is for us to try to
figure out how to nurture the productive uses of virtual
currencies while protecting consumers from scammers and other
sorts of threats.
Now, one argument I often hear is that cryptocurrencies are
decentralized, that anyone can mine new currency, unlike our
current system, which relies on a central bank to perform that
function.
Dr. Roubini, I know you are a skeptic of that claim. Could
you just say a word about why?
Mr. Roubini. First of all, I am in favor of digital payment
systems, but we can have digital payment systems without having
cryptocurrencies. And as I pointed out, in the United States,
in China, in India, in Africa, in Europe, there are tons of
digital payment systems that do billions of transactions every
day, they are used by billions of people, at low cost. So it is
not the question of being in favor of only cash or a digital
payment system. The FinTech allows you to do that. In the
case----
Senator Warren. No, I understand that. The question I am
asking about is about decentralization, the claim that
cryptocurrencies have the benefit because they are
decentralized, and I said you are skeptic of that.
Mr. Roubini. It is false. The miners are all centralized,
and it is a problem because, one, you can have 51 percent
attacks, and those kind of attacks have occurred every day on
smaller cryptocurrencies. So you can steal the money, and it is
gone forever, those of such attacks. And people say, well, if
you do it on Bitcoin, you are destroying Bitcoin. But if you
have an oligopoly, what does an oligopoly do? They increase the
prices, increase their margins of profit. If you look at the
transaction costs in the space, they have gone through the roof
as miners get their share of transaction. In the last year,
they have gone up by 200 percent because they are using that
oligopoly power to impose higher fees. It is an oligopoly. That
is why it is inefficient.
Senator Warren. So let me ask you the question then about
the consequence of this concentration that you see. Is that
inherent in the cryptocurrency or is it something that
Government could do something about?
Mr. Roubini. It is inherent because there are economies of
scale in mining, and these economies of scale that are in proof
of work become worse once we get to scalable systems like proof
of stake where whoever has a greater stake to begin with can do
more of the mining. So there is massive concentration already
in proof of work. People say that is not scalable, we are going
to move to proof of stake. The proof of stake is going to
become an even more concentrated cartel by definition of the
system. You need massive
mining factories all over China or Iceland to do the scale of
transaction. You cannot do it on a laptop. That is why you lead
to concentration in oligopolies.
Senator Warren. OK. So you are saying it is inherent here.
You know, these new technologies create these new
opportunities, but if we are not careful, they can follow the
same old patterns of they make the rich richer and they leave
everybody else behind.
I want to ask about another one, and we will see if we can
get these together because I want to ask Mr. Van Valkenburgh,
according to reports, more than $1.1 billion of cryptocurrency
was stolen in the first half of 2018. Why is cryptocurrency so
easy to steal? And what should we be thinking about to secure
it?
Mr. Van Valkenburgh. So those thefts were primarily with
regard to newer cryptocurrencies who had experienced massive
price increases and were being secured by exchanges or
businesses, usually overseas, who did not scale their security
in line with the value that was rising. That was a speculative
bubble. I would not disagree with Dr. Roubini at all on that
account. That was irrational, and it was triggered by this ICO
market, which is largely fraud or unregistered securities
issuance, which is, of course, not permitted.
So Bitcoin was not involved in the majority of the amounts
that you are talking about there. It was these smaller
currencies.
Senator Warren. You know, I worry, though, because a lot of
small investors get into the virtual currency market through
Initial Coin Offerings, or ICOs, which allow companies to raise
money by creating and selling these new virtual currencies. And
you have just described a huge bubble around one of these.
In 2017, companies raised more than $6 billion using ICOs,
a record that has been broken by April of this year. So let me
ask you, Mr. Van Valkenburgh, a study came out earlier this
year that said that 80 percent of ICOs in 2017 were scams. SEC
Chairman Jay Clayton has suggested the right approach to
uncovering the scams and protecting investors is to regulate
ICOs as security offerings, and I just want to ask if you agree
with that approach. I know we are over time, but if I could
just permit the witness to answer.
Mr. Van Valkenburgh. I do agree with that approach. As I
said, the majority of ICOs have either been unregistered
securities issuance or scams, as Chairman Clayton has said. The
SEC has made very careful and deliberate policy here. I think
they have done an excellent job. They released a report helping
people understand these things. They created a website helping
them understand them in a visual, physical way. And they have
brought targeted enforcement actions that I think have started
to chill these markets and make them more rational.
That said, I think you can do a token sale and comply with
securities laws, as you should, and we are seeing the emergence
of companies doing that, selling only to accredited investors,
or--and I think this will happen in the near future--even doing
public registration and offering tokens to shareholders.
Senator Warren. But what I hear you saying at its core is
that an unregulated market puts consumers at risk, and what is
critical is to get the right regulations in place.
Mr. Van Valkenburgh. Often our current regulations.
Securities laws worked well for the last 100 years, or almost,
and I think they will continue to.
Senator Warren. All right. Thank you.
Senator Brown. Senator Van Hollen.
Senator Van Hollen. Thank you. Thank you both for being
here.
Dr. Roubini, you mentioned your support for digital payment
systems innovation, and FinTech clearly has reduced
inefficiencies in the payment system. It has not yet succeeded
in getting the Fed, though, to move to a real-time payment
system, something I have been pushing hard for, because the
current system where it takes time still to clear checks has
really been hurting a lot of lower-income people who are living
paycheck to paycheck. I was pleased to see the Fed recently
announce that it is going to try and accelerate this effort.
Do you have an opinion on using innovation to get to real-
time payment system as the Fed is moving toward, I hope?
Mr. Roubini. Yes, I am all in favor of it, and technology
can be used to achieve that particular result. In principle,
you know, the banks have access to the balance sheet of the
Fed, but you could have a system where every corporation or
individual has access to that balance sheet. You do not need to
have a blockchain for that. You have it on one ledger. It is
secured by the Fed. And if you do that, however, you have
consequences, because right now the deposits in the banking
system are essentially forms of money that are sent to the
payment system. If you go to a central bank in digital currency
and you have everybody accessing that one, then there will be
massive disintermediation of private deposits, and then the
banks have to fund themselves in a different way.
So there is talk about going in that direction, of opening
up the balance sheet of the central bank to everybody, but it
has important consequences for the financial system.
The point, however, is that you can do all these things,
but you don't need blockchain. Or if you want a system----
Senator Van Hollen. I am not disagreeing----
Mr. Roubini.----it is not going to be a public one where a
bunch of miners in China are going to verify the transactions
of our financial system. That does not make any sense.
Senator Van Hollen. I am not disagreeing with you, Dr.
Roubini. I have just been pushing--I have been disappointed the
Fed has not moved more quickly to implement a real-time payment
system, and I think that fact is a drag on a lot of consumers.
While I have got you here, though, I do want to ask you a
question of where you see the economy going, because you are
one of the people who predicted the 2008 financial crash. You
not only predicted it, but you predicted the mechanics and the
economic and financial forces behind it. And you have written
about your concern about the economy around 2020, a concern I
share, and I just want to note your article of September 11th,
``Is the next financial crisis already brewing?'' where you
talk about the fact that the stimulus, which was the sort of
tax cuts, which added $1.8 trillion to our debt, was ill-timed,
that it will create a drag on the economy in a number of years,
and that you foresee difficult economic times ahead.
Given that you predicted the 2008 financial crash, I
thought I would take the time to get your opinion on where we
are headed right now.
Mr. Roubini. Well, in brief, I would say this year growth
is going to be because of the stimulus close to 3 percent. It
is going to be less than 3 percent next year. My concerns are
about 2020, one, because we will have a fiscal cliff; second,
because the Fed, rightly, with an overheating economy has to
gradually increase interest rates. Short rates are going to go
higher, long rates are going to go higher. The dollar is going
to strengthen. Credit spreads are going to widen. That
tightening of financial condition is going to slow economic
growth.
I worried about protectionism and trade wars slowing down
economic growth, and I also worried about other stagflationary
policies like restricting migration, restricting capital
inflows and outflows and FDI, restricting investment in the
environment and not having an infrastructure plan, reducing
growth and increasing inflation.
We also know that asset prices are faulty, and if there is
a shock to growth, there could be a significant correction. So
those combination of factors may lead to a stall of economic
growth by 2020.
Senator Van Hollen. Well, you summarized it very well, and
my question to you, if you could just take a moment and talk
about something many of us have said is likely to happen, which
is when you have an economy that was already on a rapidly
rising trajectory, and you add to that a huge amount of debt,
how that creates a fiscal drag and crowds out private
investment down the road and actually slows down the economy
after the overheating period is over. Can you just talk about
that for a second?
Mr. Roubini. Yeah, briefly. It is the first time we have a
$2 trillion fiscal stimulus in peacetime without a recession.
That leads to higher short-term and long-term interest rates.
It leads to overheating and forces the Fed to hike more, soon,
and faster. It leads to a stronger dollar. And it also leads to
a larger current account and trade deficit. If the savings of
the Government reduce, our trade deficit is 2 percent of GDP,
it is going to go toward 3 percent and, therefore, the
protectionist pressure may increase over time. So it is an ill-
advised fiscal stimulus.
Senator Van Hollen. Thank you. I appreciate it.
Chairman Crapo. Senator Cortez Masto.
Senator Cortez Masto. Thank you. Thank you, gentlemen, for
being here.
I would like to go back to Senator Jones' conversation with
you when it comes to identifying sex trafficking, drug
trafficking, money laundering, and I just want some
clarification. Mr. Van Valkenburgh, does Bitcoin or any similar
platform have a protocol in place to detect when its
cryptocurrency is being used by individuals to facilitate sex
trafficking, drug trafficking, or money laundering? Is there a
protocol in place?
Mr. Van Valkenburgh. So Bitcoin is a peer-to-peer network
of persons running software around the world, and that software
is developed itself by people around the world. It is a
voluntary system, if you will, so there is no corporate form to
set and guarantee policies across all users.
That said, there are several intermediaries who are
building their businesses on top of Bitcoin, just as you saw
several companies build their businesses on top of the shared
and open internet back in the 1990s. And those businesses,
especially those that are based and regulated here in the
United States, do have those policies for identifying and
policing illicit use of the network, and they do file
suspicious activity reports, and they do register with FinCEN,
which is our financial surveillance authority.
Senator Cortez Masto. So it is going to be incumbent upon
those businesses, basically what you are saying, working with
law enforcement to identify when this technology they are
utilizing is engaging in illicit activity?
Mr. Van Valkenburgh. That is right, Senator.
Senator Cortez Masto. Would you agree with that, Dr.
Roubini?
Mr. Roubini. Well, I do agree that in the United States
there are rules about KYC/AML that are being implemented. But
suppose you are involved in human trafficking and you are
setting up a Bitcoin account somewhere in a jurisdiction or
offshore financial center where these KYC/AML rules are not
being followed, and then you are doing those activities and
using these foreign accounts, and it is anonymous, it is very
hard to crack down on them, and, therefore, you are not under
the scope of U.S. legislation, and you have created an asset
class that allows this massive level of anonymity. So unless
you have a global agreement first at the G-20, but then covers
the rest of the world that makes sure that those rules are
applied by everybody else, you have created a massive loophole
that allows terrorists, traffickers, tax evaders, or criminals
to do it more easily than in the past. That is a major risk.
Senator Cortez Masto. Thank you, Dr. Roubini.
Yes, please?
Mr. Van Valkenburgh. First of all, I would just be
interested in how you can use something that is not money to
evade taxes, but that is a separate issue. I will say that with
respect to international exchanges, I absolutely agree that we
should have a unified global approach to ensure that there is
KYC. But I will disagree that if you are just transacting on
the blockchain, even using the account that you originally
created in an overseas authority that did not collect
information, that it is, as Dr. Roubini says, anonymous, it is
not anonymous at all. And I have spoken with several law
enforcement officials and investigators who, as I said, enjoy
doing their blockchain investigations because they can track
every transaction with perfect fidelity on the block chain,
very different than the international correspondent banking
system where you have shell accounts and bad records and
records all over at different institutions.
A good example of this is BTC-e, which was an exchange
based somewhere in Eastern Europe that was being used to
launder money. FinCEN, in combination with the DOJ, brought an
investigation. They looked at the blockchain. They found
transactions all from that exchange heading to a wallet, all
the fee transactions. They said, OK, this was the person
running this illicit enterprise, and they ultimately were able
to identify him based on that
information, and they arrested him when he was, I think, on
holiday in Greece. His name is Alexander Vinnik.
Senator Cortez Masto. I appreciate that. And the reason why
I asked the question, because I think it is important as we go
down this path and we are looking at the use of this new
technology that we continue to study it. That is why Senator
Toomey and I introduced the Fight Illicit Networks and Detect
Trafficking Act. The bill would require the GAO to study how
virtual currencies like Bitcoin and other online marketplaces
use, buy, sell, facilitate the financing of goods and how it is
affiliated, if any, with illicit activity.
So let me move on because I am running out of time. I am
curious, Dr. Roubini, I also sit on Energy and Natural
Resources. We have had this conversation about the use of
blockchain technology in the energy sector and how it is going
to be a game changer for the energy sector. Have you studied
the use of this blockchain technology in any other sectors
other than the financial sector? Have you looked at it and its
use in the energy sector at all?
Mr. Roubini. Well, I have not looked at it in the energy
sector, but, of course, people talk about using it in the case
of commodities. My point is that even if you use what is called
``blockchain technologies'' to do transactions, say, in energy
and commodities, you are never going to use a public,
trustless, permission-less, peer-to-peer distributed system. It
does not make any sense. So if you are using it private,
permission with trusted authorities, that is not a blockchain.
It is a system where you have trusted authority with verified
transactions that say these sets of transactions are OK. So
there are sophisticated versions of databases, but they are not
blockchain. They are not based on cryptographic consent
mechanisms that let a bunch of people in China or Russia
authenticate your transactions. No commodity exchange, no
commodity business is going to let that happen. It is going to
be private and permissioned. So it is not a blockchain. I think
it is a misnomer calling these things ``blockchains.''
Senator Cortez Masto. Thank you.
Chairman Crapo. [Presiding.] Thank you. And that does
conclude our questioning. I apologize to the witnesses. I had
to step out. I am also a member of a couple other committees,
and one of them was having a markup that I had to vote at. So I
apologize that I was absent for part of your answers.
For Senators wishing to submit questions for the record,
those questions are due in 1 week, on Thursday, October 18. And
to our witnesses, we ask that you respond to those questions as
quickly as you can. And, again, thank you for being here today.
Obviously, there is a significant difference of opinions on
these issues, but I do not think there is any disagreement that
these are critical issues that we need to face and deal with.
With that, thank you for being here today, and the hearing
is adjourned.
[Whereupon, at 11:03 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO
Today, the Committee will continue its exploration of the
opportunities and challenges surrounding the cryptocurrency and
blockchain ecosystem.
Prior to the introduction of Bitcoin and underlying blockchain
ledger in 2009, there was no similar solution to the double-spend
problem--where the same digital currency could be spent more than
once--which did not require a third-party intermediary.
While Bitcoin, the first decentralized cryptocurrency, has been
around for nearly a decade now, cryptocurrencies have gained particular
attention in the past 2 years, due in part to their meteoric rise and
subsequent fall in value last year.
Advancements since Bitcoin's creation have expanded blockchain's
uses and given way to things like ``Initial Coin Offerings,'' a method
of crowdfunding that has become popular in the cryptocurrency
community.
While the technologies underpinning cryptocurrencies have the
ability to transform the composition of, and ability to access, capital
and the financial system, much of the recent news about
cryptocurrencies has been negative, focusing on enforcement actions,
hacks on international exchanges, and concerns raised by various
regulators and market participants.
To that end, in February of this year, the Committee held a hearing
with the SEC and CFTC to examine their oversight roles of
cryptocurrency-related products and activities under their respective
jurisdictions.
Since that hearing, the agencies have made strides to provide
further clarification on their thinking surrounding cryptocurrency-
related issues.
But, some regulatory and oversight questions still remain.
The regulatory questions, price volatility and reports of things
like pump-and-dump schemes have raised a lot of questions surrounding
the cryptocurrency and blockchain ecosystem that need to be better
understood.
Blockchain networks have the potential to improve processes for
things like smart contracts, payments and settlement, identity
management and even things yet undiscovered.
In order to move forward in a productive way and give these
innovations the room to flourish and develop in a safe and sound way,
we need to sort through the static and better understand what exactly
are the opportunities and challenges facing this ecosystem.
For example, the Committee would benefit to hear about: the use of
cryptocurrencies and derivative products as a store of value or medium
of exchange or payment; the current and potential applications of
blockchain technology; and the regulatory issues surrounding the
various facets of the ecosystem and how they can be improved.
______
PREPARED STATEMENT OF SENATOR SHERROD BROWN
Thank you, Chairman Crapo, for holding this hearing. And thank you
to Mr. Van Valkenburgh and Dr. Roubini for your testimony.
Today's hearing happens to fall just shy of the tenth anniversary
of Bitcoin and the blockchain being introduced to the world--October
31, 2008. Back then we were in the midst of a global financial crisis,
and you can't blame some Americans for hoping that an alternative
banking system could be created that would be superior to the one in
shambles at that time.
Bitcoin, and other cryptocurrencies like it, promised to make
payments faster, easier and cheaper, and to eliminate our reliance on
risky financial institutions whose failures harmed workers and families
during the crisis.
Unfortunately, the last 10 years have shown that misconduct,
fraudulent investment schemes, and cybersecurity threats aren't unique
to the traditional financial system. When a cryptocurrency goes bust or
a poorly supervised exchange fails, it's often hardworking Americans
left holding the bag.
We want to see innovations in the financial system, innovations
that help Americans keep more of their money by avoiding fees or that
make it easier to borrow for a small business startup.
But so far, despite all the energy and investment dedicated to
finding a use for the blockchain, there are few real-world applications
and an alarming number of scams.
Cryptocurrency prices have swung wildly over the last year.
Inexperienced investors who were hoping to get in on the next big
financial innovation have seen the value of these investments fall by
more than 75 percent from their peak.
Though they have raised billions of dollars from investors, few if
any Initial Coin Offerings have registered with the SEC. Chair Clayton
told this Committee in a February hearing, ``Every ICO I've seen is a
security.''
And last month, the New York Attorney General released a report on
several cryptocurrency trading platforms that pointed to evidence of
widespread manipulation and identified several exchanges that don't
follow ``anti-money laundering'' or ``know your customer''
requirements.
With a decade of experience, much of the irrational exuberance
around cryptocurrencies and blockchain technology has subsided, and we
have an opportunity to set more realistic expectations for how these
innovations might be used to promote a fairer and more competitive
economy.
I hope this technology will prove useful, particularly in helping
people who are unbanked or underserved by the traditional financial
system. And I understand why individuals might be interested in it. But
at this point, it is easier to see the malign impacts on society as a
whole than the constructive ones.
I look forward to the witnesses' testimony.
______
PREPARED STATEMENT OF NOURIEL ROUBINI, Ph.D.
Professor of Economics, Stern School of Business, New York University
October 11, 2018
Chairman Crapo, Ranking Member Brown and Members of the Committee,
thank you for the opportunity to testify today on the topic of the
Cryptocurrency and Blockchain Ecosystem.
My name is Nouriel Roubini and I am a Professor of Economics at the
Stern School of Business at New York University. I am an expert of the
global economy, international financial markets, asset and credit
bubbles and their bust, and the related financial crises. I was one of
the few economists warning about and predicting in advance the Global
Financial Crisis of 2007-2009 and I am one of the leading global
scholars on the topic of bubbles and financial crises. My most recent
book ``Crisis Economics: A Crash Course in the Future of Finance'' is a
seminal treatise on the topic of asset bubbles and financial crises. I
have written dozens of papers and other contributions on the topic of
bubbles and their bust and the causes and consequences of financial
crises.
Crypto Bubble (2017) and Crypto Apocalypse and Bust (2018)
It is clear by now that Bitcoin and other cryptocurrencies
represent the mother of all bubbles, which explains why literally every
human being I met between Thanksgiving and Christmas of 2017 asked me
first if they should buy them. Especially folks with zero financial
literacy--individuals who could not tell the difference between stocks
and bonds--went into a literal manic frenzy of Bitcoin and Crypto
buying. Scammers, swindlers, criminals, charlatans, insider whales and
carnival barkers (all conflicted insiders) tapped into clueless retail
investors' FOMO (``fear of missing out''), and took them for a ride
selling them and dumping on them scammy crappy assets at the peak that
then went into a bust and crash--in a matter of months--like you have
not seen in any history of financial bubbles.
A chart of Bitcoin prices compared to other famous historical
bubbles and scams--like Tulip-mania, the Mississippi Bubble, the South
Sea Bubble--shows that the price increase of Bitcoin and other crypto
junk-coins was 2X or 3X bigger than previous bubbles and the ensuing
collapse and bust as fast and furious and deeper. Bitcoin rapidly
exploded in 2017 from $1k to $10k and then peaked almost at $20k in
December 2017 only to collapse to below $6k (down 70 percent from that
peak) in a matter of 4 months and it has been close to $6k since then.
And a 70 percent capital loss was a ``good'' deal compared to thousands
of alt-coins (otherwise better known as ``sh*tcoins'') that have lost
on average 95 percent of their value since the peak. Actually calling
this useless vaporware garbage a sh*tcoin is a grave insult to manure
that is a most useful, precious and productive good as a fertilizer in
agriculture.\1\
---------------------------------------------------------------------------
\1\ My apologies to the Members of the Senate Banking Committee for
using the scatological term ``sh*tcoin'' but the term is standard in
the crypto jargon and there are more than 500,000 references to it in a
Google search of this technical term. See: https://www.google.com/
search?q=shitcoin&oq=shitco&aqs=chrome.0.0j69i57j0l4.3571j0j8&sourceid=c
hrome&ie=UTF-8.
---------------------------------------------------------------------------
Now that the crypto bloodbath is in full view the new refuge of the
crypto scoundrels is ``blockchain,'' the technology underlying crypto
that is now alleged to be the cure of all global problems, including
poverty, famines and even diseases. But
as discussed in detail below blockchain is the most over-hyped--and
least useful--
technology in human history: in practice it is nothing better than a
glorified spreadsheet or database.
The entire cryptocurrency land has now gone into a crypto-
apocalypse as the mother and father of all bubbles has now gone bust.
Since the peak of the bubble late last year Bitcoin has fallen by about
70 percent in value (depending on the week). And that is generous.
Other leading cryptocurrencies such as Ether, EOS, Litecoin, XRP have
fallen by over 80 percent (or more depending on the week). While
thousands of other cryptocurrencies--literally scam-coins and scam-
tokens--have fallen in value between 90 percent and 99 percent. No
wonder as a recent study showed that 81 percent of all ICOs were scams
in the first place, 11 percent of them are dead or failing while only 8
percent of them are traded in exchanges. And out of this 8 percent the
top 10 coins traded--after Bitcoin--have lost between 83 percent and 95
percent of their value since peak with an average loss of over 90
percent. This is a true Crypt-Apocalypse. No wonder that a recent study
this week argued and conclude that the crypto industry is on the
``brink of an implosion.''\2\
---------------------------------------------------------------------------
\2\ https://www.newsbtc.com/2018/10/09/juniper-research-the-crypto-
industry-is-on-the-brink-of-an-implosion/.
---------------------------------------------------------------------------
No asset class in human history has ever experienced such a rapid
boom and total utter bust and implosion that includes thousands of
different crypto-assets.
Crypto is not money, not scalable
To be a currency, Bitcoin--or any cryptocurrencies--should be a
serviceable unit of account, means of payments, and a stable store of
value. It is none of those things. No one prices anything in Bitcoin.
Few retailers accept it. And it is a poor store of value, because its
price can fluctuate by 20-30 percent in a single day. And since its
price has been so unstable or volatile almost no merchant will ever use
it as a means of payment: the profit margin of any merchant can be
wiped out in a matter of minutes--if he or she accepts Bitcoin or any
other cryptocurrency--by the change in the dollar price of a
cryptocurrency. Proper means of payments need to have stable purchasing
power; otherwise no one will ever use them.
As is typical of a financial bubble, investors were buying
cryptocurrencies not to use in transactions, but because they expected
them to increase in value. Indeed, if someone actually wanted to use
Bitcoin, they would have a hard time doing so. It is so energy-
intensive (and thus environmentally toxic) to produce, and carries such
high transaction costs, that even Bitcoin conferences do not accept it
as a valid form of payment (https://slate.com/technology/2018/01/the-
most-important-block
chain-conference-of-the-year-wont-take-bitcoin-for-last-minute-
sales.html). Paying $55 dollars of transaction costs to buy a $2 coffee
cup is obviously never going to lead Bitcoin to become a transaction
currency.
Until now, Bitcoin's only real use has been to facilitate illegal
activities such as drug transactions, tax evasion, avoidance of capital
controls, or money laundering. Not surprisingly, G20 member states are
now working together to regulate cryptocurrencies and eliminate the
anonymity they supposedly afford, by requiring that all income- or
capital-gains-generating transactions be reported. Even the U.S.
Treasury Secretary Steve Mnuchin has publicly stated that we cannot
allow cryptocurrencies to become the next Swiss bank account.
Since the invention of money thousands of years ago, there has
never been a monetary system with hundreds of different currencies
operating alongside one another. The entire point of money is that it
allows parties to transact without having to barter. But for money to
have value, and to generate economies of scale, only so many currencies
can operate at the same time.
In the United States, the reason we do not use euros or yen in
addition to dollars is obvious: doing so would be pointless, and it
would make the economy far less efficient. The idea that hundreds of
cryptocurrencies could viably operate together not only contradicts the
very concept of money with a single numeraire that can be used for the
price discovery of the relative price of thousands of good; it is
utterly idiotic as the use of multiple numeraires is like the stone age
of barter before money was created.
Supply of crypto is massive. Bitcoin is deflationary
But so, too, is the idea that even a single cryptocurrency could
substitute for fiat money. Cryptocurrencies have no intrinsic value,
whereas fiat currencies certainly do, because they can be used to pay
taxes. Fiat currencies are legal tender and can be used and are used to
buy any good or service; and they can be used to pay for tax
liabilities. They are also protected from value debasement by central
banks committed to price stability; and if a fiat currency loses
credibility, as in some weak monetary systems with high inflation, it
will be swapped out for more stable foreign fiat currencies--like the
dollar or the euro--or real assets such as real estate, equities and
possibly gold. Fiat money also is not created out of thin air: these
liabilities of a central bank such as the Fed are backed by the Fed
assets: their holdings of short term and longer term Treasury
securities (that have near AAA sovereign credit status in the United
States) and holding of foreign reserves including gold and other stable
foreign currencies. The usual crypto critique of fiat currencies that
can be debased via inflation is nonsense: for the last 30 years
commitment to inflation targeting in advanced economies and most
emerging markets has led to price stability (the 2 percent inflation
target of most central banks) and for the last decade the biggest
problem of central banks has been that achieving the inflation target
of 2 percent after the GFC has become extremely difficult as, in spite
of unconventional monetary policies, the inflation rate has
systematically undershot its 2 percent target.
Instead 99.9 percent all cryptocurrencies instead have no backing
whatsoever of any sort and have no intrinsic value of any sort; and
even the so-called ``stable coins'' have only partial backing at best
with true U.S. dollars reserves or, like Tether, most likely no backing
at all as there has never been a proper audit of their accounts.
As it happens, Bitcoin's supposed advantage is also its Achilles's
heel, because even if it actually did have a steady-state supply of 21
million units, that would disqualify it as a viable currency. Unless
the supply of a currency tracks potential nominal GDP, prices will
undergo deflation.
That means if a steady-state supply of Bitcoin really did gradually
replace a fiat currency, the price index of all goods and services
would continuously fall. By extension, any nominal debt contract
denominated in Bitcoin would rise in real value over time, leading to
the kind of debt deflation that economist Irving Fisher believed
precipitated the Great Depression. At the same time, nominal wages in
Bitcoin would increase forever in real terms, regardless of
productivity growth, adding further to the likelihood of an economic
disaster.
Worse, cryptocurrencies in general are based on a false premise.
According to its promoters, Bitcoin has a steady-state supply of 21
million units, so it cannot be debased like fiat currencies. But that
claim is clearly fraudulent, considering that it has already forked off
into several branches and spin-offs: Bitcoin Cash and Bitcoin Gold.
Ditto for the various forks and spin-off of Ether from the Ethereum
cartel. It took a century for Coca Cola to create the new Coke and call
the old one Coke Classic. But it took 3 years to Ethereum to dump the
first ETH into Ethereum Classic and create and brand new spin-off, ETH.
Moreover, hundreds of other cryptocurrencies are invented every
day, alongside scams known as ``Initial coin offerings,'' which are
mostly designed to skirt securities laws. And their supply is created
and debased every day by pure fiat and in the most arbitrary way. So
cryptocurrencies are creating crypto money supply and debasing it at a
much faster pace than any major central bank ever has. No wonder that
the average cryptocurrency has lost 95 percent of its value in a matter
of a year.
At least in the case of Bitcoin the increase in supply is
controlled by a rigorous mining process and the supply is capped--at
the limit--to 21 million bitcoins. Instead, most other alt-coins
starting with the leading ETH, have an arbitrary supply that was
created via pre-mining and pre-sale; and the change of supply of that
and thousands of other cryptocurrencies is now subject to arbitrary
decision of self-appointed ``central bankers.''
And the biggest scam of all is the case of ``stable coins''--
starting with Tether--that claimed to be pegged one-to-one to the U.S.
dollar but are not fully collateralized by an equal backing of true
U.S. dollars. Bitfinex--behind the scammy Tether--has persistently
refused to be properly audited and its creation of fiat Tether has been
systematically used to prop up manipulate upward the price of Bitcoin
and other cryptocurrencies according to a recent academic paper.\3\
---------------------------------------------------------------------------
\3\ https://www.bloomberg.com/news/articles/2018-06-13/professor-
who-rang-vix-alarm-says-tether-used-to-boost-bitcoin.
---------------------------------------------------------------------------
Financial crises occurred well before fiat currencies and central
banking; and are now less virulent thanks to central banks and
fiat money.
Another totally false argument is that asset and credit bubbles are
caused by central banks and the existence of fiat currencies. Any
student of financial crises knows that asset and credit bubbles were
widespread before fiat currencies and central banks were created; see
for example Tulipmania, the Mississippi Bubble and the South Sea
Bubble. These bubbles and their busts were frequent, virulent and had
massive economic and financial costs including severe recessions,
deflations, defaults and financial crisis.
Central banks--instead--were initially created not to provide goods
price stability but rather to provide financial stability and avoid the
destructive bank, sovereign and currency runs that do occur when a
bubble goes bust. Indeed, the Fed was created in 1913 when the last of
many bubbles gone bust that had caused massive bank runs led to the
realization that an institution that could provide with lender of last
resort to the financial system was needed. That and the creation of
deposit insurance after the Great Depression is the reason why bank
runs are so rare. And the purpose of fiat currencies whose supply is
regulated by credible and independent central bank is to reduce the
frequency, virulence and severity of economic recessions, deflations
and asset and credit bubbles gone bust. And indeed the economic and
financial history of the United States and other countries shows that
severe economic recessions, depressions, deflations and financial
crises are less frequent and less costly after the creation of fiat
currencies and central banks.
Crypto-currencies instead have not and will never have the tools to
pursue economic and financial stability. The few like Bitcoin whose
supply is truly constrained by an arbitrary mathematical rule will
never be able to stabilize recessions, deflations and financial crises;
they will rather lead to permanent and pernicious deflation. While the
rest--99 percent--have an arbitrary supply generation mechanism that is
worse than any fiat currency and, at the same time, will never be able
to provide either economic or price or financial stability. They will
rather be tools of massive financial instability if their use were to
become widespread.
The real revolution in financial services is FinTech and it has nothing
to do with Blockchain or Crypto
The financial-services industry has been undergoing a revolution.
But the driving force is not overhyped blockchain (https://medium.com/
@pavelkravchenko/decline-of-blockchain-hype-and-rise-of-a-common-sense-
8de5789a794d) applications such as Bitcoin. It is a revolution built on
artificial intelligence, big data, and the Internet of Things.
Already, thousands of real businesses are using these technologies
to disrupt every aspect of financial intermediation. Dozens of online-
payment services--PayPal, Venmo, Square and so forth--have hundreds of
millions of daily users in the United States. Billions more use similar
low cost, efficient digital payment systems all over the world: AliPay
and WeChat Pay in China; UPI-based systems in India; M-Pesa in Kenya
and Africa. And financial institutions are making precise lending
decisions in seconds rather than weeks, thanks to a wealth of online
data on individuals and firms. With time, such data-driven improvements
in credit allocation could even eliminate cyclical credit-driven booms
and busts.
Similarly, insurance underwriting, claims assessment and
management, and fraud monitoring have all become faster and more
precise. And actively managed portfolios are increasingly being
replaced by passive robo-advisers, which can perform just as well or
better than conflicted, high-fee financial advisers.
Now, compare this real and ongoing FinTech revolution that has
nothing to do with blockchain or cryptocurrencies with the record of
blockchain, which has existed for almost a decade, and still has only
one failing and imploding application: cryptocurrencies.
Buterin's inconsistent trinity: crypto is not scalable, is not
decentralized, is not secure
There is a deeper fundamental flaw and inconsistency in the crypto/
blockchain space. As Vitalik Buterin correctly wrote a while ago there
is a fundamental ``inconsistent trinity'' in blockchain: you cannot
have at the same time scalability, decentralization and security.
Bitcoin, for example, is partially decentralized--even if its
mining is now massively centralized--but it is not scalable given its
proof of work (PoW) authentication mechanism--that allows only for 5 to
7 transactions a second. And it is secure--so far--but at the cost of
no scalability. And since its mining is now massively centralized--as
an oligopoly of miners now control its mining--its security is at risk.
Supporters of crypto have been promising forever--Buterin spoke of
Proof of Stake (PoS) in 2013--systems that are vastly scalable. But
leaving aside that PoS is not live yet and Ethereum is still based on
PoW, the reality is that once Proof of Stake is properly launched it
will be massively centralized and thus not secure. The whole logic of
PoS is to give greater voting power to those who have a stake in a
coin--those who own it the most and mine it the most. But that leads to
a massive centralization problem. Even Bitcoin that is based on PoW has
seen a massive centralization and concentration of mining power in a
small oligopolistic group. This problem of concentration of mining
power among an oligopoly becomes much worse with PoS as those with
greater initial stake--and Ethereum is massively
concentrated in ownership of ETH--will get a greater stake over time.
So the problems of oligopolistic cartelization of mining power that is
already very serious in PoW will become exponentially worse in PoS.
More generally, while cryptography scientists are busy inventing
every day another ``consensus'' mechanism and there are dozens of new
ones after PoW and PoS and their variant the reality is that--given
Buterin's inconsistent trinity it will never be possible to create a
consensus mechanism that is scalable while also being decentralized and
secure.
One solution to the problem of scalability is to use many alt-coins
rather than increasing the block size of each blockchain; but that
solution is highly inefficient and is not secure. A second solution is
to increase the block size; but then nodes running on a smaller
computer or laptop would drop out of the system as they will not be
able to store every transaction or state. So you would end up relying
on a small number of super-computers for running the blockchain; so you
end up with an oligopoly with market power, concentration and lack of
security. A third solution is where most of the crypto industry is
trying to go, i.e., merge mining and variant of proof of stake. In this
system there are many chains but all such chains share the same mining
power or stake. But this approach increases the computational and
storage demands on each miner by a massive factor that most miners will
not be able to support. So this solution is a backdoor way of
increasing the size of the blocks. Thus, it leads to only very few
powerful miners to participate into this proof of stake, i.e.,
participating in merge-mining each chain. So it leads again to
centralization, oligopolies of mining and thus lack of security.
Whichever way you try to slice it blockchain leads to
centralization and lack of security. And this fundamental problem when
you try scalability will never be resolved. Thus, no decentralized
blockchain will ever be able to achieve scalability that is critical to
make it useful for large scale financial or any other type of
transactions. Indeed, even those blockchains that do not have any
scalability, like Bitcoin and those based on PoW, have massive mining
concentration problems. The nature of mining implies that any form of
mining has economies of scale that require massive scale--think of the
massive energy hogging mining factories of crypto-land--and lead to
massive oligopolistic concentration of power and lack of security.
With the centralization of power comes a serious problem of lack of
security, starting with 51 percent attacks. Supporters of crypto argue
that it would not be in the interest of an oligopoly of miners to start
a 51 percent as it would destroy their source of income/fees. But
leaving aside that such an attack would allow them to steal the
underlying assets--worth is some cases dozens of billions of dollars as
in the case of BTC. The main problem is any oligopolistic cartel will
end up behaving like an oligopoly: using its market power to jack up
prices, fees for transactions and increase its profit margins. Indeed,
as concentration of mining has increased over the last year transaction
costs of crypto--as measured by miners' fees divided by number of
transactions--have skyrocketed.
No security in cryptocurrencies
So even PoW that is not scalable leads to concentration/
centralization and thus lack of security. PoS and other authentication
mechanisms that are scalable are much worse: bigger concentrated
oligopolistic cartels and thus lack of security.
Also 51 percent attacks are not a theoretic possibility that is
impossible in practice. Dozens of successful 51 percent attacks have
occurred recently. In smaller coins with a small market capitalization
you don't even need a 51 percent hash power to mount a successful 51
percent attack. And since market cap is low a few hundreds of thousands
of dollars--or at best a couple of millions--are sufficient to mount a
successful 51 percent attack whose gain is a 10 to 20X multiple of the
cost of the attack. No wonder that dozens of successful 51 percent
attack have occurred recently against smaller cryptocurrencies.
Fundamental flaws of lack of security in crypto land go well beyond
the fact that mining is highly concentrated in oligopolies in shady and
nontransparent and unsecure jurisdictions--China, Russia, Belarus,
Georgia, etc. It also goes beyond the possibility and reality of
massive and regular 51 percent attacks.
There is a deeper and more fundamentals set of security flaws in
crypto land. Conventional payment systems based on fiat currencies,
central banks and private banks are scalable and secure but
centralized; so they resolve Buterin's inconsistent trinity principle
by giving up decentralization and relying on trusted permissioned
authorities to resolve the ``double spend'' problem.
Instead, blockchains and cryptocurrencies not only are not scalable
and are massively centralized; they are also massively not secure.
When I use traditional financial systems based on fiat currencies
there are many levels and layers of security. First I rely on
institutions with a reputation and
credibility built over time; there is also deposit insurance that
guarantees the value of my deposits; there is the lender of last resort
role of central bank to avoid runs on solvent but illiquid banks;
sometimes even there is even the bailout of systemically important too-
big-to-fail (TBTF) institutions with provisos to control this TBTF
moral hazard. More importantly, a depositor or credit card holder is
made whole with little effort when fraudulent transaction occur and
someone tries to steal your money or make a fraudulent charge on your
credit card. Society pays a small fee--in a number of ways--to ensure
such safety but depositors and credit card holders are happy to pay
such a modest fee in exchange for transaction security. So while many
breaches of security may occur--as there are main weak points in the
system--the system is secure and individual users of the system are
also secure.
In crypto land instead there are none of these institutions that
provide security: no deposit insurance, no lender of last resort
backstop, no insurance of hacked and stolen funds. And the breaches of
security are massive and escalating. It is now clear that while Bitcoin
has not been hacked yet the centralized exchanges that hold the
cryptocurrencies of millions of depositors can be and have been hacked
on a regular scale. And once your crypto assets are stolen they vanish
in the vast anonymous void of crypto and cannot be found and retrieved
any more. The vast hacking of centralized exchanges has led to the
developments of dozens of decentralized exchanges (DEX) but 99 percent
of all trading is on centralized exchanges and some security flaws of
DEX imply that even the so called ``secure'' DEX are not secure at all.
Once a hacker steals your private key--whether it is stored on an
online wallet, laptop, phone, computer or tablet or centralized
exchange your crypto wealth is stolen and gone forever.
Given these massive security problems of crypto the solutions to
these severe security problems are all variants of going back to the
stone age: do not put your long private key--that no human can memorize
ever--on any digital device but rather write it down on a piece of
paper and hide it in a hole where hopefully no one will find it or no
insect or rat will destroy it. Or spend a fortune to put your crypto
assets into ``cold storage'', i.e., a digital storage that is
disconnected from anything online. The latter is the stone age
equivalent of hiding your wealth into deep caves that cannot be found
by anyone. But leaving aside the cost of such stone age security
solutions the implication becomes that your crypto wealth--hidden in
deep cold storage--cannot be easily traded or used for transactions of
any sort. This is the contemporary equivalent of mining gold deep from
the ground and then hiding it in the form of gold ingots back deep in
the ground.
Even such security solutions are not safe: criminals who know that
access to your private key is access to your entire crypto wealth
forever are now specializing into gunpoint robberies of crypto
investors and whales (also known as ``crypto robberies''). At gunpoint
you are forced to provide your private key and then your wealth is gone
for good. No wonder that crypto conferences have entire sessions
devoted to secure your insecure crypto assets.
Traditional banking systems have found secure solutions to such
criminal security problems: even if a robber forces you at gunpoint to
reveal the pin of your ATM card the amount of cash that can be
withdrawn is limited to a small amount; similarly wire transfer of a
significant size are subject to various forms of identity verification.
o there is no way that your entire wealth can be stolen with a click as
it happens daily in crypto land. While crypto relies on stone age
technologies and cannot even resolve such security problems.
Decentralization is a self-serving ideology
Blockchain's ideology is politically born out of the same mentality
as libertarian right wing conspiracies or extreme left anarchism: all
governments, central banks, moneys, institutions, banks, corporations,
entities with reputation and credibility build over centuries are evil
centralized concentrations of power that literally need to be
destroyed.
So the utopian crypto future will be one of libertarian
decentralization of all economic activity, transactions and human
interactions. Everything will end up on a public decentralized
distributed permission-less, trustless ledger; or better millions of
ledgers on computers that are now already consuming more energy than
Canada to verify and confirm transactions without the use of evil
centralized institutions. This extreme right wing ideology of crypto
has been studied in detail in the
academic book by David Golumbia ``The Politics of Bitcoin: Software As
Right Wing Extremism.''\4\
---------------------------------------------------------------------------
\4\ https://www.upress.umn.edu/book-division/books/the-politics-of-
bitcoin.
---------------------------------------------------------------------------
But the reality is just the opposite: a bunch of self-serving
greedy white men--very few women or minorities are allowed in the
blockchain space--have pretended to create billions of wealth out of
nowhere while pretending to care about billions of poor and unbanked
human around the world. It is a total pretense as crypto-land is the
most centralized scam in human history where greed for Lambos and
ostentatious consumption is greater than any Gordon Gecko ever.
There are hundreds of stories of greedy crypto-criminals raising
billions of dollars with scammy white papers that are nothing but
vaporware and then literally stealing these billions to buy Lambos,
expensive cars, villas in the Caribbean and the French Riviera. These
large scale criminals stealing dozens of billions make the small and
petty Wolf of New York robbing small investors in criminal penny stock
manipulation schemes looks an amateur.
But the most shameful of such near-criminals is a crypto guru--that
was formerly investigated for pedophilia and who has put his home and
operation--together with a group of crypto scammers--in Puerto Rico
after a devastating hurricane that killed thousands and nearly
destroyed the island.
Under the high-flatulent pretense of wanting to help the millions
who lost homes and their livelihood to the hurricane by using
``blockchain'' and new crappy cryptocurrencies these literal blood-
suckers live in super-luxury mega mansions in the island and use the
island's tax laws to enrich themselves and avoid paying their Federal
taxes. They are emblematic of a widespread crypto culture that
shamelessly pretends to care about the billions of poor and unbanked
just to enrich itself. At least the Wolf of New York had no pretense of
wanting save the world, end global poverty and the tragic misery of a
Puerto Rico devastated by a hurricane.
Decentralization is a myth: massive centralization and concentration of
oligopolistic power and cartels among miners, exchanges,
developers, wealth holders.
The reality is one of a massive centralization of power among
miners, exchanges, developers and wealth holders, the total opposite of
the lie of a decentralized system.
First, miners are massively centralized as the top four among them
control three quarters of mining and behave like any oligopolist:
jacking up transaction costs to increase their fat profit margins. And
when it comes to security most of these miners are in nontransparent
and authoritarian countries such as Russia and China. So we are
supposed not to trust central banks or banks when it comes to financial
transactions but rather a bunch of shady anonymous concentrated
oligopolists in jurisdictions where there is little rule of law?
A recent study by a scholar at Princeton University is aptly titled
``The Looming Threat of China: An Analysis of Chinese Influence on
Bitcoin.''\5\ In summary the conclusions of this paper are as follows:
``As Bitcoin's popularity has grown over the decade since its creation,
it has become an increasingly attractive target for adversaries of all
kinds. One of the most powerful potential adversaries is the country of
China, which has expressed adversarial positions regarding the
cryptocurrency and demonstrated powerful capabilities to influence it.
In this paper, we explore how China threatens the security, stability,
and viability of Bitcoin through its dominant position in the Bitcoin
ecosystem, political and economic control over domestic activity, and
control over its domestic internet infrastructure. We explore the
relationship between China and Bitcoin, document China's motivation to
undermine Bitcoin, and present a case study to demonstrate the strong
influence that China has over Bitcoin. Finally, we systematize the
class of attacks that China can deploy against Bitcoin to better
understand the threat China poses. We conclude that China has mature
capabilities and strong motives for performing a variety of attacks
against Bitcoin.''
---------------------------------------------------------------------------
\5\ https://arxiv.org/pdf/1810.02466.pdf.
---------------------------------------------------------------------------
Everything that this study argues about the nefarious impact of
China on Bitcoin can be said and applied to any other cryptocurrency
and to the role of Russia in the crypto eco-system.
Second, all trading is centralized as 99 percent of all trading
occurs on centralized exchanges while hundreds of decentralized
exchanges have no trading, no liquidity are collapsing. And centralized
exchanges are being hacked daily as there is not security in keeping
crypto assets in a wallet; and once hacked your wealth is gone forever.
Third, development is centralized as Vitalik Buterin--creator of
Ethereum--is named as ``benevolent dictator for life''. And there is
nothing immutable in the ``code is law'' motto as the developers are
police, prosecutors and judges: when something goes wrong in one of
their buggy ``smart'' pseudo-contracts \6\ and massive hacking
occurs, they simply change the code \7\ and ``fork'' a failing coin
into another one by arbitrary fiat,\8\ revealing the entire
``trustless'' enterprise to have been untrustworthy from the start.
---------------------------------------------------------------------------
\6\ https://davidgerard.co.uk/blockchain/ethereum-smart-contracts-
in-practice/.
\7\ https://www.coindesk.com/the-dao-bitcoin-development/.
\8\ https://www.cbc.ca/news/technology/ethereum-hack-blockchain-
fork-bitcoin-1.3719009.
---------------------------------------------------------------------------
``Smart Contracts'' are neither smart nor contracts. As a recent
study has shown ``smart contracts on Ethereum are worse than even
nonfinancial commercial code; as of May 2016, Ethereum contracts
averaged 100 obvious bugs (so obvious a machine could spot them) per
1000 lines of code. (For comparison, Microsoft code averages 15 bugs
per 1000 lines, NASA code around 0 per 500,000 lines.)''\9\
---------------------------------------------------------------------------
\9\ https://davidgerard.co.uk/blockchain/ethereum-smart-contracts-
in-practice/.
---------------------------------------------------------------------------
Fourth, wealth in crypto-land is more concentrated than in North
Korea where the inequality Gini coefficient is 0.86 (it is 0.41 in the
quite unequal United States): the Gini coefficient for Bitcoin is an
astonishing 0.88 (https://www.business
insider.com/bitcoin-inequality-2014-1).
Quite a feat to create an asset class where inequality is greater
than that of Kim Jong-un land.
So decentralization is just a total myth invented by a bunch of
whales whose wealth is fake; now that the retail suckers who bought at
the peak have literally lost their shirts these crypto ``whales'' are
fake billionaires as liquefying their wealth would crash the price of
the ``asset'' to zero.
Crypto is not the internet nor will it ever be
Blockchain's boosters would argue that its early days resemble the
early days of the internet, before it had commercial applications. But
that comparison is simply false. Whereas the internet quickly gave rise
to email, the World Wide Web, and millions of viable commercial
ventures used by billions of people in less than a decade,
cryptocurrencies such as Bitcoin do not even fulfill their own stated
purpose (https://www.project-syndicate.org/commentary/why-bitcoin-is-a-
bubble-by-nouriel-roubini-2018-01?barrier=accesspaylog.)
The comparison with the early days of the internet is nonsense as
even the early internet in the early 1990s saw a rapid boom of
applications and explosion of user adoption: email became widespread
and thousands of useful website used by millions of people for useful
purpose sprang overnight. The boom in web sites creation was so vast,
rapid and massive that early on directories of such web site--such as
the start of Yahoo--and search engines became necessary to navigate the
richness of information of the World Wide Web (WWW).
The WWW went live in 1991 and by 2000--nine years later--it already
had 738 million users; and by 2015 the number of users was 3.5 billion.
Crypto has been around for over a decade now and in 2018 the number
of crypto wallets was only 22 million and out of this figure the number
of active Bitcoin users is only between 2.9 and 5.9 million and
falling. And the number of crypto transactions has collapsed by at
least 75 percent between 2017 and 2018.
Successful new technologies have a few key features: exponential
increase of the number of users, exponential increase of the number of
transaction, sharp and persistent fall of transaction costs. That is
the history of the internet--almost one billion users in a decade since
start and billions of billions of transactions in the first decade--and
is also the history of financial markets where trading activity--say in
equity markets--includes an exponential increase in users, exponential
and permanent increase in number of transactions and a sharp fall in
transaction costs (as measured by falling bid-ask spreads and by the
collapse of brokers' fee for equity transactions).
Crypto land is just the opposite: the number of users in a decade
is still barely 22 million globally and, after the bust of crypto in
2018, the active users are a fraction of that number; the number of
transactions on crypto exchanges in 2018 has collapsed and is down
between 75 percent and 80 percent; same for the size of transaction
values given the collapse of crypto asset prices; and transaction costs
are surging through the roof rather than falling as measured by the
total value of miners revenue as a share of the number of transactions.
And after over a decade crypto land has not a single killer app.
So crypto and blockchain are not like the early years of the
internet that was booming in every dimension in its first decade; it is
instead literally collapsing and imploding in every possible dimension.
It is a failing set of technologies.
ICOs are not compliant securities when they aren't outright scams
Initial coin offerings have become the most common way to finance
cryptocurrency ventures, of which there are now nearly 1,600 and rising
(https://coinmarketcap.com/all/views/all/) . In exchange for your
dollars, pounds, euros, or other currency, an ICO issues digital
``tokens,'' or ``coins,'' that may or may not be used to purchase some
specified good or service in the future.
Thus it is little wonder that, according to the ICO advisory firm
Satis Group, 81 percent of ICOs are scams (https://medium.com/
@sherwin.dowlat/cryptoasset-market-update-b678aeda4c5e) created by con
artists, charlatans, and swindlers looking to take your money and run.
It is also little wonder that only 8 percent of cryptocurrencies end up
being traded on an exchange, meaning that 92 percent of them failed. It
would appear that ICOs serve little purpose other than to skirt
securities laws that exist to protect investors from being cheated.
If you invest in a conventional (noncrypto) business, you are
afforded a variety of legal rights--to dividends if you are a
shareholder, to interest if you are a lender, and to a share of the
enterprise's assets should it default or become insolvent. Such rights
are enforceable because securities and their issuers must be registered
with the State.
Moreover, in legitimate investment transactions, issuers are
required to disclose accurate financial information, business plans,
and potential risks. There are restrictions limiting the sale of
certain kinds of high-risk securities to qualified investors only. And
there are anti-money-laundering (AML) and know-your-customer (KYC)
regulations to prevent tax evasion, concealment of ill-gotten gains,
and other criminal activities such as the financing of terrorism.
In the Wild West of ICOs, most cryptocurrencies are issued in
breach of these laws and regulations, under the pretense that they are
not securities at all but rather ``security tokens.''\10\ Hence, most
ICOs deny investors any legal rights whatsoever. They are generally
accompanied by vaporous ``white papers'' instead of concrete business
plans. Their issuers are often anonymous and untraceable. And they
skirt all AML and KYC regulations, leaving the door open to any
criminal investor.
---------------------------------------------------------------------------
\10\ We will discuss below the other scam of so-called ``utility
token.''
---------------------------------------------------------------------------
Jay Clayton, the chairman of U.S. Securities and Exchange
Commission, recently made it clear that he regards all cryptocurrencies
as securities, with the exception of the first mover, Bitcoin, which he
considers a commodity (https://finance.yahoo.com/news/sec-ico-tokens-
regulated-securities-205650102.html). The implication is that even
Ethereum and Ripple--the second- and third-largest crypto-assets--are
currently operating as unregistered securities.\11\ Gary Gensler, a
former chairman of the Commodities and Futures Trading Commission who
now teaches a course on blockchain (https://www.project-syndicate.org/
commentary/blockchain-technology-limited-applications-by-nouriel-
roubini-and-preston-byrne-2018-03?barrier
=accesspaylog) (the technology underlying cryptocurrencies) at MIT, has
also suggested as much (https://www.bloomberg.com/news/articles/2018-
04-23/ether-ripple-may-be-securities-former-cftc-head-gensler-says).
---------------------------------------------------------------------------
\11\ A legal scholar such as Preston Byrne has shown that Ripple
Labs has created XRP; see https://prestonbyrne.com/2018/09/20/for-the-
last-time-ripple-created-xrp/.
---------------------------------------------------------------------------
And legal scholars such as Preston Byrne have not only confirmed
that they Ether was created makes it a clear security.\12\ They have
also shown that the creation of Ethereum may have been a criminal
insider con job where a small group of whale--starting with the
billionaires who created this scheme--pretended to make a market-based
``pre-sale'' of Ether but they instead sold to themselves--most likely
at bargain basement prices--a great fraction of the ETH created in the
pre-sale. And so far regulators have done nothing to investigate, let
alone, prosecute such a cartelized scam.
---------------------------------------------------------------------------
\12\ https://prestonbyrne.com/2018/04/23/on-ethereum-security/.
---------------------------------------------------------------------------
Tokenization: cartels aimed to gouge consumers. No numeraire and return
to barter
So hundreds of ICOs that have raised billions of dollars from
investors in recent years have been technically illegal as they are
noncompliant securities hiding under the label of ``security tokens''.
Even worse, the business model behind most of the remaining ones--the
so-called ``utility tokens''--is simply to fleece customers, as
Izabella Kaminska of the Financial Times and Martin Walker of the
Center for Evidence-Based Management recently demonstrated in a report
(http://data.parliament.uk/writtenevidence/committeeevidence.svc/
evidencedocument/treasury-committee/digital-currencies/written/
82032.html) for the U.K. House of Commons Treasury Committee.
In normal business transactions, customers can buy goods and
service with conventional currencies. But in an ICO, customers must
convert that currency by buying into a limited pool of tokens in order
to make a purchase. No legitimate business that is trying to maximize
profits would require its customers to jump through such hoops of first
buying an ``utility token'' before being able to transact goods or
services.
In fact, the only reason to restrict a purchase to token-holders is
to create an illegal cartel of service providers who are safe from
price competition and in a position to gouge their customers. Consider
Dentacoin, a ridiculous cryptocurrency that can be spent only on dental
services (and which almost no dentist actually accepts). It would be
hard to come up with a better illustration of why business cartels are
illegal in all civilized countries.
Of course, the crypto-cartels would counter that customers who
incur the cost of buying a token will benefit if that token appreciates
in value. But this makes no sense. If the price of the token rises
above the market value of the good or service being provided, then no
one would buy the token. The only plausible reason for forcing the use
of a token, then, is to hike prices or bilk investors.
Beyond facilitating illegal activity, crypto-tokens obfuscate the
price-discovery benefits that come when a single currency operates as a
unit of account. In a crypto-utopia, every single good and service
would have its own distinct token, and average consumers would have no
way to judge the relative prices of different--or even similar--goods
and services. Nor would they have any real certainty about a token's
purchasing power, given the volatility of crypto-token prices.
Imagine living in a country where instead of simply using the
national currency, you had to rely on 200 other world currencies to
purchase different goods and services. There would be widespread price
confusion, and you would have to eat the cost of converting one
volatile currency into another every time you wanted to buy anything.
The fact that everyone within a given country or jurisdiction uses
the same currency is precisely what gives money its value. Money is a
public good that allows individuals to enter into free exchange without
having to resort to the kind of imprecise, inefficient bartering on
which traditional societies depended.
That is precisely where the ICO charlatans would effectively take
us--not to the futuristic world of ``The Jetsons,'' but to the modern
Stone Age world--that is worse than ``The Flintstones''--who at least
used clam shells as their money and understood the importance of a
single numeraire--where all transactions occur through the barter of
different tokens or goods. It is time to recognize their utopian
rhetoric for what it is: self-serving nonsense meant to separate
credulous investors from their hard-earned savings.
Massive manipulation: pump-and-dump, spoofing, wash trading, front
running, exchanges conflicts of interest, Tether scam
There is now massive evidence--from serious press investigations
and academic studies--that the entire crypto-land is subject to
massive, systematic and widespread price manipulation of every sort
known in the annals of criminal manipulation: pump-and-dump schemes,
wash trading, spoofing, front-running, serious conflicts of interest
between exchanges and their customers, vast insider trading, creation
of pseudo stable coins that are rather fiat cryptocurrencies that are
used only to prop up Bitcoin and other cryptocurrencies. While price
manipulation does occur in a variety of financial markets, there are
strict laws against it and it is subject to draconian criminal
prosecution; thus, it is the exception rather than the rule. While
criminal price manipulation and insider trading is systemic in crypto
land. For example, various investigations by the Wall Street Journal
have shown that hundreds of criminal ``pump-and-dump'' chat rooms exist
on the Telegram chap app that are aimed only at systematically
manipulating the price of hundreds of cryptocurrencies.\13\
---------------------------------------------------------------------------
\13\ https://www.wsj.com/graphics/cryptocurrency-schemes-generate-
big-coin/.
---------------------------------------------------------------------------
In 2018 cryptocurrency values fell by 90 percent on average from
their December peak. They would have collapsed much more had a vast
scheme to prop up their price via outright manipulation not been
rapidly implemented (https://coinreport.net/teetering-tether/). But,
like in the case of the sub-prime bubble, most U.S. regulators are
still asleep at the wheel while having started investigations months
ago.
The mother of all manipulations in the crypto land is related to
Tether and Bitfinex--a shady crypto exchange--that is its backer.
Bitfinex--behind the scammy Tether--has persistently refused to be
properly audited and has hopped on four continents changing every
season the shady bank that provides it banking service linked to fiat
dollars. And the supply of Tether is increased randomly--by hundreds of
millions of chunks at a time via pure fiat--as a way to manipulate and
prop up the value of Bitcoin and the entire related cryptocurrency
system. Tether has already created by fiat billions of dollars of a
``stable coin'' that has never been audited. The creation of fiat
Tether has been systematically used to prop up manipulate upward the
price of Bitcoin and other cryptocurrencies according to a recent
academic paper by a leading scholar at the University of Texas. Without
such outright criminal manipulation the price of Bitcoin would now be
about 80 percent lower than its current value, i.e., about $1200 rather
than the current $6500.\14\
---------------------------------------------------------------------------
\14\ https://www.bloomberg.com/news/articles/2018-06-13/professor-
who-rang-vix-alarm-says-tether-used-to-boost-bitcoin.
---------------------------------------------------------------------------
No killer app in crypto/blockchain after a decade: only ponzi schemes
Even supporters of crypto and blockchain do admit that there no
killer app in crypto or blockchain even after a decade of developments
and attempts. And as shown above the comparison with the early days of
the internet is utter nonsense as the internet had massive adoption and
many early killer apps or websites.
The only think that Crypto/Blockchain is DAPPS or Distributed Apps.
But recent studies show that 75 percent of the highly illiquid and
bared used DAPPS are Krypto-Kitties, Pyramid and Ponzi schemes and
Casino games. And the Ethereum community is doing nothing--literally
nothing to stop or block such Ponzi games as it parasitically
financially profits from them. The remaining 25 percent of DAPPS are
decentralized exchanges that no one uses as 99 percent of all crypto
trading occurs on centralized exchanges. So pretty much most DAPPS are
scams or useless gimmick and their transaction volumes are close to
zero. Pretty much no adoption of anything. So the comparison with early
days of the internet is nonsense.
The energy consumption of crypto is an environmental disaster
The environmental costs of the energy use of Bitcoin and other
cryptocurrencies is so vast that has been correctly and repeatedly
compared to an environmental disaster. No need to repeat how such
energy mis-use and waste is massive--larger than the energy use per
year of a mid-sized advanced economy. Such an environmental disaster
has shamed even supporters of crypto who have become defensive given
the embarrassing evidence of such energy costs and pollution.
But now zealot supporters of crypto are pretending that this
environmental disaster can be minimized or resolved soon. Since using
millions of computers to do useless cryptographic games to secure the
verification of crypto transactions is a useless waste of energy--as
the same transactions could be reported at near zero energy costs on an
single Excel spreadsheet--crypto zealots argue that such costs could be
massively reduced if crypto moves from energy-hogging PoW to less
energy-wasteful Proof of Stake. But as we discussed above in detail,
scalability of crypto transactions via PoS will be massively
concentrated in dangerous oligopolies--even more so than PoW--and
therefore such centralization of mining power will lead to most severe
problems of security. So, there is no free lunch here. Either crypto
keeps on using energy-hogging and environmental-disaster PoW or it will
become an insecure, centralized, and dangerous system.
The other argument made by crypto zealots is that other financial
activities--such as gold mining or running the traditional financial
system--hog a lot of energy. Those apologies are utter nonsense. The
mining of gold or the provision of financial services produces value
added and output to the economy that is 1000X than the pseudo value
added of crypto mining. And financial services provide payment and
other services to billions of people daily in hundreds of billions of
daily transactions. So of course their use of energy will be larger
than crypto. Crypto is used by 22 million folks globally--less than 5
million active ones today--and its entire market cap is 200 billion--
not the 300 trillion of global financial and real assets--and is
producing value added that is a few billions a year--new crypto mining.
But its energy use cost is already about $5 billion a year. So
comparing the energy use of useless, inefficient and tiny crypto to the
services of financial institutions serving daily billions of people is
utter nonsense of comparing apples and oranges or, better, crypto
parasites with useful financial services (payments, credit, insurance,
asset management, capital market services) used by billions. That is
why a recent scholar has defined Bitcoin as being ``as efficient as a
lame hippopotamus with an hangover.''\15\
---------------------------------------------------------------------------
\15\ https://prestonbyrne.com/2018/10/05/bitcoin_hippo/.
---------------------------------------------------------------------------
Blockchain is most overhyped technology ever, no better than a
glorified spreadsheet or database
And why is blockchain no better than an Excel spreadsheet or
database?
There is no institution under the sun--bank, corporation,
nonprofit, Government, charity--who would put on public, decentralized,
peer-to-peer permission-less, trust-lees, distributed ledgers its
balance sheet, P&L, transactions, trades, interactions with clients and
suppliers. Why should all this information--mostly proprietary and
highly valuable--be on a public ledger and authenticated by some
random, not transparent and shady group of ``miners''? No reason and
thus there is NO institution whatsoever using a public, permission-less
distributed technology.
The only applications of blockchain--so called ``enterprise DLT''--
have in reality absolutely nothing to do with blockchain. They are
private not public, they are centralized not decentralized, they are
not distributed as they are on a few controlled ledgers not millions of
public ones, they are permissioned with very few legitimate individuals
authorized to add and change the ledgers rather than being permission-
less, they are based on trusted authorities that have reputation and
credibility build over time rather than being trustless, they are not
peer-to-peer as a centralized and permissioned intermediary is in
charge of authentication. In other term they are called blockchains but
they are not blockchains as they have nothing to do with a public
distributed ledger technology.
So all so called ``decentralized'' blockchains end up being
centralized private permissioned databases, i.e., effectively no
improvement over using an Excel spreadsheet rather than hogging more
energy than most large-sized economies to put private information on
millions of computers all over the world.
And no wonder as no person or firm or institution in authority in
the private or public sector would ever allow all of its transactions
to be verified by an oligopoly of shady nontransparent agents in
autocratic countries where all power is centralized. So it is no
surprise that any institution under the sun after experimenting with a
pilot ``blockchain'' dumps it into the garbage bin or turns it into a
private permissioned database that is no ``blockchain'' in any
dimension but its misleading name.
Also as for the underlying pseudo-blockchain technology, there are
still massive obstacles standing in its way. Chief among them is that
it lacks the kind of basic common and universal protocols that made the
internet universally accessible (TCP-IP, HTML, and so forth): there are
1000s different ``blockchain'' incompatible with each other and totally
lacking the critical ``inter-operability'' that the internet had from
the beginning. More fundamentally, its promise of decentralized
transactions with no intermediary authority amounts to an untested,
Utopian pipedream (https://www.ft.com/content/b5b1a5f2-5030-11e7-bfb8-
997009366969). No wonder blockchain is ranked close to the peak of the
hype cycle of technologies with inflated expectations (https://
www.project-syndicate.org/commentary/why-bitcoin-is-a-bubble-by-
nouriel-roubini-2018-01?barrier=accesspaylog).
So blockchain is one of the most overhyped technologies ever
(https://www.project-syndicate.org/commentary/why-bitcoin-is-a-bubble-
by-nouriel-roubini-2018-01?barrier=accesspaylog). Blockchains are less
efficient than existing databases. When someone says they are running
something ``on a blockchain,'' what they usually mean is that they are
running one instance of a software application that is replicated
across many other devices.
If it is truly distributed the required storage space and
computational power is substantially greater, and the latency higher,
than in the case of a centralized application. Blockchains that will
incorporate ``proof-of-stake'' or ``zero-knowledge'' technologies will
require that all transactions be verified cryptographically, which
slows them down. Blockchains that use ``proof-of-work,'' as many
popular cryptocurrencies do, raise yet another problem: they require a
huge amount of raw energy to secure them and are not scalable. This
explains why Bitcoin ``mining'' operations in Iceland are on track to
consume more energy this year than all Icelandic households combined
(http://www.bbc.co.uk/news/technology-43030677).
Blockchains can make sense in cases where the speed/verifiability
tradeoff is actually worth it, but this is rarely how the technology is
marketed. Blockchain investment propositions routinely make wild
promises to overthrow entire industries, such as cloud computing,
without acknowledging the technology's obvious limitations.
Consider the many schemes that rest on the claim that blockchains
are a distributed, universal ``world computer.'' That claim assumes
that banks, which already use efficient systems to process millions of
transactions per day, have reason to migrate to a markedly slower and
less efficient single cryptocurrency. This contradicts everything we
know about the financial industry's use of software. Financial
institutions, particularly those engaged in algorithmic trading, need
fast and efficient transaction processing. For their purposes, a single
globally distributed blockchain such as Ethereum would never be useful
and they will never use it.
Another false assumption is that blockchain represents something
akin to a new universal protocol, like TCP-IP or HTML were for the
internet. Such claims imply that this or that blockchain--among
thousands that are incompatible with each other--will serve as the
basis for most of the world's transactions and communications in the
future. Again, this makes little sense when one considers how
blockchains actually work. For one thing, blockchains themselves rely
on protocols like TCP-IP, so it isn't clear how they would ever serve
as a replacement.
Furthermore, unlike base-level protocols, blockchains are
``stateful,'' meaning they store every valid communication that has
ever been sent to them. As a result, well-designed blockchains need to
consider the limitations of their users' hardware and guard against
spamming. This explains why Bitcoin Core, the Bitcoin software client,
processes only 5-7 transactions per second, compared to Visa, which
reliably processes 25,000 transactions per second (https://www.project-
syndicate.org/commentary/blockchain-technology-limited-applications-by-
nouriel-roubini-and-preston-byrne-2018-03?barrier=accesspaylog#).
Just as we cannot record all of the world's transactions in a
single centralized database, nor shall we do so in a single distributed
database. Indeed, the problem of ``blockchain scaling'' is still more
or less unsolved, and is likely to remain so forever.
Although we can be fairly sure that blockchain will not unseat TCP-
IP, a particular blockchain could eventually set a standard for
specific private permissioned, not general and public, applications,
just as Enterprise Linux and Windows did for PC operating systems. But
betting on a particular ``coin,'' as many investors currently are, is
not the same thing as betting on adoption of a larger ``protocol'' that
does not require the use of any coin. Given what we know about how
open-source software is used, there is little reason to think that the
value to enterprises of specific blockchain applications will
capitalize directly into any coin.
A third false claim concerns the ``trustless'' utopia that
blockchain will supposedly create by eliminating the need for financial
or other reliable intermediaries. This is absurd for a simple reason:
every financial contract in existence today can either be modified or
deliberately breached by the participating parties. Automating away
these possibilities with rigid ``trustless'' terms is commercially
nonviable, not least because it would require all financial agreements
to be cash collateralized at 100 percent, which is insane from a cost-
of-capital perspective (https://preston
byrne.com/2017/12/10/stablecoins-are-doomed-to-fail/).
Moreover, it turns out that many likely appropriate applications of
blockchain in finance--such as in securitization or supply chain
monitoring--will require permissioned centralized intermediaries after
all, because there will inevitably be circumstances where unforeseen
contingencies arise, demanding the exercise of discretion. The most
important thing blockchain will do in such a situation is ensure that
all parties to a transaction are in agreement with one another about
its status and their obligations before a trusted and permissioned
central authority verifies the transaction.
It is high time to end the hype. Bitcoin is a slow, energy-
inefficient dinosaur that will never be able to process transactions as
quickly or inexpensively as an Excel spreadsheet. Ethereum's plans for
an insecure proof-of-stake authentication system will render it
vulnerable to manipulation by influential insiders. And Ripple's
technology for cross-border interbank financial transfers is already
left in the dust by SWIFT, a nonblockchain consortium that all of the
world's major financial institutions already use (https://
www.swift.com/our-solutions/swift-gpi#). And the technology behind
Ripple is different from its coin XRP: some may use the technology/
protocol but no one will use the underlying coin whose value has
collapsed. Ditto for Ether versus Ethereum. Similarly, centralized e-
payment systems with almost no transaction costs--Faster Payments,
AliPay, WeChat Pay, Venmo, Paypal, Square--are already being used by
billions of people around the world who are doing billions of low cost/
fee secure transactions.
Ultimately, private permissioned blockchain's uses will be limited
to specific, narrow well-defined, and complex applications that require
transparency and tamper-resistance more than they require speed. So
they are not truly a ``blockchain''.
A case in point, among hundreds of other cases, is the recent
announcement of the IBM food ``blockchain'' going live with a major
supermarket giant being on board with this project. Leave aside that
the success of such a project--as any other Enterprise DLT one--is more
than sketchy as there is no general accepted protocol to make this
system inter-operable among thousands of users and customers. The key
issue is--as the IBM spokesman quoted in the article say--that this
system ``obviously requires the growers, the suppliers, and the
retailers all to be part of the solution, sending in information in a
trusted and permissioned fashion and we link it all together.''\16\ So
this alleged blockchain system is trusted not trustless, permissioned
not permission-less and managed and linked strictly by IBM, not a
distributed peer-to-peer consensus mechanism managed by millions of
anonymous computers. Therefore, this project has nothing to do with
blockchain, as defined in standard terms. It is a traditional database
with the usual key elements of a private, permissioned databased
managed by centralized and trusted authorities. And the same exact
model is the base of any other Enterprise DLT: none of them have
anything substantial to do with blockchain even if they use this faddy
and catchy label.
---------------------------------------------------------------------------
\16\ https://www.coindesk.com/ibm-food-supplychain-blockchain-
carrefour-live-production/.
---------------------------------------------------------------------------
Enterprise DLT/Blockchain: All hype and no reality
This is also the reason why corporate blockchains or Enterprise DLT
are another fad this is now fading and imploding, as a recent Bloomberg
analysis revealed.\17\ Most companies will halt their blockchain or DLT
tests this year; and in 90 percent of the cases ``the experiments will
never become part of a company's operations.'' An analyst from
Gartner--the leading tech research firm--concluded: ``The disconnect
between the hype and the reality is significant--I've never seen
anything like it. ``In terms of actual production use, it's very
rare.''
---------------------------------------------------------------------------
\17\ https://www.bloomberg.com/news/articles/2018-07-31/blockchain-
once-seen-as-a-corporate-cure-all-suffers-slowdown.
---------------------------------------------------------------------------
And the interest in corporate blockchain is collapsing: ``Only 1
percent of chief information officers said they had any kind of
blockchain adoption in their organizations, and only 8 percent said
they were in short-term planning or active experimentation with the
technology, according to a Gartner study. Nearly 80 percent of CIOs
said they had no interest in the technology.''
Crypto is corrupt eco-system full of charlatans, con-men, self-
interested insiders and scammers. But I have NO conflict of
interest
Crypto-land is an eco-system of con artists, self-serving peddlers,
scammers, carnival barkers, charlatans, and outright criminals. While
every successful technological revolution includes some bubbles and
some scammers, most of the real ones--like the internet--create real
goods and services that billions of folks use around the world even
after the initial frothiness and bubble has burst. And the criminal and
scamming element in real technological revolutions is the exception,
not the systemic rule that it is in crypto land. Scams in
cryptocurrencies were so widespread and systemic that the SEC had to
create a fake website that parodies the scammy ICO to warns investors
of the plethora of scams and criminal enterprises that infest and
dominate crypto land.\18\
---------------------------------------------------------------------------
\18\ https://www.marketwatch.com/story/the-sec-created-a-mock-ico-
website-to-show-just-how-easy-it-is-for-investors-to-get-fleeced-2018-
05-16.
---------------------------------------------------------------------------
This scammy eco-system is consistent with the idiotic crypto
jargon: HODLers are suckers who have hold on their collapsing
cryptocurrencies even after they lost 90 percent of their value; Lambos
refer to the crypto obsession with stealing investors' money to buy
luxury energy hogging cars; Whales are large early crypto billionaires
who are stuck with their fake wealth after the suckers of retails
investors--who bought into the FOMO of the peak 2017 bubbles--lost 90
percent of their investments; those suckers are also called BagHolders.
The entire crypto jargon is not of a new industry developing a creative
disruptive technology but that of an industry of con artists,
criminals, scammers and carnival barkers.
Unlike all self-interested crypto insiders and scammers who talk
and spin their book 24/7 and use a media/press eco-system of pseudo-
journalists to spin their endless fake news I have zero position and
financial interest in this entire space. I have zero long or short
position in any coin or cryptocurrency and any blockchain business
venture. And even my support of nonblockchain FinTech is not driven
from any direct or indirect financial interest; I have zero exposure to
FinTech ventures. Bitcoin or any crypto-asset could go ``To The Moon''
or crash to zero and I would not make a penny either way. The only
thing that is at stake is my personal, intellectual and academic
reputation.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HELLER FROM PETER VAN
VALKENBURGH
Q.1. In your opinion are cryptocurriencies a security or a
commodity?
A.1. Typically the term cryptocurrency refers to completely
decentralized digital currency networks and their related
scarce tokens, like Bitcoin and Ethereum, that have no issuer
and no central party that controls these networks. These are
commodities and not securities. The SEC has made it clear that
Bitcoin is not a security, while the CFTC treats it as a
commodity.
Q.2. How does the current regulation of cryptocurrencies in the
United States compare to what other countries are doing?
A.2. The Library of Congress has published a comprehensive
breakdown of cryptocurrency regulation nation-by-nation, we
recommend this as a resource to the Senator if he has country-
specific questions.\1\ Approaches by the G20 member states
vary, however, application of existing Anti-money laundering
controls to financial institutions dealing in cryptocurrencies,
as FinCEN did in 2013, is a common approach. We do not believe
that nations should ``eliminate the anonymity'' that
cryptocurrencies may afford; to do so would harm the legitimate
privacy interests and rights of citizens. Rather, we believe
that states should balance the rights of their citizens to
privacy against the need for law enforcement to obtain
information about criminal activities. This balance has already
been struck in the context of existing forms of money, like
cash transactions, and mere application of these same laws to
financial institutions dealing in cryptocurrency is the best
path forward. FinCEN has already offered guidance explaining
why existing laws apply and all major U.S. cryptocurrency
exchanges of which we are aware now comply with these data
collection obligations. The worse case is for these developers
to be forced overseas through bad policy.
---------------------------------------------------------------------------
\1\ https://www.loc.gov/law/help/cryptocurrency/world-
survey.php?loclr=ealrr.
---------------------------------------------------------------------------
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE FROM PETER VAN
VALKENBURGH
Q.1. Blockchain, or decentralized computing, clearly has the
potential to be disruptive to traditional banking operations,
but it can also enhance our efforts to rein in money
laundering.
Q.1.a. How does the investigative process for tracking down
criminal money on the public Bitcoin network compare with our
methods for tracking down criminal money within traditional
financial institutions?
A.1.a. In several ways, transacting with Bitcoin is far more
public than transacting using the legacy financial system.
Banks, although obligated under law to identify customers, may
nonetheless (A) keep imperfect records of transactions; they
may (B) fail to maintain records from many years ago; and (C)
there will be several banks with independent records in unique
data formats that must be obtained, aggregated, and merged in
order to get a full picture of a person's financial history.
Bitcoin, by contrast, (A) has a perfect record of all
transactions made globally (because if a transaction is not in
the blockchain it does not exist), (B) has a record that is
maintained from the start of the network in 2009 to the present
with full copies kept redundantly across several tens-of-
thousands of independently owned computers the world-over, and
(C) has a single record that is complete rather than partial
records scattered across several institutions. Finally, Bitcoin
transactions are far more transparent than physical cash
transactions, which leave no record whatsoever.
Q.2. Will FinCEN's regulatory approach, requiring crypto-
currency exchanges to know their customers and engage in
suspicious activity reporting, lead to the stifled growth of
cryptocurrencies, as their main appeal for users is their
anonymity and decentralization?
A.2. No. These technologies offer several benefits beyond
anonymity. Interoperability is just one of many other benefits.
Using cryptocurrency hardware and software developers have
instant access to payment networks that can be built into their
consumer products (even a smart light bulb can have a Bitcoin
wallet and verify Bitcoin payments) without any need to seek
and maintain a relationship with a bank or payments provider.
We have a paper, Open Matters, that goes into this issues in
greater detail.
Q.3. At what point of regulation would cryptocurrencies fail to
provide any real or perceived advantages over existing
currencies?
A.3. The primary value of cryptocurrencies is not their lack of
regulation. Their primary value stems from the fact that they
are natively digital, easy for machines to interoperate with,
worthy of trust even if there is no trusted party within the
system, and available to users with nothing more than free
software and an internet connection. Unless regulation quite
literally banned persons from using these tools (and perhaps
even then) they will always have certain advantages over
existing currencies.
Q.4. Mr. Valkenburgh, is there a danger if other countries
decide not to follow America's lead in classifying these
exchanges as money services, considering our lack of control
over this global currency?
A.4. Those who would use these tools for crime will find ways
to access exchanges overseas and do their business on
unregulated and unsurveiled platforms. If approaches differ
overseas, there will be gaps in law enforcement's ability to
track cryptocurrency payments just as the same would be true
with respect to traditional financial networks.
Q.5.a. Will blockchain change the way Government agencies work,
including how census data and public records are stored and
maintained?
A.5.a. Public blockchain networks may allow for greater
integrity and transparency of records, just as the Bitcoin
blockchain provides integrity and transparency of records
related to Bitcoin transactions.
Q.5.b. If so, how far out are we from these practices, in your
opinion?
A.5.b. We do not believe that blockchain technology is yet
mature enough to warrant wide implementation in the public
sector. Premature adoption could mean poor security for public
data and it could also result in agencies adopting
technological means that are rapidly made obsolete by newer
developments. We've yet to see clear technological winners and
losers in this space and much remains uncertain. This is a
necessary stage in the evolution of new technologies. Just as
the Government should not have immediately switched to email
systems for messaging in the 1970s or immediately to the web
for public communications in the 1990s, Government should
carefully watch but generally not use public blockchain
networks today. Limited pilot programs may prove the best
approach. These systems required about 20 years maturation
before they were truly ready for widespread public sector
usage. Perhaps a similar time horizon is likely here, however
prediction is difficult, especially about the future.
Q.6.a. What about efforts to move health records to the
blockchain ecosystem, particularly as interoperability
continues to be an issue in this space?
A.6.a. This would be a good use case given that the health
record issue primarily revolves around the need for a universal
log of access permissions over records that can be transactions
(e.g., one doctor granting another permission to view a chart)
and interoperable between several otherwise mutually
mistrustful (from a data-security standpoint) institutions and
persons including hospitals, issurers, governments, and
patients. However, privacy over health data and availability of
data in emergencies is paramount and public blockchain networks
may not yet be mature enough to warrant such critical usage.
Q.6.b. In your view, should Government play a role in
facilitating this exchange of date?
A.6.b. We believe it is still premature for Government to play
a role in promoting usage of public blockchain networks for
critical information such as patient records.
Q.7. Where is there potential for blockchain technology outside
of financial services?
A.7. Public blockchain networks have great potential to improve
security and competition within the growing Internet of Things.
Firstly, open blockchain networks allow for a truly
decentralized data-structure for device identity (a bulb in
this home's kitchen) and user access authorization (the user
with address 0xE1A . . . is the only person who can turn me on
and off). The redundant and
decentralized nature of data on these networks can ensure that
these systems have true longevity, and that a manufacturer's
decision to end support for a product will not destroy the
user's ability to securely access the product's features.
Second, open blockchain networks can help ensure that devices
are interoperable and compatible because critical
infrastructure for device communication, data storage, and
computation can be commoditized and shared over a peer-to-peer
network rather than be owned (as a server warehouse is owned)
by a device manufacturer that may be reticent to opening its
costly platform to competitors. Last, device payments for
supporting and maintaining that networked infrastructure or
allowing the device's user to easily engage in online commerce
can be made efficient by utilizing the electronic cash systems
that only open consensus mechanisms can facilitate. For more,
please see our paper Open Matters.
Q.8. Does the explosion of FinTech and digital payment systems
compliment an emerging crypto market or detract from its
usefulness?
A.8. The explosion of FinTech systems underscores the
importance of cryptocurrency and public blockchain technology.
As we move to a world where all economic activities will be
mediate through digital payments platforms we risk an erosion
of our privacy and autonomy. If massive centralized databases
are used to record and mediate payments rather than
blockchains, the administrators of these databases will become
incredibly powerful and also incredibly vulnerable to cyber
attack. For example China's economy is increasingly cashless.
Cash accounted for 96 percent of payments in 2012, today that
number is below 15 percent. Today mobile payment platforms like
AliPay and WePay account for over $16 trillion annually--over
100 times than in the United States. Everything you buy is
noted by these financial intermediaries and can be used as an
input to your Social Credit score. As an Alibaba executive told
a Chinese magazine in 2015, the company judges the purchases
consumers make. ``Someone who plays video games for 10 hours a
day, for example, would be considered an idle person, and
someone who frequently buys diapers would be considered as
probably a parent, who on balance is more likely to have a
sense of responsibility.'' This is a self-evident threat to the
privacy of citizens but it also jeopardizes their freedom and
autonomy. The centralization of these platforms and the
unavailability of cash alternatives means that a citizen
disfavored by his government (perhaps a bit too idle) can, with
little effort, be blocked from transacting and systematically
excluded from economic life.
Q.9. Some say that cryptocurrencies are more secure from
privacy attacks than traditional currencies given their
decentralized, anonymous nature and use of a private key, with
individuals alone maintaining access to their data. Others
counter that these same features actually make these currencies
less secure.
Where do you fall on this spectrum and what evidence
supports your viewpoint?
A.9. Cryptocurrencies are more secure from attacks than
traditional currencies because transactions occur on a public
blockchain (thefts are immediately evident) and individuals can
control their own keys (meaning that no single organization's
negligence would inherently endanger everyone's security). That
said, once cryptocurrency is stolen, there is no centralized
party who can reverse the transactions. Thus while these tools
may be less vulnerable to attack; attacks may be harder from
which to recover.
Q.10. Currently, it appears that many users view
cryptocurrencies more as an investment opportunity than a
viable, useable currency. Cryptocurrency is highly volatile and
lacks any substantive backing. Our fiat currency, while not
tethered to a material commodity, is backed by the Federal
Government and is partly secured by its usability as a payment
for taxes.
Can crypto, as a purely digital currency with no backing,
ever be practically and reliably used as a common currency?
A.10. Even with its current volatility Bitcoin can be useful as
a store of value or as a currency substitute in regions of the
world where sovereign currencies have been debased or are
otherwise unavailable to persons wishing to transact.
Similarly, even with its current volatility these currencies
may be superior for micropayments (which are non-economical if
interchange fees are larger than the amount being transacted)
or for machine-to-machine payments (because devices cannot have
bank accounts). It's difficult to speculate about the future of
digital currency volatility, just as all economic prediction
under uncertainty is fraught. However, we could imagine that if
a large number of persons used these currencies for payments
and wealth storage rather than as speculative investments, the
volatility may smooth.
Q.11.a. You've stated that Vitalik's trilemma is a challenge
and not an impossibility.
Can you expand, conceptually, on how a system could be
scalable, decentralized and secure?
A.11.a. Several efforts are underway to achieve these values
simultaneously. We can discuss Bitcoin alone to give an
example. Bitcoin is already highly secure. While individual
exchanges with poor security practices have been hacked, the
blockchain itself has never been hacked. Bitcoin, however,
lacks some level decentralized because of the concentrated
power of proof-of-work miners, but solutions are already being
implemented to address this issue.
Currently the lumpy bits of Bitcoin's mining distribution
are made up of powerful ``mining pools.'' Several individual or
business miners will voluntarily join a pool in order to obtain
more smoothed out payments than if they mined by themselves. A
single miner working alone may win a new block reward once
every 2 years but several working together will win regularly
and can divide the profits pro rata amongst themselves. A pool
administrator is the entity who shows up on the blockchain as
generating the blocks for the pool--so one administrator may
seem to have 20 percent of the mining power but she is merely
aggregating mining power from hundreds of participants. If a
pool administrator attempts to attack the network or simply is
considered too powerful then individual people tend to leave
the pool, meaning that administrator's share of power in the
system declines. This is a natural check on too much
centralization. The root cause of this problem, however, is
that the pool administrator is the one who chooses which
transactions to put into a block. This is why a powerful pool
could afford its administrator the ability to censor
transactions. There's already a fix for this, however, and it's
called BetterHash. In BetterHash pools, the individual
participants of a pool get to choose which transactions they
want to include when they perform the work and send it to the
administrator. Thus the administrator has no ability to censor
transactions and only plays a role in smoothing economic
returns for participants. This decreases the centralization of
Bitcoin without decreasing scalability or security.
Similarly, the Lightning Network increases scalability but
does not require increased block sizes to accomplish that feat.
Larger blocks would increase the infrastructure costs of mining
which would inherently increase centralization (fewer parties
can afford the higher fixed costs of getting started), so
Lightning can enable scalability without increasing
centralization. BetterHash and Lightning are merely two
examples of technical solutions to Vitalik's trilemma. It is a
challenge being addressed by brilliant developers, not an
impossibility.
Q.11.b. How far away are we from developing such a system and
is there a place for cryptocurrency without it?
A.11.b. This is difficult to predict. It was impossible to
stream high definition video over the internet in the early
1990s but many had reasonable predictions that it would
eventually work. Even without the scalability or
decentralization improvements described above, cryptocurrencies
like Bitcoin can play an important role as a store-of-value for
persons without access to traditional financial tools and
networks, or persons looking to hedge risks inherent in those
networks.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR COTTON FROM PETER VAN
VALKENBURGH
Q.1. The United States has long been the world's most appealing
market for development and innovation, creating economic
opportunity for millions of people. Within the cryptocurrency
space however, the United States appears to be lagging behind
other countries in the race to become the development and
innovation leader.
Perianne Boring, president and founder of the Chamber of
Digital Commerce, said in a June New York Times piece that our
current crypto regulatory regime is, ``unorganized and
incredibly complicated,'' Michael Arrington, founder of
Arrington XRP Capital, said recently that he will cease
investing in American companies, ``until the SEC clarifies
token rules.'' He further stated he is looking to move his
operations out of the United States due to the regulatory
uncertainty surrounding the space.
In order to make the United States a market leader, should
the SEC create a sandbox that allows for regulatory
experimentation and innovation in the currency and blockchain
market?
A.1. The best thing the SEC can do to make the United States a
market leader is to create greater regulatory certainty around
their application of securities laws to tokens. Specifically,
the SEC should clarify that securities laws do not apply to
functional tokens
powered by decentralized networks (e.g., Bitcoin, Ethereum, and
others) but do apply to promises of future tokens made by
promoters to investors. By and large, the recent statements of
Director Hinman and the remarks of Chairman Clayton create this
certainty. We do not prefer a sandbox approach because it, by
necessity create bespoke regulatory standards for individual
companies, eroding the uniformity of the rule of law and
offering preferential treatment to select firms.
Q.2. Most Americans want to work in legitimate blockchain and
cryptocurrency operations. Is our legal system set up to make
American the best place to be?
A.2. Our constitutional protections for free speech and
prohibitions on warrantless search make America a welcoming
home for developers of cryptocurrency and public blockchain
software. However, two policies could be improved to make the
United States more friendly to innovators. The State-by-State
licensing regime for money transmitters has costly redundancies
and inappropriately tailored compliance obligations.\1\ Tax
policy could also be improved, even small transactions in
cryptocurrency trigger capital gains tax such that basis must
be calculated and taxes paid whenever minor purchases, e.g., a
cup of coffee, are made using cryptocurrency.\2\ Finally, while
the current policy of the SEC with respect to classifying
tokens as cryptocurrencies as securities is wise, as described
above, it could be codified to provide additional certainty
that future administrations or interpretations do not confuse
this application of law.
---------------------------------------------------------------------------
\1\ See our research on State money transmission licensing here:
https://coincenter.org/entry/federal-alternative-to-state-money-
transmission.
\2\ H.R. 3708, https://www.govtrack.us/congress/bills/115/hr3708.
Q.3.a. Is there anything Congress should do to ensure that we
don't wake up in 5 years and find that all the cryptocurrency
---------------------------------------------------------------------------
and blockchain experts are in China or Russia?
A.3.a. Congress could pass laws that preempt State money
transmission licensing obligations (as described above) and
create new uniform and reasonably calibrated consumer
protections in their stead. Congress could pass laws that
rationalize tax treatment with respect to small transactions
and capital gains (as described above). Congress could pass a
law codifying the current interpretation of the SEC with
respect to which technologies are and are not securities (as
described above).
More generally, Congress can continue to honor and protect
our constitutional freedoms by not passing laws that would seek
to abridge those freedoms in return for the illusion of
security. The freedom of persons to write software code related
to these technologies (as guaranteed by the 1st Amendment) and
the freedom from warrantless search (as guaranteed by the 4th
Amendment) are America's best advantages with respect to
providing a friendly home for developers building these
critical technologies. These are freedoms not enjoyed by
persons living in repressive regimes such as China or Russia.
While new technologies will inevitably present challenges for
law enforcement and financial surveillance regimes, it is
imperative that we do not chip away at these freedoms
and destroy the dynamism and liberty at the heart of American
ingenuity. Attempts to ban the publication and distribution of
cryptography-related software, for example, would backfire:
these technologies exist and cannot be uninvented. They will
proliferate globally whether we want them to or not. Better
that America lead in these technological discoveries and
pioneer a free society. This will not only preserve American
ideals, it will inevitably make the stability of repressive
regimes less tenable as their people adopt American tools, and
clamor for American freedoms.
Q.3.b. And is there any national security risk for the United
States if other countries are more welcoming, in terms of
business & regulatory climate, of these new technologies?
A.3.b. Yes. The internet was the single greatest creator of
jobs and prosperity in the late 20th century. America was a
welcoming home for innovators building these systems and
therefore continued to prosper culturally and economically.
Public blockchain technologies will likely offer similar
prosperity to the nations that host its pioneers. Moreover,
these systems (both the internet and public blockchain
networks) will continue to be essential to the security of
critical infrastructure both civilian and military. Ignoring
these technologies or forcing innovation overseas could prove
disastrous if it leads to the further erosion of American
expertise in cybersecurity and automation.
Q.4. I've recently heard from several financial institutions
who have seen a growing interest in digital currency purchases.
These banks and credit unions want to be able to meet customer
demand while at the same time protect their customers from
potential market volatility and other risks.
As the cryptocurrency market continues to grow, do you
believe the Federal Government, particularly the financial
regulatory agencies, should play a more active role in
providing guidance to financial institutions on the purchase of
cryptocurrencies?
A.4. As described earlier, a Federal alternative to State money
transmission licensing would provide more cost-effective
regulation of the businesses that exchange cryptocurrencies for
customers. Additionally, we welcome the OCC's FinTech charter
and anticipate clearer guidance on how chartered banks can
safely hold cryptocurrencies on behalf of their customers.
Public Sector
Preamble: Governments across the world are exploring using
blockchain technology to improve government efficiency and
public services. Central banks have experimented as well.
Q.5.a. Do you believe blockchain technology is mature enough to
begin implementing within the public sector?
A.5.a. We do not believe that blockchain technology is mature
enough to warrant wide implementation in the public sector.
Premature adoption could mean poor security for public data and
it could also result in agencies adopting technological means
that are rapidly made obsolete by newer developments. We've yet
to see clear technological winners and losers in this space and
much remains uncertain. This is a necessary stage in the
evolution of new technologies. Just as the Government should
not have immediately switched to email systems for messaging in
the 1970s or
immediately to the web for public communications in the 1990s,
Government should carefully watch but generally not use public
blockchain networks today. Limited pilot programs may prove the
best approach.
Q.5.b. If so, what are some of the applications for blockchain
in our Government that you expect could be successful?
A.5.b. Limited pilots could include using blockchain technology
for identity and access control systems.
Q.6. Would you suggest the Federal Reserve consider using
blockchain in its operations, as some other central banks are
doing?
A.6. Blockchains are most useful when there is not a single
party that everyone is willing to trust. Without this trusted
party to maintain a centralized ledger of transactions,
blockchains present an alternative in systems where parties are
mutually distrustful. Given that we are (and will likely
remain) willing to trust the Federal Reserve's decisions with
respect to monetary policy, there seems little reason not to
also trust them to build and maintain centralized ledgers (such
as FedWire) for clearing and settlement between banks.
Blockchains are not efficient or necessary in such
applications.
Law Enforcement benefits from a thriving crypto/block-
chain industry
Preamble: Similar to the way the creation of anti-virus
software was necessary to combat computer viruses obtained
through the internet, new technology will be required to track
and prevent crypto or blockchain-related illicit financial
activity.
Q.7. What regulatory changes can Congress or the executive
branch make to ensure that American companies have the best
ability to develop the necessary technology and help law
enforcement combat illegal activity in the crypto and
blockchain space?
A.7. The best step that Congress and the executive branch can
take, is allowing security researchers to do their work
unfettered by ill-conceived rules and laws intended to prevent
illicit finance by placing limits on fundamental technological
research and development. Anti-virus software manufacturers
must--by necessity--obtain, study, and even publish virus
software publicly in order to develop these defenses. The same
is true for persons doing research into blockchains and their
illicit use. Technology inevitably leads to arms races between
criminals and law enforcement. Laws that try to deny persons
access to these new technologies, whether by banning their
publication or otherwise limiting public access, do not benefit
law enforcement, instead these ill-conceived policies benefit
criminals who--by definition--have no respect for law and would
therefore have a monopoly on the development and use of these
tools should they be banned or made hard to obtain through law.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED FROM PETER VAN
VALKENBURGH
Q.1.a. Ten or twenty years from now, what is the best case
scenario for our economy, especially for consumers and mom-and-
pop businesses, with respect to cryptocurrencies?
A.1.a. These technologies will be as generative for prosperity
and freedom as the internet has been. The best case scenario is
that good policies encourage innovators to build public
blockchain technology here and that America is able to reap the
job growth and cultivate the security expertise inherent in
those efforts.
Q.1.b. What is the worst case scenario?
A.1.b. The worse case is for these developers to be forced
overseas through bad policy.
Q.1.c. What should we be doing now at the Federal level to
drive toward the best case scenario?
A.1.c. Congress could pass laws that preempt State money
transmission licensing obligations and create new uniform and
reasonably calibrated consumer protections in their stead.\1\
Congress could pass laws that rationalize tax treatment with
respect to small transactions and capital gains.\2\ Congress
could pass a law codifying the current interpretation of the
SEC with respect to which tokens and cryptocurrencies are and
are not securities.
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\1\ See our research on State money transmission licensing here:
https://coincenter.org/entry/federal-alternative-to-state-money-
transmission.
\2\ H.R. 3708, https://www.govtrack.us/congress/bills/115/hr3708.
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More generally, Congress can continue to honor and protect
our constitutional freedoms by not passing laws that would seek
to abridge those freedoms in return for the illusion of
security. The freedom of persons to write software code related
to these technologies (as guaranteed by the 1st Amendment) and
the freedom from warrantless search (as guaranteed by the 4th
Amendment) are America's best advantages with respect to
providing a friendly home for developers building these
critical technologies. These are freedoms not enjoyed by
persons living in repressive regimes such as China or Russia.
While new technologies will inevitably present challenges for
law enforcement and financial surveillance regimes, it is
imperative that we do not chip away at these freedoms and
destroy the dynamism and liberty at the heart of American
ingenuity.
Attempts to ban the publication and distribution of
cryptography-related software, for example, would backfire:
these technologies exist and cannot be uninvented. They will
proliferate globally whether we want them to or not. Better
that America lead in these technological discoveries and
pioneer a free society. This will not only preserve American
ideals, it will inevitably make the stability of repressive
regimes less tenable as their people adopt American tools, and
clamor for American freedoms.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER FROM PETER VAN
VALKENBURGH
Q.1. Many have speculated that blockchain technology or
decentralized computing will revolutionize every aspect of our
economy.
Why haven't we seen a breakout star application using
decentralized computing yet?
A.1. The internet may be a good analogy to answer this
question. Development of the networking standards that would
become the internet that we know today began as early as the
1960s. Email, arguably the first ``killer app'' was not
invented until the mid-1970s. Even then, it was not in wide use
until the commercial internet began to grow in the 1990s. It
wasn't until 1991 that the web (which is synonymous for most
with the internet) was invented, and the first web browser
(Mosaic) was not released to the public until 1993. Google was
founded in 1998 and Facebook in 2004. So, given that
decentralized computing is as radical and experimental a
departure from existing technology as the internet was when it
was first being developed, it may not be surprising that in the
10 years since Bitcoin was invented we have yet to see a
mainstream ``killer app.''
Q.2. What is the best use case you've heard of for blockchain
technologies or decentralized computing and their prospects for
development and launch?
A.2. The best use case is payments without the need for a
third-party intermediary. This is what cryptocurrencies like
Bitcoin provide today. Perhaps more exciting from a commercial
vantage point is the promise they hold to make true
microtransactions economically feasible for the first time.
Q.3. What led to the collapse in cryptocurrency prices this
year? Did the introduction of the Bitcoin futures contract have
anything to do with it?
A.3. This is beyond the scope of my expertise.
Q.4. What approaches are other countries taking toward the
regulation of cryptoassets? Are they appropriate?
A.4. The Library of Congress has published a comprehensive
breakdown of cryptocurrency regulation nation-by-nation, we
recommend this as a resource to the Senator if he has country-
specific questions.\1\ Approaches by the G20 member states
vary, however, application of existing Anti-money laundering
controls to financial institutions dealing in cryptocurrencies,
as FinCEN did in 2013, is a common approach. We do not believe
that nations should ``eliminate the anonymity'' that
cryptocurrencies may afford; to do so would harm the legitimate
privacy interests and rights of citizens. Rather, we believe
that states should balance the rights of their citizens to
privacy against the need for law enforcement to obtain
information about criminal activities. This balance has already
been struck in the context of existing forms of money, like
cash transactions, and mere application of these same laws to
financial institutions dealing in cryptocurrency is the best
path forward. FinCEN has already offered guidance explaining
why existing laws apply and all major U.S. cryptocurrency
exchanges of which we are aware now comply with these data
collection obligations.
---------------------------------------------------------------------------
\1\ https://www.loc.gov/law/help/cryptocurrency/world-
survey.php?loclr=ealrr.
Q.5. Mr. Roubini, in his testimony, describes Vitalik Buterin's
``inconsistent trinity'' in blockchain--that you cannot have at
---------------------------------------------------------------------------
the same time scalability, decentralization, and security.
Q.5.a. Is that an accurate description?
A.5.a. It is not an accurate description, as Buterin has stated
himself to Roubini. Firstly, what Roubini refers to as the
``inconsistent trinity'' or ``impossible trinity'' was posited
by Buterin as the ``scalability trilemma,'' and that is how
computer scientists refer to the problem. This trilemma simply
states that is it difficult--not impossible--to achieve
decentralization, scalability, and security at the same time in
a crypto network. However, it is not an either-or proposition;
it's a matter of tradeoffs along a scale.
Q.5.b. Do you believe proof of work consensus is scalable?
A.5.b. It is likely that proof-of-work consensus can scale
efficiently. Proof-of-work does, indeed, use large amounts of
electricity (discussed in the next answer), however the number
of transactions on the network does not affect the amount of
energy used. Thus a Bitcoin network processing only five
transactions per second would use about as much electricity as
one processing thousands per second. Miner energy usage moves
up or down with the amount of competition between miners, not
the number of transactions being validated. Digital signature
validation uses a trivial amount of computing power. A 3-year-
old laptop can verify a signature in a matter of milliseconds,
and the energy used would be undetectable in an electrical
bill.
Why is there so much competition driving so much energy
usage? Economics. Bitcoins are expensive, and every 10 minutes
one miner will get 12.5 new ones. This competition is healthy
because it means that the effort spent securing the network
scales automatically with the value of the transaction data on
the blockchain. So the more value there is riding on the
Bitcoin network, because individuals value it more as reflected
in the price, the more resources will rationally be devoted to
the network's security. That makes for a noteworthy contrast
with data secured by, say, Equifax or any other big data
company where effort spent securing data scales with a
corporate management team's estimation of risks and fear of
liability.
This competition may get less fierce as time goes on. The
reward of new bitcoins halves every 4 years until it goes
effectively to zero. Miners will keep working because they can
also collect fees that users of the network add to their
transaction messages, but the total take-home payment for a
winning miner will probably be less than it is today even if
the price of a bitcoin continues to rise. Smaller rewards will
mean less computing power dedicated to winning and less
electricity consumed.
Q.5.c. What do you think of his argument that proof of stake
results in a centralization and concentration of mining power?
Does that concern you?
A.5.c. Credible estimates have concluded that a single proof-
of-work-based cryptocurrency like Bitcoin consumes as much
power annually as a developed nation like Ireland. And as the
value of Bitcoin grows, the energy consumption is estimated to
grow even greater. And that's just for a single of the many
cryptocurrencies that rely on a proof-of-work consensus
mechanism.
Q.6. In light of last week's report from the UN's Panel on
Climate Change that the world has at most a decade to
comprehensively address climate change, shouldn't all
cryptocurrency efforts be
focused on less energy intensive, proof-of-stake-based crypto-
currencies?
A.6. Whether cryptocurrencies are contributing to climate
change is not exclusively a question about the consensus
mechanism that they use. Perhaps more important is what kind of
energy they use.
Energy use is not bad in and of itself. It is greenhouses
gases that are bad, but it's not a given that Bitcoin will, on
net, worsen greenhouse emissions in the long run. In fact, if
Bitcoin mining becomes the dominant driver of energy
consumption on the planet, then that could be a good thing for
the environment. Just as the consumer electronics revolution
drove the massive computing efficiencies known as Moore's law;
the Bitcoin revolution could drive a similar explosion of
innovation in clean efficient energy.
Aluminum smelting consumes about 3 percent of the entire
global supply of energy, yet we don't read articles raising the
alarm on unibody MacBook Pros like we see about Bitcoin.
Smelting isn't often thought of as a problem because heavy
industry drives electricity efficiency. Why? Because heavy
industry is a big consumer, so they're always looking for the
cheapest possible source of electricity.
Heavy industry can generally be based anywhere, and
electrical costs tend to be a large percentage of their total
costs. Electricity is 40-45 percent of costs to chemicals
manufacturing (like chlorine production) and a whopping 30-50
percent of costs to steel and aluminum smelting. That means
that heavy industry will base itself where costs are lower, and
that will tend to be wherever electricity is affordable because
its production is more efficient. Demand drives supply and thus
rewards those who develop cheaper modes of electricity
generation. Lately that has roundly been a green affair. The
cheapest electricity on the planet is now wind and solar
energy. Geothermal and hydroelectric are also top contenders
and don't have to deal with storage issues.
However, electricity costs may not always be top of mind
for your typical heavy industry proprietor. They may put up
with expensive, dirty energy if other costs drive their
decisionmaking. Industries also like to be where their
customers are, where it is cheap to ship material inputs like
metal, and where governments grant them subsidies in order to
encourage industrial growth.
But electricity costs matter even more to a Bitcoin miner
than typical heavy industry. Electricity costs can be 30-70
percent of their total costs of operation. Also, Bitcoin miners
don't need to worry about the geography of their customers or
materials shipping routes. Bitcoins are digital, they have only
two inputs (electricity and hardware) and network latency is
trivial as compared with a truck full of steel. One miner moved
an entire GPU farm across the United States because of cheap
hydroelectric power in the Pacific Northwest and, in his words,
``it's worth it!'' That's also why we see miners in Iceland or
other places with excess capacity. Aside from beautiful vistas
you can find abundant geothermal and hydraulic power in the
land of volcanoes and waterfalls.
If Bitcoin mining really does begin to consume vast
quantities of the global electricity supply it will, it
follows, spur massive growth in efficient electricity
production--i.e., the green energy revolution. Moore's Law was
partially a story about incredible advances in materials
science, but it was also a story about incredible demand for
computing that drove those advances and made semiconductor
research and development profitable. If you want to see a
Moore's-Law-like revolution in energy, then you should be
rooting for, and not against, Bitcoin. The fact is that the
Bitcoin network, right now, is providing a $200,000 bounty
every 10 minutes (the mining reward) to the person who can find
the cheapest energy on the planet. Got cheap green power?
Bitcoin could make building more of it well worth your time.
Q.7. I've heard a lot about how a lack of a clear regulatory
framework for cryptocurrencies, particularly regarding the
status of whether or not a token is a security, is hindering
innovation.
Q.7.a. What would be the effect in the cryptocurrency industry
of the SEC setting out clear guidelines for determining whether
or not a crypto asset is a security?
A.7.a. Lack of clarity has led high-quality entrepreneurs and
investors to avoid risking time and capital on otherwise
promising novel projects and business models. It has also
allowed scammers to pretend the securities laws don't apply to
the schemes they are pedaling. Greater clarity would allow
investors and entrepreneurs to come safely off the sidelines,
and would make clear that certain schemes are frauds. That
said, the SEC has done an admirable job, in a relatively short
period of time, of providing much of the clarity that
innovators have sought.
Q.7.b. Do you think Congress should take action?
A.7.b. The SEC has been slowly, but surely, providing the
needed clarity by explaining how it interprets the securities
law. In particular, see a speech given in June by the Director
of the SEC's Division of Corporation Finance, William
Hinman.\2\ There are still certain questions that remain open,
and to the extent the SEC does not answer them it may be
appropriate for Congress to do so, but there's no reason to
think the SEC won't continue to provide further clarity.
---------------------------------------------------------------------------
\2\ https://www.sec.gov/news/speech/speech-hinman-061418.
---------------------------------------------------------------------------
Q.7.c. What would you propose?
A.7.c. At this point, to take a wait-and-see approach. That
said, the guidance contained in the Hinman speech was just
that--guidance--and the securities laws could be interpreted
differently by a future Commission. It might be useful for
Congress to codify the principles outline in the Hinman speech.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORTEZ MASTO FROM
PETER VAN VALKENBURGH \1\
---------------------------------------------------------------------------
\1\ Peter is Director of Research at Coin Center, the leading
independent nonprofit research and advocacy group focused on the public
policy issues facing cryptocurrency technologies such as Bitcoin. This
testimony is based largely on a report published by Coin Center. See
Peter Van Valkenburgh, ``Open Matters: Why Permissionless Blockchains
are Essential to the Future of the Internet'' Coin Center (2016)
https://coincenter.org/entry/open-matters.
---------------------------------------------------------------------------
Q.1. If a State were to use a stable Blockchain token as a
store of value, would that be considered coinage?
A.1. The Constitution permits Congress to coin money in Article
1, Section 9 and denies States the power to coin or to print
their own money in Article 1, Section 10. This is called the
coinage clause. If a State merely used an existing blockchain
token or crypto-
currency for payments or investment purposes, this would not,
we believe, be coinage. If on the other hand a State decided to
create and issue its own Blockchain token, then the State may
well be coining money, contravening the constitution.
Q.2. What is the best way to crack down on the use of
cryptocurrencies to finance illegal transactions dealing with
drug and sex trafficking?
A.2. Applying existing Bank Secrecy Act recordkeeping and
reporting requirements to financial institutions even when
those institutions deal in cryptocurrencies for their customers
is the best way to crack down on the use of these tools for
illegal transactions. FinCEN made these obligations clear to
businesses holding and transmitting cryptocurrencies in its
2013 Guidance and since then all major U.S. cryptocurrency
exchanges of which we are aware now comply with the Bank
Secrecy Act. The data provided by these regulated exchanges to
FinCEN and law enforcement is essential to identifying illicit
uses of the technology.
Q.3. What are G20 member states doing to regulate crypto-
currencies and eliminate the anonymity they supposedly afford?
A.3. The Library of Congress has published a comprehensive
breakdown of cryptocurrency regulation nation-by-nation, we
recommend this as a resource to the Senator if she has country-
specific questions.\2\ Approaches by the G20 member states
vary, however, application of existing anti-money laundering
controls to financial institutions dealing in cryptocurrencies,
as FinCEN did in 2013, is a common approach. We do not believe
that nations should ``eliminate the anonymity'' that
cryptocurrencies may afford; to do so would harm the legitimate
privacy interests and rights of citizens. Rather, we believe
that states should balance the rights of their citizens to
privacy against the need for law enforcement to obtain
information about criminal activities. This balance has already
been struck in the context of existing forms of money, like
cash transactions, and mere application of these same laws to
financial institutions dealing in cryptocurrency is the best
path forward. FinCEN has already offered guidance explaining
why existing laws apply and all major U.S. cryptocurrency
exchanges of which we are aware now comply with these data
collection obligations.
---------------------------------------------------------------------------
\2\ https://www.loc.gov/law/help/cryptocurrency/world-
survey.php?loclr=ealrr.
Q.4. Do you think bank customers should be able to buy
cryptocurrency from their bank accounts without worrying that
---------------------------------------------------------------------------
their bank account could be closed if they do?
A.4. Yes. If customers are unable to buy cryptocurrency though
regulated financial institutions they will be more likely to
seek cryptocurrency through unregulated channels, e.g., face-
to-face trading for cash. This would decrease the amount of
information available to law enforcement investigating illicit
transactions.
Q.5. Should cryptocurrency customers have their cryptocurrency
purchases taxed? Such as sales tax, capital gains, etc.?
A.5. State sales tax is generally only imposed on purchases of
tangible personal property and not on purchases of intangible
property except for State-specified digital goods. See, for
example, TAM--2015-1(R)--Issued July 28, 2015 by the New Jersey
Tax Authority.\3\ Cryptocurrency sold as an investment should
be taxed as a capital gain and the IRS has clearly articulated
this policy.\4\ We believe there should be an exemption from
capital gains taxation for small sales of cryptocurrency made
for retail purposes, e.g., when someone uses Bitcoin to buy a
cup of coffee. This would mirror an exemption from capital
gains taxation for purchases made in foreign currency, e.g.,
when someone buys a baguette with euros they purchased in
advance of a trip to Europe. A bill has been introduced in the
House that would create this exemption.\5\
---------------------------------------------------------------------------
\3\ https://www.state.nj.us/treasury/taxation/pdf/pubs/tams/tam-
2015-1.pdf.
\4\ Notice 2014-21 https://www.irs.gov/pub/irs-drop/n-14-21.pdf.
\5\ H.R. 3708, https://www.govtrack.us/congress/bills/115/hr3708.
Q.6. Should initial coin offerings be regulated as securities,
---------------------------------------------------------------------------
commodities, or currencies? Are they legitimate investments?
A.6. If an initial coin offering meets the existing test used
by the SEC to determine whether an offering should be
registered as a security then is should be regulated as such.
This test, known as the Howey test, is met when a purchaser
invests her money in a common enterprise with an expectation of
profits dependent on the promised efforts of the ICO promoter
or some other third party. Tokens traveling on a blockchain
that is functional and decentralized (rather than merely a
hypothetical future blockchain being promised by an ICO issuer)
are not securities and should be regulated as commodities and
as currencies if they are used as currency substitutes. While
several ICOs have been fraudulent; many have also been
legitimate investments in new technologies.
Q.7. Should cryptocurrencies have the same investor
protections, the same rules against market manipulation and
market fraud? Should they have adequate disclosures and
investor protections? The same as bonds and stocks have?
A.7. Cryptocurrency offerings that qualify as securities as
described above should have identical investor protections as
traditional securities including adequate disclosures. This is
the official policy of the SEC at present. Cryptocurrencies
that are not securities are commodities and the CFTC has
authority to police these cryptocurrency spot-markets where
there is evidence of fraud and manipulation.
The Securities and Exchange Commission, the Commodities
Futures Trading Commission and the Financial Crimes Enforcement
Network are all underfunded. Monitoring these constant new
cryptocurrencies is putting a further strain on their
resources.
Q.8. Please provide, if any, letters to legislators or
statements from crypto firms seeking appropriations for
regulators so they can better monitor these investments.
A.8. Apologies, but we are aware of no such letters. Coin
Center is not an industry association; we are a nonprofit
research and advocacy organization focused on educating members
of the Government on the subject of public blockchain
technologies.
Q.9. What funding level for these agencies would virtual
currencies and Blockchain firms support to ensure consumer and
investor protections?
A.9. We do not have an opinion on this matter.
Q.10. Last summer, Forbes and the New York Times published a
story about hackers stealing mobile phone numbers. Hackers
stole phone numbers, reset someone's password and then looted
their virtual currency wallets. It looks like telephone-based
security is not safe.
Q.10.a. Can you describe steps owners of cryptocurrencies
should do to prevent these thefts? What about the exchanges
themselves? And the phone companies? And Federal and State
agencies?
A.10.a. Phone numbers have been used as a second factor for 2-
factor-authentication at many cryptocurrency exchanges. This
means that the customer must remember and enter a password to
login but she must also repeat a unique and ever-changing code
that is sent to her by text message. It is true that hackers
have convinced phone companies to assign numbers to the
hacker's mobile phones in order to fraudulently obtain this
second factor for log-in. It is true that some hackers have
succeeded in stealing funds with this approach. Users should
not rely on phone numbers for 2-factor-authentication. They
should use device-specific tools like Google Authenticator
instead. These tools cannot be reassigned to other devices by
phone companies. Federal and State agencies should ensure that
phone companies do not reassign phone numbers of their
customers without robust proof that the request is coming from
the customer themselves and not from a hacker.
Q.11. How can we either avoid mobile phone hacks or tell people
that doing financial business on a mobile phone could open you
up to theft?
A.11. Nothing about mobile phones makes activities performed
while using them inherently vulnerable to hacking. The problem,
as described above, is that the phone's number is assigned by a
phone company to an individual's device and hackers can
convince phone companies to improperly reassign numbers by
impersonating subscribers over the phone. This vulnerability
stems from centralized companies being incapable of properly
securing the integrity of data and ledgers related to their
customers. Longer term, public blockchain networks could
provide an alternative method of storing and maintaining the
integrity of user data, just as the Bitcoin blockchain secures
the data relevant to all Bitcoin transfers, without relying on
trusted third parties like phone companies.
Q.12. In your testimony, you mentioned women from an African
nation who were paid in bitcoin to retain their earnings
instead of being forced to give their income to their husbands.
How were the women able to spend their bitcoins? On what goods
and services? How were those goods and services priced? What
exchange fees were charged for transactions?
A.12. The woman I mentioned is Roya Mahboob and she is from
Afghanistan. The primary use of Bitcoin in her story is as a
store of value for women, as an alternative to savings
accounts, which banks will not offer women, or cash which will
often be stolen if stored in the home. As such, I am not aware
of any details about spending activities. You can read more
about Mahboob's story here: https://www.ibtimes.com/afghan-
tech-entrepreneur-uses-bitcoin-empower-women-2575881.
Additional Material Supplied for the Record
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