Crypto regulation anyone?

Definitely not in the gray world of cryptocurrencies and crypto exchanges.

Just like abolishing the carried interest tax loophole is like showing the silver cross to vampires, enacting regulation in the crypto world is a real deal-breaker.

So with the Ukraine invasion as the catalyst to stop Russian oligarchs from moving and laundering their money via crypto a real event, Senator Elizabeth Warren (D-Mass.) wants to enact legislation that would, among other things, prevent transfers of over $10,000 in crypto without identifying the account owners.

As the Boston Globe reported, the proposed legislation “would grant the Treasury Department the authority to prohibit cryptocurrency exchanges under US jurisdiction from processing transactions involving addresses affiliated with Russians and would give the president the authority to apply secondary sanctions to foreign exchanges that do business with sanctioned people, companies or government entities, according to Warren’s office.”

A provision of the bill would force Russian oligarchs and those connected to Russian President Putin to reports crypto transfers of over $10,000 to the Treasury Department’s Financial Crimes Enforcement Network.

The proposed legislation is sponsored by Democrats. No Republicans have so far signed on to the proposals, which is not unexpected. Republicans hate all forms of tax and business regulations, especially those that affect the well-funded financial lobby.

Recently, the crypto world has gotten more aggressive in its lobbying, regulatory judo, and PR campaigns, by sponsoring ads in the Superbowl and spending millions on lobbying efforts. The industry’s goal is to remain a money laundering and unregulated speculative game for many unsophisticated investors, who are being told that crypto is an asset class, a hedge against inflation, and viable addition to a diversified portfolio. All of those are lies.

To push their gray agenda, the industry is paying big money to some revolving-door federal regulators, akin to white-collar mercenaries, who work both sides of the fence, depending on who is paying them. Among them are former CFTC regulator Brian Quintenz, who joined Andreessen Horowitz, a venture-capital firm and an investor in crypto startups; Jay Clayton, the previous head of the Securities and Exchange Commission; Brian Brooks, who ex-acting Comptroller of the Currency; Chris Giancarlo, a former head of the CFTC; and in the UK, Philip Hammond, a former chancellor of the exchequer, according to The Economist.

Lobbying Against Crypto Regulation

It is also spending big on more lobbying. The Washington Post reports that crypto lobbyists spent $2.8 million in 2020, and increased that amount to $4.9 million through the first nine months of 2021, according to figures from the Center for Responsive Politics.

No doubt the crypto lobbying group, the Crypto Council for Innovation, opposes most forms of regulation as an assault on “innovation.”  As one of their first PR forrays, the Council responded to federal officials who said crypto is being used for illicit financial activities.

In response, the Council’s Michael Morell, former Acting Director, Deputy Director, and Director of Intelligence at the Central Intelligence Agency, headed a team which refuted “the general assertion that the Bitcoin market is rife with illicit activity. Morell concludes that Bitcoin’s use in illicit finance activity is limited and orders of magnitude lower than what has been cited by government officials.”

While the group disputed the extent of crypto fraud, it also said it was much easier to trace fraud and criminal activities via blockchain analysis.  The Council, which is oddly heavily comprised of former intelligence, US State Department, and federal financial market regulators, has not issued a response to Senator Warren’s proposed legislation. But, based on this report, they should not object to using blockchain to trace any Russian transfers of money via crypto, especially if the embargoes are Russian oligarchs are sanctioned by the U.S. Government.

However, at this stage of crypto’s presence in the financial markets, the heavily-credentialed Council should also address crypto’s more mundane and shaky role as a very speculative investing alternative.

They can issue a report about how it affects average, unsophisticated investors, who are more familiar with Robin Hood day trading scams, and meme stocks. This report should address whether crypto is an asset class, what drives crypto prices, is it a hedge against inflation, and how it is being used as a proxy for gambling and gaming. Also, what use are non-fungible tokens, or are they even connected to the crypto frenzy?

Financial regulators are justified to be concerned about crypto. No one knows who is behind its expansion, and who runs its “exchanges”?

Reality Check: Crypto is Not The Brave New World of Finance

Traditionally, US stock and futures exchanges operated under well-specified regulatory acts. The modern equity markets date back to the Securities Act of 1933 and the Securities and Exchange Act of 1934. These Acts passed after the stock market crash of 1929 that led to the Great Depression. The Commodity Futures Trading Commission (CFTC) was created in 1974 through the Commodity Futures Trading Commission Act, to enforce price transparency and regulated exchanges.

No such regulation exists for crypto “exchanges,” which have stolen the term to gain more legitimacy. There is no transparency for these “exchanges” nor any accountability.

Senator Warren’s proposed legislation is ethically based on preventing Russian oligarchs from war profiteering, tax evasion, and money laundering.

The Crypto Council should not waste its money on high-priced former federal officials who defend oligarchs if the industry chooses to prevent regulatory enforcement or gain any traction on the PR front.

Crypto is popular because we are unfortunately in a neo-liberal era when the financialization of everything is the new normal. Crypto and crypto “exchanges” offer great markets for arbitrage, fee and commission generation, as well as tax evasion and money laundering.

People are buying and selling it and they have no idea why its prices rise and fall. There are no financial balance sheets and fundamentals that allow even the most basic financial Graham-Dodd or supply-demand analysis. Crypto is in the same category today as roulette, and more astute roulette players have better odds, plus they can get a free drink.

Unfortunately, the former CIA and State Department analysts who are part of Washington’s revolving-door titles-for-hire should get on the right side of history regarding Senator Warren’s proposed crypto legislation.

As of today, despite the well-financed hype, crypto is not the engine behind the Brave New Financial World it is touted to be.

We live in the age of the “big lie,” but it would be a mistake to think this mass deception is restricted solely to politics.

It’s now evident in the once-staid world of investing.  Today, the world of investing, including federal regulators and the financial media, has caved into social media pressure, faddism, anti-government movements, and “democratized investing” (whatever that is) to create the global bubble and hype surrounding crypto.

Crypto is a $2 trillion global market, and it has created a black hole of hype fueled by some 1,400 crypto companies in the U.S. today. However, while this extraordinary promotion and price volatility mainly go unchallenged, one of this industry’s biggest lies is that crypto is an asset class.

Nothing could be farther from the truth.

Being considered an asset class is based on the academic definition and its application in modern portfolio management.

This will sound nerdy to those hyping cryptos and all of their iterations, including coins named after dogs and fantasylands. Still, an asset class is a legitimate investment category that determines real-life portfolio allocation and risk management decisions.

The people hyping crypto know this. They also know they lack the rigorous data and solid factual foundation to convince investment professionals and informed adults that crypto is an asset class.

Crypto As a Fantasy Investment

So, what is an asset class, and why do crypto propagandists want their fantasy investment categorized as such?

The reason is simple: the key to being included in an institutional and extensive wealth portfolio is to be named an asset class. This category means the asset in question can be considered an element in a diversified portfolio.  When this happens, portfolio managers who make the allocation decisions analyze the asset class, its inherent risks, and potential benefits to hold it as a diversifier and risk reduction instrument.

This process also means that the value of the asset class in question can grow dramatically once legitimate portfolio managers decide to include it in their portfolios.

That’s why crypto hypesters float the big lie that crypto is an asset class. Unfortunately, many financial media and some questionable financial professionals buy crypto and use the lame excuse that it is an asset class. Unfortunately, this is one of the biggest lies in the investment world.

What Is an Asset Class?

Academic finance has objective criteria to empirically evaluate an asset class based on risk, efficiency, and actual returns over time.

The traditional asset classes are stocks, bonds, Treasury bills, precious metals, and real estate.  In addition, academics have included different investment strategies, such as those involving futures, options, private equity, and hedge funds, as vehicles and instruments that offer different and expanded risk management and return characteristics.

This process is used when analyzing any asset class mix in a diversified portfolio.  When managed futures were considered an asset class supplement, academics relied on historical data, standardized definitions, and indexes to see what benefits futures made in a diversified portfolio.

As noted in the book I edited, Managed Futures in the Institutional Portfolio, consultant Harry Marmer wrote: “Traditionally, finance academics have analyzed anything that wants to be considered an asset class to analysis using modern portfolio theory techniques.  This involves plotting historical prices against an efficient frontier to determine risk returns, often using mean-variance analysis (MVA).  MVA is based on the belief that rational investors (which probably does not include many crypto people) choose investments that maximize expected return for a given degree of risk and minimize risk for a given level of return.

Given this rule, academics run an optimization model to determine the efficient frontier.  This efficient frontier is plotted as a curve that contains all the portfolios that maximize expected returns at each level of risk. (Risk is measured as the variance or standard deviation of returns.)

But all this is just the starting point. While breathless crypto news reporting is daily, the hypesters have not yet produced a serious, impartial academic paper that approaches this rigorous analysis.  Instead, we have celebrities like Matt Damon and Tom Brady hyping crypto.

Even someone named Alexis Ren, who has appeared as a swimsuit model and contestant on Dancing With the Stars, opines that “the economic structure we have been living on is a lie and it’s delusional, and it’s just an agreement, and so we need to find something better, and I think bitcoin and cryptocurrency are that.”

According to Yahoo Finance, Ren continued that “the economic ‘agreement’ (maybe she means hard currencies) that had been in place for a ‘very long time’ needed to be changed for something new and acknowledged that was ‘scary.'”

So, what does Ren suggest?  Crypto, of course.

Her observations about the state of global finance can now be added to a young crypto buyer who told CNBC that he bought “a meme coin,” called unisocks, or $SOCKS, a digital token representing a claim on a physical pair of socks.

Sad News for Young Investors

The dangerous part of crypto hype is that 80% of crypto buyers are Gen Z and Millennials. Most people in this age group have little or no knowledge of traditional investing, distrust traditional banks, or claim they don’t have access to these firms.

Interviews with crypto buyers who claim they have some investment knowledge sound as if they never heard of portfolio diversification, the role of fixed income, or even high-beta stocks or precious metals that have more benefits than crypto.

This should not be surprising. Global surveys have found that Americans have very low literacy rates in investing and politics.

According to the 2014 S&P Global Financial Literacy Survey, only 57% of US adults are financially literate, as measured by their knowledge of at least three of the four basic financial concepts assessed by the survey: risk diversification, numeracy, inflation, and compound interest.

An earlier 2008 study by the IMD World Competitiveness Yearbook found that the US ranked 22 out of 55 nations in financial literacy. (Singapore, Finland, and Ireland were in the top three.) A few years ago, 401(k) educators launched “financial wellness” programs to educate participants about investing.

Uninformed investors cannot manage retirement planning, household finances, debt, and credit management and are susceptible to hype and lousy advice.  A 2021 study by the Milken Institute said that “financial literacy is critical in the US, where individuals are—to a large extent—solely responsible for ensuring their financial security. Indeed, with Americans having more access than ever to increasingly complex financial products and services, financial literacy is crucial in preventing ill-informed decisions that could have negative long-term consequences on their financial well-being.”

So, who benefits when Americans are uninformed about investing and politics?

That is a loaded question. Entire industries, such as those in payday loans, people who buy Medicare Advantage plans, rent-to-own, used car leasing, and crypto, are based on selling expensive items to uninformed, often lower-income individuals.

Crypto Scams, Tax Evasion, Online Gambling, and Avatars

Finally, while crypto has been around for a decade, the hype machine now in high gear comes at a time when online gambling, Facebook pushing avatar identities, money laundering, online scams, and tax evasion are all reaching new heights. 

Crypto is a great way to evade taxes and launder money. It is even better if the user has an avatar, distrusts the government, or, as the swimsuit model cited earlier, who also has an Instagram channel that links exercising and dispensing financial advice, says the hard currency global system is on the verge of collapsing.

This must-have merit is evident in Forbes, Business Insider, Yahoo Finance, and shady websites that survive on ad revenues generated by sending unsuspecting Millennials to brokers selling crypto. These sites hyped SPACs to naïve investors who thought they were getting the “insider” prices on IPOs.

A Bad Mix of Greed and Hype

Today, Millennials day trade crypto and ignore the basic observation that only greed and hype are the driving forces of these anti-government currencies. This must amaze traditionally trained investment people in established firms, who are looking on in amazement at descendants of the mob that fueled the tulip bulb mania in the early 1600s. At its height, people who bought the bulbs were “spending a year’s salary on rare bulbs in hopes of reselling them for a profit.”

So, what should rational investors do?

The Big Lie about crypto is that it is not an asset class. It has the same role in an investment portfolio as a flyer in a high-beta stock, but even that stock has fundamentals to analyze. Instead, crypto has the same role as roulette, except, unlike a crypto buyer, a casino will give a player a free drink.