The standard textbook approach to regulation is that free markets are generally best except for cases of “market failure”. Frequently cited examples of market failure include externalities and monopoly. Now there is a call to regulate the crypto industry:
The White House said Friday it was closely monitoring the collapse of digital-asset empire FTX, citing its bankruptcy filing as proof the cryptocurrency industry required strong regulation.
The White House and other agencies were monitoring the situation, an administration official said, adding that Americans risked getting harmed without proper oversight of cryptocurrencies.
I’m wondering if this is just a knee jerk reaction, or if there is some market failure that I missed. A few comments:
1. It’s perfectly legal for Americans to invest in all sorts of extremely risky ventures, such as biotech start-ups. Most of these firms fail, while a few achieve great success. To use the terminology of administration officials, “Americans get harmed” when risky biotech start-ups fail. Yes, investors understand that biotech is risky, but I’d say the same about crypto.
2. It’s perfectly legal to lend money to high-risk businesses, where the loans may not be repaid. Remember junk bonds?
3. Fraud is already illegal.
So what’s the argument for new regulations of crypto? Surely not the fact that Bitcoin prices have plunged by 75%? Surely not the fact that creditors to FTX are going to lose their money? Surely not that fact that there are accusations of fraud in the recent FTX collapse? These are all either normal parts of our financial system, or are already outlawed by regulation. So what is the specific argument for additional regulation of crypto? To “protect crypto investors”? Why would we want to do that? To protect the banking system? I’ve seen no evidence that crypto threatens the banking system.
Do we really want to make people who invest in crypto feel safer about their investments? Wouldn’t that make “bubbles” even more likely? Isn’t it healthy for crypto investors to fear they might lose their investment? Wouldn’t it make them more careful?
And what is the social value of crypto? Why should social policy encourage investment in that area?
Here I need to walk a fine line between crypto critics and fans, as I’m in neither camp. I don’t see where crypto has produced much value to society, and it’s a fairly costly industry (if only in energy consumption). So I don’t see any reason to encourage the growth of crypto through government policy. I don’t wish to protect crypto investors. At the same time, I see no reason to inhibit the growth of crypto. Just because it doesn’t seem very useful to me, doesn’t mean the industry is of no value. The whole point of free markets is for people to explore new ideas and profit from them if they prove to be useful. Why would we wish to inhibit a new and innovative industry that might pay great dividends in the future?
Again, there may be market failure arguments of which I am unaware. But “bankruptcy and fraud” are not textbook examples of market failure that require regulation. One is a part of any well functioning market, while the other is already illegal. It may seem obvious to you that “something must be done”, but it is not at all obvious to me.
