Most cryptocurrency observers are living in very different worlds. Critics predict an imminent collapse of the Bitcoin bubble and call for outright bans, while crypto-proponents are still waiting for the crypto-revolution and demise of government currency. The recent wave of attention to cryptocurrencies has left more confusion than clarity, which has been counterproductive in regulatory efforts.
This is not because one side or the other is inherently wrong about cryptocurrency. Rather, it is because we have relied for too long on language from the last decade. As the digital currency space grows at break-neck speeds, the terminology of ‘cryptocurrencies’ has become increasingly unhelpful. In working to craft regulation that balances innovation and risk, the term has reached a point of near uselessness.
‘Cryptocurrency’ refers to an extremely broad class of instruments that use encryption to make transactions secure. The terminology is helpful because it distinguishes new technology from old ones, which required some entity to oversee transactions. However, this is like distinguishing bank vaults by the kind of lock they use. While it helps to separate technologies of security, it does nothing to tell us what is inside the vault – or in this case, what economic activity is being secured.
The ambiguity in our language is an issue for decisions on how to regulate cryptocurrencies. Specifically, it allows us to imagine that all of these instruments conveniently fall into a single bin. The inconvenient truth for critics and proponents alike is that the things we call cryptocurrencies vary quite a lot in what they are designed to do. As a result, different cryptocurrencies require unique regulation.
If you download (or open) a cryptocurrency trading app, you will find a long list of different digital tokens you can buy and sell. We call all of these cryptocurrencies – and indeed, most of them use encrypted ledgers. Beyond this, though, these coins could not be more different. Where Bitcoin and some others are designed to actually work as currencies in a traditional sense of the word, other coins are a far cry from what we would call money or currency. In fact, many resemble currencies far less than they look like other, very different economic instruments.
Some cryptocurrencies more closely resemble private money like the kind used in banking. Chainlink and Band protocol are examples of ‘oracle tokens’, which allow blockchains and smart contracts to interface with external data. These are important components in the budding decentralized finance space, which seeks to make a digital Wall Street. Grouping these coins in as ‘currency’ misses the crucial role they serve in propping up new economic markets and actors, much like other private money in history.
Other cryptocurrencies look a lot like equities. ICP, for example, is a token designed to power the network behind the Internet Computer, a new initiative designed to decentralize the web. Orchid, Golem, and other coins fall under this group of ‘utility tokens’ which power a blockchain network. These tokens allow blockchains to operate and offer services without central management and are better understood in a corporate ownership framework than as currency.
Yet other tokens are instead much more like derivatives, as they find value from building on top of other cryptocurrencies. Many of these tokens exist to address inefficiencies in other digital currencies’ networks. Polygon, for example, is something called a ‘layer 2 protocol,’ which is designed to decongest the Ethereum network and lower fees associated with sending money. We don’t need to look more than 15 years in the past to see what mismanaged derivatives can do to a market when they are grouped in with other instruments.
We use different words for equities, private money, and derivatives because they are designed to do different things. For the same reason, we would not apply identical regulations to such different instruments in the economy. Current efforts at the SEC, Federal Reserve, and Treasury are likely to falter without nuance in identifying what, precisely, is being regulated. The current single-moniker approach is a head-down, not head-on approach to managing this growing market.
In order to meaningfully balance innovation with risk, we need to start with the simple task of updating our language. ‘Cryptocurrency’ may be a convenient term for pundits seeking to win applaud from either side, but for the hard work of governing, we must pay more attention to what these instruments do, and name them accordingly.
Tim Marple 