Crypto fails as money. Regulators can save it.

That goal might be achievable – with help from the governments the crypto was supposed to put aside.

Ordinary money leaves a lot to be desired. Most people keep it in the big banks, which have at times used subterfuge and even outright fraud to tax their customers – and which have proven to be disturbingly fragile in a crisis. Transferring money can take days, especially if it has to make its way through the archaic and hackable network of correspondent banks that handles international transfers. For those who don’t have a bank account – including millions of Americans, disproportionately Black and Latino – things are worse. Check houses, ATMs, card issuers, and money issuers all charge high fees.

Bitcoin, the original cryptocurrency, was designed to bypass all of this. Anyone with an Internet connection could create a pseudonymous account, controlled by a private key. Users could send digital tokens anywhere, anytime, thanks to a voluntary network of computers that recorded transactions on a public ledger called a blockchain. High power cryptography and decentralization protected against abuse and malfunction. The technology has inspired hope not only for a more equitable type of financing, but also for greater stability: the demise of one or more major global banks would do much less damage if payments could proceed without they.

Bitcoin has created quite a stir, but it has so far failed as money. Pure cryptocurrencies are far too volatile to be useful except for speculation, illicit trade, and the occasional funding of activists in oppressive regimes. The computational power required for the Bitcoin blockchain makes it slow and expensive for small transactions, not to mention environmental damage. People are afraid of losing the keys to their crypto (it is estimated that around a fifth of all Bitcoins have been lost this way), so they hand them over to wallet apps and other platforms which are often hacked. . Most crypto “believers” engage through the same types of middlemen – exchanges, PayPal, specialty ATMs, dark trust companies – that the technology was meant to replace. Many of these businesses are less secure and more expensive than traditional banks. Their rapid growth threatens more financial instability.

However, all is not lost. Even so, crypto innovation can still offer a better payment system.

Consider stable coins. They manage volatility by tying their value to fiat currencies – implicitly acknowledging the biggest flaw in pure cryptocurrencies. They can run on blockchains that work more efficiently than Bitcoin and have a lower carbon footprint. Currently, they are mainly used by crypto speculators to park funds while deciding what to bet on next, or to earn interest in unregulated loan pools. But as a unique form of electronic money, they have the potential to make transfers easy, instant and cheap. The Diem association initiated by Facebook, for example, wants to use them to enable payments on mobile applications such as Facebook Messenger and WhatsApp. Ultimately, the infrastructure they use could even provide the rails on which government-issued digital currencies could travel.

Another initiative, known as Lightning, seeks to address Bitcoin’s flow and energy issues by establishing secondary channels through which multiple payments can be made, with only the final balance recorded on the blockchain. The system enabled an app, Strike, to use Bitcoin as a utility for remittances between the United States and El Salvador. User money can come in as dollars in one country and emerge as dollars in the other, spending virtually no time in a volatile crypto.

Innovations like these hold promise, but they also pose risks that regulators need to consider.

• They could trigger races. Stable coins exchangeable for fixed rate fiat currencies and fiat currency balances in applications such as Strike must be secured. Often they are not. A recent Bloomberg Businessweek exploration of Tether, the most popular stablecoin with around $ 70 billion in circulation, found a company “stuck with red flags.” everyone rushes to the exits.

Regulators should insist on support in the form of high-quality assets, and ideally in fiat currency. In the United States, this can be achieved by requiring payment applications and stablecoin issuers to invest only in bank deposits which are in turn held at the Federal Reserve, or by creating a narrowly defined banking license allowing them to invest. ” open reserve accounts directly with the Fed.

• They could undermine traditional banks. If people could keep their money safe in stablecoins and payment apps, they could stop depositing it in banks, depriving them of the resources they need to make loans. The resulting credit crunch could bring the economy down.

A recent Bank of England analysis suggests that these concerns are overblown. People will likely be slow, its authors say, to embrace new forms of digital currency, allowing time for the system to adapt. Still, regulators should err on the side of caution, prohibiting stablecoins and payment apps from paying interest, or reducing the interest they receive on their Fed deposits. These restrictions could be relaxed later, once authorities can assess any threat to banks and credit.

• They could crash or be hacked. It’s one thing that Facebook apps shut down for a day; it would be another if the company ran a global payment system. The new protocols have yet to be proven, as the recent failure of the Solana blockchain demonstrated. Lightning has known vulnerabilities.

Regulators should require sufficient capital to absorb unexpected losses and set standards for security and governance, for example by testing resilience and identifying who is responsible for handling emergencies. If a business cannot prove that it would act responsibly, it should not be allowed to operate a payment system. Additionally, systems should be interoperable, so that a dollar in one can easily be converted to a dollar in the other.

• They might encourage crime. Crypto platforms typically identify users only with an alphanumeric address. This has made them useful for ransomware developers, tax evaders, and other criminals – and raised concerns that they may undermine international sanctions and anti-money laundering laws.

Platforms and applications can and should require identification if necessary to enforce the law. If regulators demanded it – for example, when balances or transactions exceeded certain thresholds – crypto payment systems could remain widely accessible and be even much more transparent than the current banking system. In most cases, transactions are already visible in public records, which has helped both law enforcement and the crypto community track down and recover ill-gotten gains.

For many, the speculative frenzy surrounding cryptocurrencies will not end well. Officials such as US Treasury Secretary Janet Yellen are right to call for urgent action to deal with the growing risks. But they’re also right not to ban crypto entirely, as China has sought to do. The rise of innovation is already stimulating competition, both private and public, to modernize a financial system that can certainly be improved. The result could benefit people around the world – as long as regulators don’t fall further behind in protecting against the dangers.

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