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May 2, 2023 - Truth Podcast - Vivek Ramaswamy
47:41
The Dark Side of Crypto with Lee Reiners | The TRUTH Podcast #21
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Time Text
So,
one of the remarkable things after the 2008 financial crisis was the supposed restoration of the financial system that we created in its aftermath actually just created and sowed the seeds for even worse in the future.
not in the form of financial crises, but in the form of financial policies that permanently, I would say, gutted, or at least since then, ever since then, have gutted the essence of American capitalism itself.
The first thing we did was we ushered in an era of easy money in this country, money raining from on high like mana from heaven from the Federal Reserve that was supposedly a short-term stopgap measure to pump liquidity into the markets on the back of the 08 crisis in the middle of that year became QE1 and then QE2 and then Operation God Knows What that actually continues year after year to create We're good to
down economics from Ronald Reagan's era when economic growth is really just driven by artificial paper being printed from the top, only planting the seeds for possibly the next financial crisis, which as we have this conversation today, maybe, you know, in the early stages of unfolding, in part because of self-inflicted behavior from the Federal Reserve in part because of self-inflicted behavior from the Federal Reserve on the back of the 2008 financial crisis.
You saw the rise of the ESG movement, the politicization of capital markets, a sort of dowry that was paid for the arranged marriage between big business and government as effectively a price, a delayed price for the 2008 bailouts on the back of the 2008 financial crisis.
So what do we learn?
We learn that these crises are occasions to actually plant the seeds for quite possibly far more damage done over a longer period of time that follows But as a justification for a response to that crisis.
So let's learn that lesson now as we enter the modern banking instability that we appear to be entering right now.
What are we going to see on the back of potential bank failures in the United States, of brokered marriages between large banks absorbing small ones?
We're having this conversation right on the back of the failures of Silicon Valley Bank and Signature Bank.
What I predict we're going to see is a march towards a new response or a new opportunity really seized by the federal government as they did in the back of the 08 financial crisis to see, for example, the advent of central bank digital currencies or CBDCs on a retail scale saying that these small banks couldn't be trusted.
We had to intermediate the system through big banks instead.
Why not use the federal government that brokers those marriages to actually get its ultimate wish list, which is control over its citizenry in a way that Ordinarily, the citizenry wouldn't have stood for, but for the existence of a crisis that justified it.
We learned that in 2008. I'm afraid we're learning that same lesson in the early stages of it right here in 2023. And today, I'm joined in the podcast by a guest who understands a little bit of something about financial market regulation and even as it relates to the rise of cryptocurrency as a Let's just say a competitive parallel system to the existing financial system.
Some of the risks that that poses, but possibly the opportunities as well.
I'm looking forward to approaching today's conversation with an open mind.
We don't know each other that well, but Lee, welcome to the podcast and I want you to introduce yourself and I'm looking forward to rolling up our sleeves and getting into it.
So welcome to the podcast, introduce yourself and tell me a little bit about your background and what got you interested in financial regulation and then more recently in crypto and we'll go from there.
Well, thanks for having me, Vivek.
It's good to be with you.
So yeah, I mean, I've been at Duke now for almost seven years in a variety of roles, but I'm a lecturing fellow in the economics department and at the law school.
And so a lot of my work at Duke is around financial regulation and regulatory policy.
That's my background before coming to Duke.
I worked at the Federal Reserve Bank of New York.
Primarily as a bank examiner, so supervising large, systemically important financial institutions, otherwise known as too-big-to-fail institutions, certainly relevant to what's going on now because that definition seems to be expanding.
And yeah, I mean, so...
You know, I got into cryptocurrency just as a curiosity when I was at the Federal Reserve Bank of New York, I think like a lot of people.
But then when I came to Duke, I had an opportunity to start teaching classes on fintech law and policy.
Crypto was sort of a part of that course.
But then as sort of crypto grew and the regulatory and policy issues grew with it, it was sort of taking up more and more of that course.
So I just created a standalone crypto law and policy course.
I'm very active in crypto policy debates.
I've recently testified in the House Financial Services Committee.
Patrick McChair McHenry created a new digital asset subcommittee.
I was up there a few weeks ago last month.
I testified in the Senate Banking Committee around crypto regulation.
And it's really fascinating.
It's moving quickly.
The business is moving quickly.
And the regulatory environment is moving very quickly.
So it's a lot of fun to teach, but it also can be a bit exhausting.
That's good.
I think it's cool to be able to teach a subject.
I went to law school as well, you know, years ago.
And it's interesting.
It's a rare opportunity to both be, you know, what I would actually find in law school is like the topics that were then cutting edge at the time, you wouldn't actually get much of the meat of the legal principles because you were just learning like the thing, like the new thing, whatever it was, having nothing to do with law.
Yeah.
Now, the topics that were most, I guess, like legally rich and intellectually stimulating were, at least for me, stuff like criminal law, hardcore stuff that had been around for a long time.
But I think something like crypto regulation, you know, crypto-related law could probably be an example that bucks that trend a little bit.
Because on one hand, you do have this, relatively speaking, new thing, cryptocurrency.
But you have old foundational principles of financial regulation, market regulation, et cetera, that apply or don't apply, but you can actually sort of roll up your sleeves and still have the intellectual richness of some of the first principles, but as applied to something different than the old banks or securities regimes that we've been but as applied to something different than the old banks or securities regimes that So long way of saying, I guess I would probably take that class if I were in law school right now.
You seem like...
I think our team said you did a great job with the testimony.
So I'm excited to learn from you today.
But that sounds like a...
Don't be too exhausted by it.
I think it actually sounds pretty cool as well.
No, no.
I love it.
I wouldn't do it if I didn't love it.
And you're right.
I mean...
I think the reason that crypto appeals or is interesting to so many people, because it's been around a while now, and it's kind of polarizing, I've sort of discovered.
People are either all in, love it, it's the future of money, finance, or they're kind of the Charlie Mungers of the world, right?
Like, this is all nonsense, it's good for nothing but money laundering.
You know, the students are more just curious, right?
I mean, especially law students, you know, you know, they're generally risk averse, right?
You know, most of them, I pull them at the start of class, like how many of you actually own crypto or used it?
It's not a lot.
Obviously, if I was at the business school and asked that question, like every hand would go up.
Right?
But it pulls from so many disciplines.
I mean, as you mentioned, obviously, financial regulation.
But also, like, you know, what is money?
You know, it's forced us to kind of rethink, like, these questions that most people hadn't thought about, you know, in their lifetime.
What is the relationship between the sovereign and money?
Right?
I mean, it obviously draws on technology, cryptography, math.
You know, politics.
So there's kind of something in it for everyone is what I like to say.
And, you know, it's still from a legal and regulatory standpoint, it's nascent.
So I tell my students, like, listen, when you finish this class, like you are now a crypto regulatory expert, right?
And there's not a lot of them out there.
And you can go to your firm or wherever you go and make an immediate impact.
And so I think that's what makes it so fun to teach and why I like students are just so into it.
You've got my juices flowing, so I'm pretty pumped for this.
I'm a little bit, the FOMO instincts in me are right now making me feel like we might not even have enough time here, but let's get as far as we do.
This is actually going to be fun.
Yeah, let's do it.
So, table stakes, okay?
What is a cryptocurrency?
Yeah, I mean, you know, it's obviously got currency in the name, so I think that's what kind of most people think about it.
You know, currency or money, you know, has, you know, a technical definition.
So economists like to say that, you know, money fulfills three functions, right?
Medium of exchange, meaning we can use it to buy and sell goods and services.
Unit of account, meaning we can use that, you know, monetary unit to compare the relative value of things.
And then a store of value, meaning that you feel comfortable keeping your money, your wealth in that unit.
You know, crypto kind of fails, really, in my opinion, on all three of those things.
So we can kind of get into a conceptual conversation around like, you know, why is crypto valuable?
Why does it fail on number three?
Actually, let's just depress on that, for example.
Why wouldn't crypto be a store of value?
Well, because it's too volatile.
I mean, you can keep your money there, but it's just far too volatile to be a useful store of value.
When I talk to crypto proponents, I say, listen, what is your valuation methodology?
Because at the end of the day, any asset is worth whatever people are willing to pay for it.
But professional investors have some type of framework they use to make a determination whether or not a given asset is overvalued or undervalued.
Well, I don't know.
You know, I mean, I think you could say that about any currency, though, right?
What's the fundamental store of value in the peso?
Yeah, I mean, there's a sovereign, you know, like there's a sovereign entity that stands behind it.
So the reason that, you know, the dollar is valuable and people use it, whether or not they think about it, is that they're making an implicit judgment about the United States government, and that the United States government is going to be a going concern, right?
And, you know, God willing, it will be, right?
Because we got deep, you know, deep problems if it's not.
But with crypto, there's no issuer, right?
So who are you trusting in?
And in essence, you're trusting in math.
Is what you're trusting in.
Explain how that works.
That's what I was looking to get to.
So for the first time, you know, so really crypto is, you know, what makes it run is blockchain technology, which is a decentralized database.
Everyone has the exact same copy of the database.
And in crypto's context, let's just stick with Bitcoin to keep it simple.
You know, that database records every single Bitcoin transaction in the history of Bitcoin.
And it's fully transparent.
Everyone can see it.
Every computer that's running that, you know, the Bitcoin blockchain software has the exact same copy.
And so what that means is that it's a system that everyone can trust the contents of that ledger without having to trust any intermediary or single person.
So for the first time in history, we have the ability to transmit value peer-to-peer Without the need for any third party intermediaries.
And I think that aspect is what excites so many people about crypto is the ability to transact peer to peer.
Now that's in theory, that's the principle behind it.
That's what Satoshi Nakamoto, the creator of Bitcoin, the first cryptocurrency, he lays out this vision for a peer to peer payment system.
Of course, as we sit here today, you know, 14 years later, the crypto economy looks very different, right?
I mean, it's littered with intermediaries, you know, because it turns out people like intermediaries, right?
People don't want to have to store their money on a thumb drive in a coffee tin that's buried in their backyard.
I mean, because that's what it takes to kind of secure, you know, there's this adage in cryptocurrency, not your keys, not your coin, because you have a public address.
If you want to send crypto, you need to have a public address so I know where I'm sending it to.
But then you sign that transaction with your private key, simply an alphanumeric string of characters.
So if you don't have access to that, if someone has access to that private key, then they have access to your crypto.
So for those reasons, People prefer to use intermediaries, right?
Like crypto exchanges.
And the situation we have now is that those exchanges are essentially unregulated or lightly regulated.
They're not regulated to the extent that traditional securities exchanges are.
Like Coinbase.
Coinbase.
Yeah, so like Coinbase.
So like Coinbase, right?
And people like intermediaries, right?
And actually, this is useful.
I mean, I thought, I mean, you think you know something, but then you also recite words and you realize you didn't really understand that, you know, some of the details in between.
Your point is, like, those passcode, you know, the 12 character containing things that you'll see crypto people carrying around that stick into their computer and allow them to log into the blockchain.
Yeah.
Right?
Like, actually, how does that actually work?
Because I've always only used exchanges in the limited experience I've had with crypto as well.
Like, how does that actually work?
Is like, you just type it into the World Wide Web and you get there?
Um, no.
I mean, you have to sign your transaction.
So, I mean, you basically have to, and if you're running the, you know, most people, like, aren't running, like, the full Bitcoin software on their computer.
Right?
But if you were, you would have to access that and you would sort of enter in your private key directly into that, you know, through that software interface.
You see a person who wants to buy Bitcoin but not using an exchange or whatever, or wants to transact in Bitcoin you already have but not use an exchange, you know, like a Coinbase type of thing to do it.
You have your store of value.
Like, literally, how do you access the blockchain?
Like, where is it?
Well, you can download it.
You can go to GitHub and download it.
Download the algorithm from?
From GitHub, which is where a computer...
Yeah.
And so that's what, like, the hardcore folk do directly.
Yeah.
I mean, the hard...
You know, again, like, the motto is, like, not your keys, not your coins.
So, like, the hardcore folk are...
What does that mean, though?
Not your keys, not your coin.
Like, what does that mean?
That basically means if someone else has access to your private key associated with your cryptocurrency digital wallet, then that's a security vulnerability.
Right.
Because...
They can just take it as their own.
If they know your public address, then they can send a transaction to anyone.
They can send a transaction to you.
I mean, to themselves, right?
So...
And we've seen this play out, this security vulnerability, in a variety of contexts.
I mean, going back to 2015, when the largest crypto exchange in the world at the time was called Mt.
Gox.
They were based in Japan.
And so they were maintaining all their customers' private keys on an internet accessible device.
And they had very poor security protocols.
You know, a hacker got in, was able to take all the private keys, and then once they had it, they're able to drain all the cryptocurrency.
You know, we've seen nation states actually ramp up their activity in this space, notably North Korea.
So North Korea specifically targets crypto intermediaries who have notoriously lax security protocols.
And once inside, they're able to gain access to the private keys and then steal the crypto, send it to an exchange in Russia or somewhere else.
and cash out i mean so there's estimates that last year alone north korea stole 1.7 billion dollars worth of crypto in north korea meaning people in north korea you think they're state affiliated no no um this is what's called the lazarus group so it's a state-sponsored um it's part of the military so it's a state-sponsored state-sponsored that's like a serious amount of money actually $1.7 billion is a lot of...
I think it's like...
I mean, the last time I checked, their annual exports were like $200 million.
I mean, it's a closed economy, right?
But yeah, I mean, so the UN... Because there's been some reporting coming out of what the UN's done.
And crypto last year funds up to a third of their...
Or cyber.
And crypto is a big part of that.
Funds up to a third of their ballistic missile program.
So there are real problems out there.
And this is why, again, the hardcore crypto people would say, you have to self-custody your crypto.
You need to keep it offline in some type of...
It could be like a hard drive that's like a thumb drive.
I mean, there's special...
There's companies that provide these products.
Again, you can just write it down.
I mean, it's just an alphanumeric string of characters.
There's a really good book for people that are interested in crypto, and it's like a really light read.
The author's name is Ben Mesrick.
He wrote Burning Down the House about the MIT Blackjack Club.
Yeah, I remember.
I read a couple of his books, actually.
Yep.
Yeah.
So he wrote one called Bitcoin Billionaires.
And it's about the Winklevoss twins who parlayed their Facebook settlement money.
Into crypto and built the Gemini cryptocurrency exchange, which is one of the larger exchanges in the US. And the book talks about how when they first invested in crypto, they wrote their private key down on pieces of paper.
They cut that piece of paper into multiple strips, and then they stored those strips in physical safety deposit boxes.
So that's the most extreme version of...
Keeping your keys secure, your crypto secure.
Right.
Again, the average person isn't going to do that.
And that's why they use exchanges like Coinbase, right, which are holding on to those keys for you.
And, you know, when we get into like the regulatory aspects, this is one of the, you know, the thornier issues because crypto exchanges are fulfilling multiple functions that are normally separate in traditional securities exchanges.
So one, they're the broker, right?
Like they're the place you go to to place your order.
Two, they're the exchange.
So they're actually running the matching engine to execute your order.
Three, they're the clearing agent.
Four, they're the custodian, meaning that you're keeping your crypto with Coinbase.
Five, they're often the market maker.
And then six, many of these exchanges have a venture capital arm that are investing in crypto projects that, guess what, end up getting listed.
On that exchange, because once you're listed on exchange, that provides liquidity, right?
It's very different from the normal model of what an exchange is actually doing.
That's a kind of an interesting multi-hat model.
Yeah.
And so, you know, like a normal exchange, right?
Like you and I can't place trades directly on the New York Stock Exchange or the NASDAQ. We have to go through a broker.
Right.
And the New York Stock Exchange and the NASDAQ, by law, have to allow broker-dealers in good standing to be members.
Right?
And so that's just kind of one difference between how crypto exchanges operate and traditional securities exchanges.
Can I just rewind for a second before that, which is an interesting, just kind of like a philosophical question where...
The thing that backstops the value of most currencies, to borrow your framing of it, was the sovereign.
Okay, the fact that there's a sovereign nation that stands behind the value of that currency.
Now, the Mexican peso, we can debate that, right?
Is it a bunch of drug cartels that actually run the country or which sovereign is backing that up?
Let's put those geopolitical quips to one side.
That's philosophically, at least, the way this works.
Whereas here, as you said, it's math that backstops it, right?
It's backstopped by math, by code, by a formula.
Do you think that some people would make even an argument on the theft case, right?
So if it's not backstopped by a sovereign, if the US doesn't, you know, the US backstops the dollar, but it's not backstopping Bitcoin or pick your other favorite cryptocurrency.
Is there some argument that even the property rights regime...
That somebody else, that the US would apply to protect crypto?
Do you think the people who are hackers would say that it's all math?
So I hacked in and got your stuff because that's the rules of this road and the rules of this terrain.
It's backstopped by math itself, not by a sovereign.
So the rules of the sovereign, which include those property rights, don't apply.
And so by definition, it's internal to the rules of crypto to say that there can be no such thing as a data breach or theft because data breach or theft is internal to the rules You see what I'm saying?
I'm not making some argument for crypto hackers.
No, you're very perceptive.
I mean, this is an argument that's been going on in crypto from the very beginning.
Oh, it has?
Because I'm not breaking new ground here or anything.
No, not at all.
And there's been a number of, there within crypto at least, high-profile incidents where this has come to bear.
Because there's certainly a lot of people within crypto who adopt the mantra.
Here's another one for you.
Code is law.
Right.
People say this stuff.
I don't agree with it.
But I want to take it seriously, though.
Yeah.
Yeah.
So if there's a flaw in the code of an underlying blockchain or cryptocurrency, then, you know, by definition, you're not doing anything wrong if you exploit that.
And, you know, sort of the I think the most high profile example of this is, Was in 2016, when there was something called the DAO. DAO. It stands for Decentralized Autonomous Organization.
It ran on the Ethereum blockchain, which is the second most popular.
The Ethereum blockchain is the second most popular blockchain behind Bitcoin.
The native cryptocurrency from the Ethereum blockchain was Ether.
Again, second most popular token behind Bitcoin.
And what the DAO was, was essentially a decentralized venture capital fund.
Where you bought into it.
So you would send Ether to what's known as a smart contract address on the Ethereum blockchain.
In return, you would get a DAO token.
And that DAO token entitled you to vote on various proposals that were put forth to the entire DAO token holding community.
And if the community voted to fund that proposal, you know, then they would release from the Treasury Ether to the, you know, whoever was proposing this.
And if it made money, then the proceeds would be distributed back, you know, proportionally.
So anyway, there was a flaw in the code.
And someone drained all the Ether, most of the Ether that had been sent to...
Ether is Ethereum, the currency.
Yeah, Ethereum.
They drained the...
Yeah, so they stole the Ethereum cryptocurrency associated with this project.
And, you know, there's a real existential debate because, you know, Ethereum was still in its nascent stages at that point.
And so people are like, well, what do we do?
And obviously, folks who had money, you know, I don't want to use the word stolen, but who, you know, who had money, you know, had money in and then it was gone, you know, thought like, hey, like, we got to do something about this.
And so Vitalik Buterin himself weighed in.
He's the creator of the Ethereum blockchain and I think probably the most high profile figure within crypto because we still don't know who Satoshi is.
And he said, like, listen, like, you know, we gotta make this right.
And the majority of folks in the Ethereum community agreed with him.
And they did what's known as a hard fork.
So they essentially altered the blockchain code to go back in time to right before the hack happened.
So as if it never happened.
And in so doing, they sent people a new cryptocurrency that's now called, well, we call that one Ether, but the original blockchain where the hacks still happen is an operational and that one's called Ethereum Classic.
So you can go on Coinbase, you can go to an exchange and you can buy...
It's by definition different.
They changed the rules, right?
Yeah.
Yeah.
So they changed the rules.
So the community collectively changed the rules, but it was very acrimonious for the reasons that you said.
Because people were saying, listen, code is law.
If there's a flaw, then so be it.
We have to live with the consequences.
Who's to say it's a flaw?
Yeah, exactly.
Who's even to say it's a flaw, right?
So these are absolutely sort of the existential debates that people are having within crypto.
Now, of course, for the average person, when they hear about this stuff, they're like, oh my god, this is craziness.
Like, why would I ever get involved?
And they should have.
That's how they feel, right?
I mean, that's perfectly a legitimate response.
But this wasn't where I expected to spend most of the time.
And maybe we're just going to have to talk about the financial regulatory stuff another time.
But it is kind of interesting because it reminds me so much of the two-facedness of – and we'll get to the Silicon Valley Bank stuff, but – The Silicon Valley libertarian mindset of wanting non-governmental intervention in the banking system and not having,
you know, regulatory constraints and capital constraints imposed on Silicon Valley bank that's not systemically important only to then cry to mommy that actually we are systemically important and the depositors need to be bailed out above the uninsured depositor level is something that irritated the heck out of me and that's a Silicon Valley specific Silicon Valley bank episode.
But there's like a form of that here I have conviction on my views there.
This is an issue I haven't thought about for much longer than this conversation because I wasn't aware of that incident, but it smells like that to me where code is law.
We're in the wild west frontier of the sovereign backs the currency, but we're in the post-national environment in which we don't want currencies that are backstopped by a nation.
What are nations?
Nations have laws.
Laws are preconditioned for property rights.
So that's a whole regime saying, no, no, no.
We're opting out of that.
It's just code.
But then, when things didn't go the way you expected, that somebody else had code, that you call a hack, he calls more code, that you call a flaw, he calls part of the system, says that I actually drained your money, somehow the people who were the code is law people Go back crying to mommy, just like the Silicon Valley venture capitalists that went crying to mommy who they thought they were the cool libertarians that wanted to declare independence from.
Same thing here, saying that actually the creator has to change the protocol to allow them to get their money back according to what set of rules?
According to what principles?
And I'd be really curious here.
It makes me almost want to ask the question of what was the The human phenotype, to the extent we know it, of the hackers, versus what was the phenotype, broadly speaking, of the people who got hacked and who lobbied effectively for their rewrite of the rules.
I'm just curious what the sociology around that was.
Yeah, I mean, I'm not as immersed in that.
I'm not that deeply immersed in the technological community.
I don't know if anyone actually, I mean, the nature of crypto itself is that It's sort of pseudo-anonymous, right?
So no one knows who one another is.
And that's by design.
You only know what the public address is.
So that's why you're not fully anonymous.
Although there are some cryptocurrencies that do provide greater degrees of anonymity.
So I don't think we'll ever know the differences in that phenotype, as you say.
But you're absolutely hitting on You know, what is one of multiple ironies when it comes to crypto?
Because, you know, the truth is that you cannot code every single contingency, right?
Things go wrong.
Things will happen.
Disputes will arise.
And, of course, in the traditional economy, right, that, you know, the off-chain world, as they say, those disputes are settled in the courts.
Yeah.
Right?
And, you know, and so that's another kind of debate is, you know, how can we reconcile blockchain with the courts?
Is it even reconcilable?
It may not be.
Yeah, and it may not be.
And listen, you know, and obviously something like, you know, this topic is, you know, so far over the head of most judges, right?
So, I mean, we're still kind of in the early stages of these, you know, of these debates.
But, you know, things have gone wrong within crypto repeatedly.
And, you know, it's like the old Mike Tyson adage, right?
Everyone's got a plan until they get punched in the face.
Right.
And when things go, you know, so you can claim to adhere to this code as law philosophy, decentralization, you know, no intermediaries.
But when your money is, you know, gone, right?
Like, you know, is there one day and it's gone the next and I won't use stolen.
You know, then, you know, you want...
But maybe it wasn't your money in this world, right?
In the world of the sovereign, it's your money, but it's like Max Weber had this famous sort of paradox of do people have ideas or do the ideas pre-exist in the universe and then we just open our minds and capture them?
Well, this is like that as applied to the realm of money, right?
In the sovereign world, right?
People have property rights invested in money that they create.
But in this other world, it seems like it was purposefully created to say that the code really is the money, if you will.
And it pre-exists.
And you just mine and discover it.
But the fact that somebody else actually, the rules of that code itself allowed that other person to then take it from your pocket.
That's part of the Wild West.
It is fascinating, man.
I'm just talking through this and it actually makes me think more about The case and perhaps some of the paradoxes in even the case for crypto regulation that the crypto industry, whatever, crypto advocates or whatever, embrace.
I'm sure other people who are immersed in this have thought about this more than me, but it seems like there's a basic philosophical decision to be made.
Do we want this entire system?
What do you call the...
The off-chain and on-chain world, right?
So do we want the on-chain world to sort of be this parallel universe where we don't apply the conventional system of sovereign applied property rights, etc., courts, police state, backstop to filter it?
And like, is that what we want it to be?
In which case the on-chain world is backstopped by the very state that recognizes the currency also created the court system that recognizes and vests those property rights.
Like the purist in me, which says it should be, if you want it to be a parallel world, guys, have at it, but stop complaining and using the court system.
If you now want that to be re-regulated, what's the point of crypto?
Well, and it's not only just stop complaining and don't use the court system.
It's, you know, stop trying to integrate into the traditional financial system.
Yeah, exactly.
Right, you know, right now.
I mean, so that's where the lobbying is happening.
It's kind of fascinating.
Yeah.
You know, we want access, you know, the crypto saying, oh, well, you know, we want access to the banking system, right?
You know, and going back to the first Bitcoin transaction, 2009, it included text to a Times of London newspaper article with the headline, Chancellor on Brink of Second Bailout for Banks, right?
So the origins of crypto are in the 2008 financial crisis.
And it was created to be the anecdote to that.
Wait, how was that origin?
Can you explain that to me?
I'm not familiar with this.
Yeah.
So, you know, you can include in any Bitcoin transaction, you know, superfluous text.
And so the first...
So, you know, the Bitcoin white paper was introduced by Satoshi to an online cryptographic message board on Halloween 2008. However, the first Bitcoin transaction didn't occur until 2009. So that transaction, that first transaction...
on the Bitcoin blockchain, included a reference to a Times of London newspaper article about bank bailouts in the UK.
And really, it was techno libertarians that sort of flocked to crypto initially and sustained it.
Now, obviously, at this point, there are millions of people that are into crypto for thousands of different reasons.
But that ideological origin is that current still runs deep through the crypto community.
And you're hitting on some of the Because I'm a crypto skeptic, right?
I'm a regulator.
I can tell.
Yeah.
Right?
Yeah.
So these are kind of debates though that even within the crypto community have been ongoing for quite a while.
And I'm with you.
I mean, listen, I wouldn't care really If, you know, we had this code-as-law world, you know, on-chain, there's no connections to the traditional financial system, you know, let them eat themselves, right?
And yeah, you know, some people are going to lose money, and that's bad.
But, you know, like, capitalism's risky, right?
I mean, people lose money in the stock market.
But they're not losing money.
They're losing...
Crypto.
Yeah, well, yeah.
They're literally losing crypto, right?
Yeah, they're losing crypto, right?
Money, presuppose a property rights system.
They're losing something of value.
Yeah, they're losing something that is valuable to them.
I'll put it that way.
And someone else gained something of value on the other side of it.
Yeah, so I wouldn't...
So if that's all that was happening, I really wouldn't care and I would move on and spend my time doing something else, you know, more pleasant and enjoyable.
The problem is that that's not the world we live in.
And crypto creates pretty significant negative externalities, in my opinion.
So one, you can just start with the energy consumption and the emissions associated with that.
The Bitcoin blockchain runs on something called the proof-of-work consensus mechanism.
Remember how I said, every computer running the Bitcoin software has the exact same copy of the database?
Well, how does that happen?
How does everyone agree?
And the way they agree is through what's known as the crypto mining process, where you have select computers running a specialized variant of the Bitcoin software, gathering up the most recent batch of transactions and then effectively competing to solve a puzzle that allows them to post to the broader blockchain those most recent transactions.
And solving that puzzle, that mathematical puzzle, just requires brute computing force.
Which, you know, to do that, you need, obviously, power.
You need electricity.
So, you know, that provides...
And there's good and bad things about it.
Obviously, the bad is the energy consumption.
You know, the good is that because there's a cost associated with doing this...
Presumably, only people that cared about Bitcoin would incur that cost.
It keeps away people who would want to do bad things, just change the contents of the ledger.
So there's a cost to maintaining this.
What's the benefit?
Well, if you're lucky enough or have enough computing power and you solve the most recent puzzle, You get rewarded with new Bitcoins, right?
So that's how new Bitcoins get put into circulation.
So that's the incentive.
So there's a cost and there's an incentive.
And that's what makes this whole thing kind of work.
But again, it's very energy intensive.
So going back to my point, that's one negative externality.
We know that crypto is being used to undermine national security.
I talked about what North Korea is doing.
Yeah, but to be honest with you, traditional finance is equally likely to be able to do that too, right?
It's about proportions, of course.
You could also track the transactions in a blockchain in a way that you never could with respect to actually an opaque banking system with traditional currency, right?
For sure.
I mean, this is like, obviously, bad actors have been using dollars since there's been dollars.
Yeah.
But dollars were not trackable on a ledger through an opaque international banking system in the same way that Bitcoin or other blockchain-based cryptocurrencies are, right?
So it is a little bit of an ironic argument to make the laundering argument, you know, national security-based laundering argument for at least a technology that in principle can actually trace its transactions versus one that can't.
Yeah, that's true.
So because the blockchain does provide transparency, you can trace the flow of funds.
And there are blockchain analytics companies out there that do that.
So, you know, TRM Labs, Chain Analysis.
You know, there's another great book recommendation for folks that are interested in this that just came out is Tracers in the Dark.
And it's about the rise of people tracing, you know, law enforcement and these other, you know, these analytics companies tracing illicit flows on the blockchain.
The problem is, okay, we can trace it, but we need to tie that blockchain address to a real-world identity.
And that's not always so easy.
That identity, then, that person needs to be located in a jurisdiction where we can get to them.
And when it comes to illicit transactions in crypto, At this point, it's pretty much all roads lead to Russia because we still live in a fiat currency world.
It's very hard to spend any large amount of crypto.
You can't really buy and sell much with it.
So you need to cash out.
Where do you cash out?
You cash out at exchanges that are operating in jurisdictions that are hostile to American interests, notably Russia.
And we've seen the Treasury Department since the invasion of Ukraine ramp up They're sanctioning Russian-based crypto exchanges.
But the issue is once you sanction one, a new one sprouts up.
So yes, when people bring up, well, blockchain actually helps law enforcement because it's transparent, my retort is, well, that's like saying we should give credit to the tobacco companies for creating Nicorette gum.
I mean, blockchain created the problem.
It's a lot easier to move $100 million worth of crypto than it is to move $100 million worth of dollar bills.
And just look at ransomware, right?
Every ransomware payment, every single one.
Is cryptocurrency, principally Bitcoin.
Now it's true, ransomware does predate crypto, but not anywhere to the scale that we're dealing with right now.
It wasn't front page news.
Look at the Colonial Pipeline hat.
I hear you.
So I think we have, and I think this is useful.
I'm already officially, if you're down for it, going to declare like we're going to have a second conversation on some of the specifics.
But I think here to get just the philosophical foundation down is Your case for potentially a regulatory regime governing crypto is based on negative externalities, largely based on energy consumption and secondarily based on the fact that it facilitates bad action that you otherwise wouldn't have won.
I personally think that the second of those is debatable.
We can debate that.
The first of those, I think, is also this energy consumption as inherently bad Is part of a broader, what I call, climate cult in the country that we have to actually potentially even question the suppositions on which that whole assumption set rests, that energy utilization is at all a negative externality, as long as you're paying for that energy.
And I think that's a separate point that, you know, we can have.
But, each of which have philosophically rich, you know, debates in and of themselves, right?
There's a lot of rabbit holes for sure.
And by the way, it is fair to say that people who are mining for Bitcoin are paying for their own energy, no?
Well, in some cases, there's actually government subsidies to do this.
So if you get the government subsidies out of it, though, internalizing that negative externality solves that problem for you, I mean, as a justification for regulation.
Like, one way you could just sort of not open a whole regulatory Pandora's box would be to say, if you just internalize the costs of energy consumption to the people who are actually mining for it, that solves that problem and takes that justification for regulation off the table.
Yes and no.
I mean, it's energy consumption for no economic purpose.
But who's to judge that, right?
Because there could be an economic value to having this parallel system.
I mean, there's a wide range of utilization of energy.
What's to say that this is a less worthy category than the next one?
It's just a casino.
I mean, crypto, it's just merely speculation.
Fine, but a casino literally uses energy, and we don't say the same thing for a casino, right?
So I'm just literally asking the question of making that judgment.
Well, you get free drinks at the casino.
You don't get free drinks in crypto.
Well, which people then drink and then drive home and then crash in cars with each other, right?
You could make this argument all day long.
Yeah.
But I would say that to the extent- But you're right.
Yeah.
To the extent you're describing it as an externality, we could internalize that externality by actually- You know, you avoid, and I don't know, I've known people in the crypto world, I'm not some person of the crypto world or anything, but I imagine that many of them, if they had a choice to say, internalize the cost of your negative externalities by paying for your energy utilization, but we trade that off for, like, a regulatory regime that doesn't have to exist, I think there are some people in that world who I presume would say yes to that trade-off, and that's at least a first principles clean solution.
The other negative externality is the potential for there to be some type of, like, crypto-caused financial crisis, right?
Systemic risk.
Yeah, but whatever, man.
You could have that anyway, right?
You could also have crypto mitigant.
You could.
And we have regulations.
Now, obviously, we've seen with SVB, right?
Like, ineffective in a lot of cases, right?
Or even creating the very conditions for the financial crises.
We have none of that with crypto at all.
And so a lot of, you know, what I spend my time doing is saying, like, listen, like, Keep crypto out of the traditional financial system, going back to its origins.
If you want to be this casino off to the side where tech-savvy people play, whatever, that's fine.
I don't really care about that.
But that's not where the industry is.
The industry is, give us an ETF. The industry is, we want to be regulated by the CFTC. The industry is, give us a bank account.
We actually want to create our own special banks.
That's where the industry is.
I love this conversation because you know what's so fascinating about this?
I'm going to put a bookend on this for today and then we're just going to pick up where we left off at some date not too distant future if you're down for that, man?
For sure.
Yeah, this is fun.
You, in this conversation, by airing, I would say, your skepticism of unregulated crypto, have made a stronger case to me, or have, for me, awakened more of a pro-classical crypto bent.
Then I did a bad job.
No, you did a great job.
Then any crypto enthusiast who has been, like, spewing nonsense words at me for, like, the last two years about the future promise of the promised land of crypto, dude, it's like, That did not land well with me, but understanding the cases you've made it, though you come from the other side, has actually solidified, I think, a lot of my instincts in the pure version of it.
But I think here's what we might share in common.
I'm going to give you a hypothesis because the last part of what you said probably aligns with what I'm about to say is I don't think the negative externality argument is actually the strong argument, and I'm going to be presumptuous here.
I don't even think that's actually what is at your intuition, at the heart of your intuition.
Try this one on with me because here's where I'm at on it is if you want the actual Wild West, go have your Wild West and don't talk to us.
Do your little pin keys and lose your key and you forget your passcode.
Tough luck.
That's the game you signed up for.
Somebody hacks you.
By definition, it's not a hack because it's the same system.
Code is law, okay?
You want to play in the code is law world, have at it.
And the government, the sovereigns, they ask in the direction of sovereigns is stay out of my hair.
And the bargain's got to be yes.
But the flip side is the sovereign has to have the right to say, we stay out of your hair.
Don't come crying to me or to my court system or to my property rights regime funded by taxpayers through the traditional financial system.
Don't come crying to me when things go wrong for you either.
That works for me.
And I think that that's probably the original ideologues in the crypto world.
And crypto is an ideology in this purest sense of the world.
I believe in allowing that to exist peacefully on its own terms.
But it's the effective cronyism embedded in that to say, "Now we need, actually, you should regulate us so that we can have access to the traditional banking system, too," that creates the hypocrisy.
And I don't want to, I'm not playing your psychologist here, but hearing your arguments, at least that's the more persuasive strand to me.
And I think, like, I could just even like watching you in this conversation, I think that's what animates you and gets you going to me, gets me going, too.
But it could equally be an argument for then saying if the direction you go is saying, okay, if that's the direction you guys want to go, then welcome.
Welcome to the game of being regulated, and here's what that looks like.
And we'll have a separate episode on what that looks like.
But to me, what I would say is don't ever cross that Rubicon.
In the first place, the thing we should actually have left to one side was the idea that let the alt-world be the alt-world.
We have off-chain and on-chain, and may the twain be held separate.
And I think that that's actually something that you've done for this conversation, that the greatest purists in this world haven't been able to persuade me of through the front door, and this was actually quite useful.
Well, listen, I would be fine with that world.
You're right.
But the Rubicon was crossed a long time ago.
And so the crypto industry is doing what every...
And it is an industry.
Yeah.
Is doing what every industry that's come before them has done, which is crawl to Washington, D.C. and ask for special favors, right?
Totally.
They want subsidies, they want light touch regulation, and they want favorable taxation.
And they're no different than anyone else, despite the claims of their technology.
I'm against cronyism in all of its forms, but I believe in the purism and being a purist on the true vision of the original vision of what crypto and the promise of the blockchain was, too.
This was so useful.
Lee, great episode of the podcast.
I have a feeling we're going to be doing this at least another time.
So, appreciate it.
Awesome.
Thanks for having me.
Appreciate it.
I'm Vivek Ramaswamy, candidate for president, and I approve this message.
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