Former FDIC director Sheila Bair testifies before the House Financial Services Committee hearing on “Examining How the Dodd-Frank Act Could Result in More Taxpayer-Funded Bailouts” on Capitol Hill, June 26, 2013. REUTERS/Yuri Gripas More The nearly 2000% run up in bitcoin’s ( BTC-USD ) price over the past year, followed by its recent precipitous drop , is stirring the usual calls to regulatory arms. Watching a volatile asset bubble (and yes, anything up by 2000% in less than a year is a bubble) can be painful for regulators. They know it’s going to turn.
They know people are going to lose a lot of money. But what should they do? Some argue that bitcoin performs no socially useful function and thus should be banned.
But value — like beauty — is in the eye of beholder. Since the beginning of commerce, humans have assigned value to things of no readily-apparent intrinsic worth.
Particularly in the case of mediums of exchange, aka currency, we assign value simply because those with whom we transact do so as well. Whether it is the cowry shells of ancient India or the thin green pieces of paper many of us still carry in our wallets today, worth depends more on psychology than physical attributes. ‘More faith in technology than in government’ This is also true of fiat currency, even though backed by governments and their taxing power, and central banks and their money-printing power. When the public loses confidence in those institutions — as they did in the Weimar Republic in post-WWI Germany, or Southeast Asia in the late 1990s — value evaporates.
Indeed, these days, the lack of reliance on central bank backing may add value in the eyes of bitcoin’s more passionate investors, who have more faith in technology than in their government. Sparks glow around a commemorative bitcoin (real bitcoins are not tangible) in this illustration. REUTERS/Dado Ruvic More The number of businesses and individuals recognizing bitcoin as a medium of exchange is of sufficient scale to belie attempts to label it as worthless. And the promise of bitcoin, eventual widespread acceptance that would allow direct, peer-to-peer transactions with anyone in the world, has a strong allure. Moreover, unlike fiat currency, its finite supply and purposeful constraints on the pace of “mining” make it attractive to many as a store of value, similar to gold. To be sure, today’s market value would seem to far outstrip the intrinsic value of these uses.
But this is hardly the first time markets have wildly over-priced assets. Netherlands didn’t ban tulips in the 1630s, nor did we ban tech stocks when they reached nosebleed levels in the early 2000s.
How government should respond to bitcoin Instead of making its own value judgements about bitcoin, what government should do is first make sure our policies don’t feed the frenzy. Certainly, federally insured banking organizations should not be allowed to directly or indirectly support bitcoin speculation. Government should also take steps to help ensure that the bitcoin price— wherever the market assigns it — is reflective of investors making informed decisions, free of fraud and manipulation, and that trading is not facilitating illicit activity. Fortunately, regulators have already taken positive steps in those directions.
For instance, the New York Department of Financial Services (NYDFS) has provided a regulatory framework in which bitcoin exchanges can operate. (I am an independent director of a blockchain development startup that also operates a bitcoin exchange regulated by the NYDFS.) This provides a vehicle for investors to trade on an exchange subject to bank-like supervision, including capital requirements, customer due diligence, and cyber-security oversight. In addition, though the Chicago Board Options Exchange and Chicago Mercantile Exchange were criticized for “legitimizing” bitcoin by launching bitcoin futures , in fact, they created additional regulated venues to take bitcoin exposure through futures trading. And while most bitcoin exchanges remain unregulated, the Commodity Futures Trading Commission (CFTC) has pressed both Cboe and CME to institute information sharing with bitcoin exchanges which will help them and the CFTC monitor for market manipulation and fraud in the underlying bitcoin market — a capability that did not exist before. Story Continues The leadership of the Securities and Exchange Commission has also stepped up efforts to warn investors about risks associated with cryptocurrencies and quash attempts to evade securities requirements by offering what is essentially a security in the guise of an “initial coin offering.
” Anyone seriously thinking about investing in any vehicle that uses the words “bitcoin,” “blockchain,” “ICO,” or “cryptocurrency” would be well advised to read SEC Chairman Clayton’s statement before doing so. It can be found here.
Importantly, the SEC warns investors about the difference between investing in bitcoin — a digital currency — and investing in companies that are trying to develop the blockchain technology that underpins bitcoin . Blockchain refers to the distributed ledger used to create a highly secure, unalterable chain of ownership for bitcoin. Many fintech companies are trying to apply that technology to other assets, such as precious metals, securities, mortgages, etc., some with more credibility than others.
This is highly sophisticated technology — promising, but probably years off in its widespread application. It is important to understand that investing in bitcoin does not give you upside potential in blockchain adaptation to other assets. They are two different things. Finally, Congress is considering legislation to strengthen government oversight of the potential abuse of digital currencies for illicit purposes, including money laundering and terrorist financing. Most bitcoin exchanges are not subject to the same level of regulation and reporting requirements applicable to banks to screen customers and detect and report suspected instances of illicit financing. They should be.
Bitcoin is not the first market mania, nor will it be the last. The best discipline for bitcoin speculation is the recent fall in price by one-third. That is a healthy reminder to those who are investing in this highly volatile asset that prices can go down as fast (or faster) than they go up.
As with any asset, don’t invest more than you can afford to lose. And do your homework before you do so. Sheila Bair is the former Chair of the FDIC (2006-2011) and served as a Commissioner and Acting Chair of the CFTC in the 1990s.
She currently serves as an independent director or advisor to a number of corporations and fintech companies. These views are her own.
Read more from Yahoo Finance about bitcoin: .
