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Speaker 1: I'm Stacy Marie Ishmael, Managing editor of Crypto for Bloomberg News.

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Speaker 1: And this is Bloomberg Crypto, a daily Bloomberg I Heart podcast.

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Speaker 1: It's Tuesday, July five. In June, Senators Kristin Jill Brand

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Speaker 1: and Cynthia Lumas introduced a sweeping Senate bill that would,

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Speaker 1: if successful, attempt to regulate crypto assets. I don't think

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Speaker 1: any bill can satisfy everyone, but I think this is

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Speaker 1: a really great start because our goals are simple. We

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Speaker 1: want to create safety and soundness in the American market.

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Speaker 1: We want transparency and accountability, and we want to have

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Speaker 1: consumer protections. Influential crypto insiders hailed this proposal as a

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Speaker 1: great starting point, a reception that suggests it might be

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Speaker 1: perceived as relatively friendly to the people it's supposed to

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Speaker 1: be regulating in the digital asset community. Hillary Allen, a

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Speaker 1: law professor at American University, is among those who think

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Speaker 1: that the proposed legislation just doesn't go far enough, especially

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Speaker 1: when it comes to consumer protection. She joins me now,

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Speaker 1: Professor Allen, thank you so much for joining us today.

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Speaker 1: It's a pleasure to be here. Thank you for having me.

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Speaker 1: You have I think if ever, somebody were to invent

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Speaker 1: a profile for somebody who feels, you know, like the

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Speaker 1: right person to comment on financial regulation, it does seem

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Speaker 1: to be the one that you have. You have written

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Speaker 1: a book about fintech, You are a professor who sort

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Speaker 1: of studies these things professionally or academically at least, and

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Speaker 1: you've had some pretty incisive commentary in the past couple

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Speaker 1: of months about your concerns over you know, financial stability

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Speaker 1: and the threats that crypto appears to pose to financial stability.

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Speaker 1: Can you say a little bit more about this proposed

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Speaker 1: legislation from these senators and like what your first, second,

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Speaker 1: and maybe third reactions have been to it. I used

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Speaker 1: to work for a law firm partner who if your

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Speaker 1: work was really arable, he wouldn't try to salvage anything

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Speaker 1: from it. He would just start and send it back

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Speaker 1: with something at the top saying start over. And that

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Speaker 1: was my initial reaction to this bill. There's not a

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Speaker 1: lot in here to salvage. The second reaction was, you know,

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Speaker 1: what are the politics going on behind this? It's very curious.

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Speaker 1: I've never seen an industry so happy with proposed legislation

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Speaker 1: that's intended to regulate them. It's almost like champagne corks

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Speaker 1: were popping all over the crypto industry. So those are

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Speaker 1: sort of my broad brush reactions, and then it got

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Speaker 1: into sort of the nitty gritty of the problems, and

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Speaker 1: they're varied from taking jurisdiction away from the sec over

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Speaker 1: things that already fit the definition of securities, to putting

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Speaker 1: stable coins in the banking environment and potentially implicitly putting

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Speaker 1: deposit insurance and government guarantees behind stable coins, to creating

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Speaker 1: regulatory sandboxes that would sort of reverse pre empt federal

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Speaker 1: legislation intended to protect investors and the stability of our

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Speaker 1: financial system. It's a lot of problems. Well, you've named

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Speaker 1: three very specific things that I'd love for us to

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Speaker 1: break down a little bit, and let's let's start from

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Speaker 1: depositary insurance and your concerns about that, because you know,

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Speaker 1: this is something that's often held up as all right,

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Speaker 1: if I'm a consumer, if I have money in a bank,

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Speaker 1: I don't personally qualify for a two and fifty deposit insurance.

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Speaker 1: I do not have any bank balances that are that

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Speaker 1: are that high. But you know the idea is if

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Speaker 1: my bank were to go under I would at least

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Speaker 1: be protected up to a certain amount, and there's no

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Speaker 1: comparable protection for folks who may have their assets in crypto.

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Speaker 1: Why is the way it's constructed that protection is constructed

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Speaker 1: in this bill? Why is that a concern for you? Well,

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Speaker 1: first of all, you know, I do want to say

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Speaker 1: that my heart goes out to the people who are

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Speaker 1: losing their money. You know, Celsius has just suspended redemptions

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Speaker 1: and a lot of people are losing their shirts. And

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Speaker 1: I'm seeing comments on Twitter saying things like, but this

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Speaker 1: is insured, right, and people don't understand that they don't

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Speaker 1: have any guarantee or insurance, and that is heartbreaking for

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Speaker 1: the individuals. But what we need to think about is

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Speaker 1: sort of the big picture when we ensure something. And

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Speaker 1: there are downsides to deposit insurance. So when deposit insurance

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Speaker 1: was introduced in the nineteen thirties after a series of

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Speaker 1: banking panics, there were a lot of economists who were

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Speaker 1: worried about it because it can incentivize some bad behavior

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Speaker 1: on behalf of the banks, because they know that people

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Speaker 1: won't be paying attention, they won't be watching their deposits,

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Speaker 1: and so you know, the banks can take more risks

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Speaker 1: knowing that they can pocket the upside and the downside

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Speaker 1: will be covered by the deposit insurance. So in the end,

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Speaker 1: notwithstanding those concerns, they decided to implement deposit insurance anyway,

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Speaker 1: and I think that was the right decision because of

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Speaker 1: the importance of banks to how our broader economy functions.

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Speaker 1: But if we're talking about stable coins, people keep talking

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Speaker 1: about these being used for payments. They're not used for

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Speaker 1: payments for every day goods and services. They're not very

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Speaker 1: useful for payments for every day goods and services. Where

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Speaker 1: they're being used is to speculate in the decentralized finance space,

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Speaker 1: which or defy um, which is a fancy way of

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Speaker 1: saying that they have created on the blockchain equivalence of

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Speaker 1: a lot of financial products and services that we already have.

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Speaker 1: But because they're on the blockchain, they're operating in an

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Speaker 1: unregulated way. So if we are ensuring stable coins, if

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Speaker 1: we're putting government guarantees behind stable coins, were essentially ensuring

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Speaker 1: people speculative activity in the defy space. And that's not

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Speaker 1: you know, building products and services. That's not employing people

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Speaker 1: in the same way that we think of you know,

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Speaker 1: traditional economic growth, so very loath to put deposit insurance

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Speaker 1: behind this very speculative space. So if I'm hearing you correctly,

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Speaker 1: it's less the idea that insurance equal bad and more

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Speaker 1: the idea that insurance equal risk reward for an activity that,

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Speaker 1: as you're describing it, doesn't seem to qualify to you

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Speaker 1: as like economically valuable exactly. That's a great way of

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Speaker 1: putting it. You're essentially giving people a safety net to

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Speaker 1: gamble um in a way that doesn't create productive use

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Speaker 1: for the rest of the economy. Are there other instances

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Speaker 1: in this bill? You know, because you you name a

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Speaker 1: couple of other things where that's where your reaction is

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Speaker 1: coming from, that these are creating incentives that may sow

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Speaker 1: the seeds of whatever the next crisis is. Absolutely, and

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Speaker 1: I've written about this at length, there are so many

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Speaker 1: parallels between what we're seeing in crypto now and what

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Speaker 1: we saw on the lead up to two thousand and eight.

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Speaker 1: The news from Wall Street has shaken the American people's

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Speaker 1: faith in our economy. The situation where Lehman Brothers and

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Speaker 1: other financial institutions is the latest in a wave of

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Speaker 1: prices that have generated enormous uncertainty about the future of

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Speaker 1: our financial markets. To be clear, I don't think an

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Speaker 1: implosion of the crypto markets right now would cause a

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Speaker 1: broader global financial crisis, but that's really about size and

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Speaker 1: integration with the broader system, rather than it being safer.

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Speaker 1: What we're seeing with crypto is, you know, we're seeing

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Speaker 1: just a far reaching complexity that people can't process, and

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Speaker 1: that makes panics more likely. It makes systems more fragile

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Speaker 1: when you can't see the interconnections of the different parts

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Speaker 1: of the system. We're seeing new ways of creating leverage

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Speaker 1: because people can create tokens out of thin air and

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Speaker 1: then use them as collateral for loans. We're seeing this rigidity,

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Speaker 1: this smart contracts, which are really just computer programs but

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Speaker 1: they run on the blockchain and they automate transactions. We're

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Speaker 1: seeing that rigidity parallel what we saw with mortgage backed

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Speaker 1: securities in the lead up to two thousan eight, where

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Speaker 1: you know, there aren't the opportunity it needs to renegotiate

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Speaker 1: these deals when they're bad for both the consumers and

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Speaker 1: for the system as a whole. And we've seen you know,

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Speaker 1: a bunch of runs on stable claims in the last

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Speaker 1: few weeks that look a lot like the runs that

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Speaker 1: we saw on money market mutual funds in the past.

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Speaker 1: But to your point, these runs don't seem to have

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Speaker 1: that sort of systemic e contagious effect that folks were

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Speaker 1: worried about in two thousand and eight. Yet, right, So

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Speaker 1: that's the thing. So you know, there's um you know,

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Speaker 1: it's a balancing act. You know, you don't want to

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Speaker 1: rush and put government backing behind all of this stuff

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Speaker 1: now because it won't have the systemic effect I think,

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Speaker 1: and it's current iteration. The thing that concerns me most

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Speaker 1: is that as this stuff starts to get integrated with

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Speaker 1: the traditional financial system, which is happening, then we start

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Speaker 1: seeing the tentacles of this stuff spreading into the traditional

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Speaker 1: finance broader economy, and then we're getting to a place

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Speaker 1: where a bailout might be necessary. So proactively to prevent

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Speaker 1: that from happening, I think the most important thing that

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Speaker 1: can happen right now is to set up a separation

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Speaker 1: between banking and crypto instead of encouraging their integration. Interesting

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Speaker 1: We'll be right back with American University law professor Hillary

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Speaker 1: Allen for more analysis of the pros and cons of

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Speaker 1: this big bipartisan piece of proposed crypto regulation. One thing

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Speaker 1: you did mention. You said this on Twitter and one

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Speaker 1: of your threads that you haven't paying attention to is

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Speaker 1: this idea of taxation as it relates to crypto. Can

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Speaker 1: you talk a little bit more about that? Sure, So,

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Speaker 1: taxation for any lawyer is terrifying if they're not a

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Speaker 1: tax lawyer. Um, it's it's the one thing that you know,

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Speaker 1: I teach business law, and I say your one job

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Speaker 1: is to make friends with the tax lawyers so that

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Speaker 1: you have someone to call when tax issues come up.

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Speaker 1: And so the taxation around oundum crypto assets is you know,

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Speaker 1: it is a very important issue that a lot of

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Speaker 1: the people who are talking about crypto sort of deal

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Speaker 1: with as an add on. So, the taxation experts that

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Speaker 1: I have talked to said that this carves out a

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Speaker 1: incredible it is an incredible sort of carve out and

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Speaker 1: give away for um crypto that doesn't exist in other

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Speaker 1: asset classes. And so that ties into this broader picture

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Speaker 1: of why are we giving crypto more favorable treatment on

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Speaker 1: every level than the existing laws accord, Why are we

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Speaker 1: treating crypto securities as different and deserving of a lighter

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Speaker 1: touch regime than regular securities. Why are we giving more

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Speaker 1: preferential treatment to taxation on crypto? And I think it

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Speaker 1: keeps coming back to this issue that I think if

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Speaker 1: the most charitable reading of all of this is that

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Speaker 1: there are a lot politicians that and policymakers who don't

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Speaker 1: want to be seen as anti innovation. When I came

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Speaker 1: to Washington, I found out that very few, if any,

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Speaker 1: members of the Senate had an awareness of how big

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Speaker 1: bitcoin and other digital assets were becoming, and that there

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Speaker 1: was a vacuum of both interest and knowledge about this topic.

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Speaker 1: And yet it was becoming more and more apparent that

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Speaker 1: a framework for regulation was going to be needed. What

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Speaker 1: this bill really says to me is that policymakers are

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Speaker 1: not looking behind the curtain to see what's really going

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Speaker 1: on here. So a lot of the technology that is

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Speaker 1: being trumpeted as being so innovative is really, according to

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Speaker 1: many tech experts, not particularly good. It doesn't scale well,

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Speaker 1: it's slow, it's expensive, a lot of its environmentally castle well.

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Speaker 1: You have compared smart contracts, for example, which is just

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Speaker 1: you know, as you said, contracts that exist on the

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Speaker 1: blockchain to mortgage backed securities. You have compared various elements

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Speaker 1: of defied to credit default swaps and somebody who used

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Speaker 1: to cover both of those things a long time ago.

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Speaker 1: I find those analogies very interesting because the big argument

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Speaker 1: that their proponents made was this is about better risk mitigation.

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Speaker 1: This is about using bleeding edge technology to solve you know,

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Speaker 1: novel problems. And when it blew up, they were like,

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Speaker 1: except under these very specific circumstances, when everything goes wrong

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Speaker 1: at the same time, yep, yep, that's always it. I mean,

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Speaker 1: especially if you're someone like me who pays a lot

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Speaker 1: of attention to financial crises and systemic risks. It's all

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Speaker 1: about the tail events. It's all about the low probability

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Speaker 1: who could have seen this happening, very high consequence events

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Speaker 1: that are not as rare as people think they are. Um,

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Speaker 1: you know, I grew up in Australia and all the

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Speaker 1: Swans they are so yes. Indeed, famously refusing the title

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Speaker 1: of the book, black Swan exactly what we And this

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Speaker 1: is a comment that I've made a lot that It's

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Speaker 1: just it surprises me how short memories are that that

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Speaker 1: these these lessons that we should have learned from the

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Speaker 1: two eight crisis. We have not learned and I think

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Speaker 1: part of the reason why people haven't learned them is

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Speaker 1: because what used to be is just sort of a

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Speaker 1: question of um financial complexity now has this overlay of

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Speaker 1: technological complexity. So to really dissect this and see why

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Speaker 1: none of this is going to work in those tail events,

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Speaker 1: you need to understand both the finance and the tech

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Speaker 1: and those are two very um complicated areas, and so

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Speaker 1: what you need are both kinds of expertise. And that's

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Speaker 1: why I think it's particularly valuable that um uh, Well,

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Speaker 1: it started out with I think twenty three leading technologists,

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Speaker 1: but then the letter was signed by over fifteen hundred

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Speaker 1: other technologists around the world. In a letter to Congress,

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Speaker 1: it was said recently they articulated the technological flaws here,

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Speaker 1: and I'm contributing my expertise on the financial flaws of this.

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Speaker 1: And when you put them together, you see that this

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Speaker 1: is an inherently flawed system that isn't fit for purpose.

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Speaker 1: This being crypto from your perspective, like the whole thing,

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Speaker 1: the whole really the whole thing, um. And so what

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Speaker 1: I would really like to see from policy makers is

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Speaker 1: not a bill like this that accepts at face value

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Speaker 1: the claims of innovation and financial inclusion, but actually interrogates

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Speaker 1: those a little before giving away the store on things

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Speaker 1: like securities, regulation and tax And I think the financial

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Speaker 1: inclusion narrative is particularly pernicious here because we keep hearing

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Speaker 1: that this will you know, this will help the emb

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Speaker 1: bank to people who haven't well. I mean, Jay z

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Speaker 1: and Jack Dorsey just set up a center for educating

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Speaker 1: kids in Brooklyn about the benefits of bitcoin. Nothing could

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Speaker 1: possibly go wrong, nothing could possibly go wrong. It's just heartbreaking.

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Speaker 1: But you know this is rhetoric we've heard before. So

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Speaker 1: in the lead up to two eight, sub prime mortgages

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Speaker 1: were going to be the thing that helped bring people

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Speaker 1: who had been previously excluded from the housing market into

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Speaker 1: the housing market, and in the end it was predatory inclusion.

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Speaker 1: People lost their homes, lost their money, et cetera, and

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Speaker 1: it was the sort of the building blocks for a

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Speaker 1: much broader systemic crisis. Right now, as I mentioned, I

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Speaker 1: don't think the crypto assets are yet the building blocks

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Speaker 1: for systemic crisis because we don't have the integration with

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Speaker 1: the mainstream financial system yet. But it's still predatory inclusion

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Speaker 1: to my mind, So if you invested in bitcoin after

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Speaker 1: December of twenty you would have lost all your money

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Speaker 1: by now. And so you know that's that's everybody who's

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Speaker 1: invested for the first time, which to be a lot

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Speaker 1: of people right there. There have been multiple surveys. I

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Speaker 1: was just looking at a couple of these right before

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Speaker 1: talking to you today, that between half and seventy depending

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Speaker 1: on how you slice it of people who currently own

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Speaker 1: bitcoin invested between now and all of them are underwater,

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Speaker 1: every single one of them. And when you when you

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Speaker 1: start a statistic like that, it really emphasizes that the

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Speaker 1: people who got in early on a lot of this

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Speaker 1: crypto stuff are going to make a lot of money,

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Speaker 1: and it's highly concentrated. This is, you know, the people

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Speaker 1: who have been in here since before, there aren't that

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Speaker 1: many of them, and a lot of them are very

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Speaker 1: very concentrated in terms of wealth. And then the newer arrivals,

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Speaker 1: the people who come in basically since the end of

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Speaker 1: any twenty um, had smaller investments, but had you know,

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Speaker 1: we're not is able to absorb losses, and as I said,

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Speaker 1: every single one of them is underwater. Well, on that note,

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Speaker 1: Professor Allen. I would like to thank you very much

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Speaker 1: for joining me today. You've certainly given all listeners quite

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Speaker 1: a lot to think about, and I will make sure

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Speaker 1: that they know where to find you on the internet.

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Speaker 1: Thanks so much pleasure. You can find Professor Hillary Allen

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Speaker 1: on Twitter at prof Hillary Allen. That's Hillary with one

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Speaker 1: L H I L A R Y on the next

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Speaker 1: episode of Bloomberg Crypto. I'm part of a generation that

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Speaker 1: grew up with the Internet, with social networks that long

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Speaker 1: predated Facebook or Twitter, and with online identities that sometimes

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Speaker 1: felt more authentic than my offline self. Experimenting with who

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Speaker 1: you are online, especially if those identities are really different

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Speaker 1: from how you present in the analog world, it's not

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Speaker 1: a new concept, so it's no surprise that folks are

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Speaker 1: using newish technologies like crypto on the blockchain to play

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Speaker 1: with their self expression. Some folks are even using blockchain

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Speaker 1: enabled structures to monetize these experiments with identity, including their

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Speaker 1: gender presentation. For more on crypto and identity, Bloomberg reports

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Speaker 1: that Emily Nicole and doctoral candidate and researcher Florence Smith

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Speaker 1: Nichols will join me on the next episode of Bloomberg Crypto.

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Speaker 1: I'm Stacy Marie Ishmael, and this is Bloomberg Crypto, a

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Speaker 1: daily podcast from Bloomberg and I Heeart Radio. For more

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Speaker 1: shows from I Heart Radio, visit the I Heart Radio app,

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Speaker 1: Apple Podcasts, or wherever you get your podcasts. Email your questions, comments,

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Speaker 1: or suggestions for the show to Crypto at Bloomberg dot

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Speaker 1: net and you'll find us on Twitter at Crypto. The

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Speaker 1: supervising producer of this episode is Vicky very Galina. Associate

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Speaker 1: producer is Thy Butler. Just to wonder at is our engineer.

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Speaker 1: Original music by Leo Sdrin. Bloomberg's head of Podcasts is

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Speaker 1: francescality As