Utility or Speculation? Dissecting the Pros and Cons of the Crypto Space

Since the publication of your research in 2019, has the cryptocurrency market finally matured into a legitimate investible instrument, or does it still function primarily as a speculative venture capital?

I think there are at least these two different aspects to the current cryptocurrency space.

One is cryptocurrency as a method of payment. There's a lot of interest in using stablecoins because they are pegged to government-issued currency and tend to hold a steady value. In Europe, they're talking now about a European Central Bank issue digital currency, and many financial firms are talking about tokenizing the trading of financial assets, so that part of the crypto space, I think, potentially serves a real purpose. 

The other part of the crypto space is meme coins, which are used primarily for speculation rather than traditional investing. 

For a while, non-fungible tokens, or NFTs, were receiving a lot of attention. 

Editor’s Note: NFTs surged in popularity during the pandemic due to a perfect storm of digital scarcity, celebrity endorsements, and intense financial speculation. By using blockchain technology to verify ownership of digital assets, they created a booming, decentralized collector's market.

Also many Initial Coin Offerings (ICOs) have come and gone. That part of the cryptos space, to me, looks purely speculative. Someone might enjoy gambling with these assets, but they are not really serving any bigger purpose than that. 

Editor’s Note: ICOs largely vanished in their original, unregulated form because the 2017–2018 boom was plagued by widespread fraud, exit scams, and regulatory crackdowns. As authorities strictly applied securities laws, the market pivoted toward compliant and vetted fundraising alternatives.

Transactions in the blockchain are recorded on a decentralized ledger – a digital record of transactions that is continuously updated, shared, synchronized, and verified across a large network of independent computers. How has this type of record keeping failed to provide accountability normally seen in traditional institutions?

The whole point of the decentralized ledger was to eliminate the reliance on institutions of any kind. That part, I've always been skeptical about. For example, if something goes wrong in some transaction you've engaged in in the markets, with the decentralized ledgers, there is no accountability. But if a transaction is placed through a financial institution and something goes wrong, the financial institution is accountable.

Bitcoin, the world’s first decentralized digital currency, is not a particularly useful mechanism for transaction purposes. Because it relies on the so-called Proof of Work concept; Bitcoin is actually slow to record transactions. Other cryptocurrencies such as Ethereum and Ripple, which rely on proof of stake, are much more efficient for recording a transaction. 

Editor’s Note: Proof of Work (PoW) and Proof of Stake (PoS) are the protocols blockchains use to verify transactions. In PoW, used by Bitcoin, "miners" solve mathematical puzzles using specialized hardware, which provides high security but requires massive amounts of electricity. In PoS, used by Ethereum, "validators" are chosen based on the amount of cryptocurrency they "stake" as collateral. While PoS is nearly 100% more energy-efficient, critics argue it centralizes power among the wealthiest users, whereas PoW is governed by raw computing power.

How can the anonymous nature of transactions in the crypto space hinder financial inclusion in lending?

The benefit of putting transactions in the blockchain or having them in the crypto space is that they get anonymized, so other people can't see the transactions. This structure means that banks potentially lose information to those transactions as well. Does that affect the quality of lending in the economy? The answer is yes, which means banks are going to become a little bit more risk averse in lending. Potentially it has negative effects on financial inclusion more broadly. 

Now the question is, how important are transactions in predicting a borrower's credit worthiness? They're important for borrowers who have limited financial history. Let's say young adults just getting out into the workforce, who really haven't had much chance to build up a credit history, or small firms that have recently emerged. The U.S. has a fairly well developed financial system. So I think in the U.S., these effects will be felt for young adults and small firms, but they'll be felt at a much larger scale in some other parts of the world.

When your research was originally published, the total crypto market cap was around $300 billion; today, it has reached the trillions. At this scale, does crypto volatility now pose a systemic risk to the wider economy, or is it still "contained" enough that a major crash wouldn't cause a 2008-style contagion in traditional financial markets?

At today's scale, I think there's a good case to be made for yes, if there were a big collapse in the crypto sector, that potentially has ramifications across the entire economy. In the short term, financial institutions and individuals who have large exposure to this sector will lose a lot of money. There is the potential for some spillover to other financial assets, if people need to sell other assets to raise cash. In the longer term, some people burnt by such a collapse will lose trust in the financial system. 

After the 2008 financial crisis, one opinion that really stuck with me was that at some meta level, you could almost view this as a game the financial sector played against the rest of the world, and the financial sector won because it got the U.S. taxpayer to bail them out. We somehow moved to a world where capitalism now means private profits and public losses.

With crypto we also have that same worry. It’s possible when these assets get so big, we might have to bail them out. I really wish we would accompany that support with not just significantly more regulation, but also requiring those in the sector who are making money to pay more in taxes going forward.