Wall Street’s sellout

I’ve been railing against cryptocurrencies since bitcoin was first introduced.  Given my bias, you won’t be surprised at my disappointment -- and annoyance -- in learning that the Securities and Exchange Commission (SEC) has just approved the creation of 11 exchange-traded funds (ETFs), which will undoubtedly be marketed to a population of dupes who will be suckered into a fool’s game.  I’m not saying that people won’t make money with their crypto currency bet – just that it’s a bet that is purely dependent on what Keynes called “Animal Spirits.”

Like all markets, the price of any cryptocurrency is a function of supply and demand, but in this case, the demand is almost entirely driven by market sentiment. When higher prices are widely expected, demand increases, and higher prices result. The catch is that prices can’t appreciate forever. Inevitably, sentiment will change, demand will decrease, and prices will fall. Many may be able to exploit this volatility successfully, but anyone who thinks of buying and holding cryptocurrencies as a long-term investment is delusional. There’s little reason to believe that prices in the long term will necessarily be higher than they are today.  It’s up to those animal spirits. 

Gary Gensler, Chairman of the SEC, is also a critic of these new products.  Despite his opposition, the SEC authorized the trading of 11 new cryptocurrency ETF contracts that allow the public to hold cryptocurrencies within a structure that meets the definition of a security and thus is subject to SEC regulations.  Gensler published a statement in which he basically asserted that the approval for these contracts was forced on him as a result of court rulings. 

Gensler’s criticism of these contracts couldn’t have been more clear, and I can’t improve on his comments: “bitcoin is primarily a speculative, volatile asset that’s also used for illicit activity including ransomware,[4] money laundering,[5] sanction evasion,[6] and terrorist financing.[7].”  (Click on the footnotes for further detail justifying Gensler’s representations.)

To digress, the mission of the SEC is the following: “to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. The SEC strives to promote a market environment that is worthy of the public's trust.” Given this mandate, I believe the approval of these new cryptocurrency contracts conflicts with the SEC’s responsibilities.

The problem I see with these contracts – aside from the above list of detriments – is that they have no bearing whatsoever on capital formation. Despite all the associated cash transfers with cryptocurrencies, no new legal or legitimate widgets are created or consumed.  After you take away the illicit and illegal rationale for using cryptocurrencies, you’re left with only one reason to hold them:  the expectation that they’ll rise in value. Put in other words, the market for these instruments serves as a vehicle either for crooks or speculators.

I don’t have a beef with speculators, particularly when they serve as individuals or institutions that willingly take on the risks that bona fide businesses want to lay off – i.e., when speculators facilitate hedging. When speculators serve in that manner, they enable legitimate businesses to better manage the inherent risks of their enterprises. This function is a social benefit that is often of profound importance. In the case of cryptocurrencies, however, there are no hedgers.  Only two categories of market participants are present: dealers and speculators. 

Dealers provide the infrastructure needed to satisfy the desires of speculators. Operationally, dealers post a two-sided market (i.e., bids and offers), and customers are invited to trade at those prices. That is, dealers buy from customers (when customers choose to sell) at the posted bid price and sell to customers (when customers choose to buy) at the posted offer price, thereby enabling the dealer to make the bid-offer spread. The greater the trading volume, the more the dealer makes. Given this structure, you can bet that dealers will do their best to market these contracts aggressively and encourage expanded market participation.

All the dealers’ customers are speculators who simply want to bet on the price going higher or lower. When you come right down to it, the primary function of these contracts is to transfer wealth from losers to winners, with no greater social benefit and certainly no capital formation. The customers are simply picking each other’s pockets. There’s nothing noble about this activity, particularly in that its operation facilitates all the negatives that Gensler so ably enumerated. All the brainpower and capital used in setting up and operating these markets could surely have been put to better use.

The countervailing argument in favor of authorizing these contracts – and, more significantly, generally legitimizing cryptocurrencies – is that we operate in a free country, where consenting adults should be able to affect mutually acceptable contracts.  In this case, however, guardrails should have been put in place to protect the greater good.