Governor Waller’s Speech On Risk In Crypto Markets

Thank you for giving me the chance to participate in this interesting discussion. It is a pleasure to speak with such a good mix of academic, industry and official sector experts on a topic of real importance to the future of the financial system. I know my remarks come after a long day, and I intend to be brief. My purpose tonight is not to comment on whether and how crypto-asset markets should be regulated. Instead, I want to make a few observations that I hope will help focus the discussion on this issue in the right place. The main problem with crypto-asset regulation is not how to protect sophisticated crypto investors; that’s how to protect the rest of us.

By any measure, the last five years have been a period of incredible growth in the crypto-asset markets. Every aspect of them has expanded, from protocols and platforms to instruments and intermediaries. Public awareness and government attention have increased. Crucially, crypto itself evolved from a limited set of coins intended to provide an alternative means of payment to decentralized finance, or “DeFi,” arrangements intended to provide alternatives to a range of products and services. financial.1 Innovation happens quickly, and many of the people and groups represented in this room have found new financial uses for this technology.

By law or practice, many crypto-related products and activities fall through the cracks of traditional legal and regulatory structures, outside the so-called “regulatory perimeter”. In this environment, the normal backstops and safety nets of traditional finance do not necessarily or reliably apply. High volatility is the rule, not the exception; fraud and theft occur regularly, often on a large scale. Your whole pot is still on the table; you participate at your own risk.


Some DeFi traders understand these dynamics well. If they don’t embrace them, they still accept them as the natural state of a new, exciting, and still relatively unregulated market. And they’re right: Crypto and DeFi may be new, but these types of freewheeling markets are not. They often emerge – to quote Professor Debora Spar – after:

“a sudden movement along the technological frontier – a moment when innovation leaps[s] suddenly outward, creating new opportunities for trade and tremendous enthusiasm among budding entrepreneurs. In each case… the technological leap also creates[s] a political vacuum. Innovation, in other words, enabling[s] businesses to play in a new sphere of activity, free from the rules or regulations that might bind them in another, more established area.”2

This was true with long-distance maritime trade in the 1400s; with the spread of railroading in 19th century America and the explosive growth of banks to finance it; with “homebrew” computing in the 60s and 70s; and with the Internet in the 1990s. New technologies – and the absence of clear rules – meant that new fortunes were made, even while others were lost.

There’s a lot to love about these types of markets. Entry is often cheap and exit is often fast. The competition can be fierce. And inefficiency can be fatal, so improvements can happen quickly. The ideas, practices and technologies that survive in these choppy waters can eventually disrupt and improve older, calmer markets. As I said before in the context of stablecoins, these positive spillovers can (under the right circumstances) make everyone better off.3

From the perspective of many market participants, those surviving and thriving in this difficult turmoil, regulation is not only unnecessary, it is counterproductive. This drives up costs, creates barriers to entry and stifles innovation. From some crypto advocates, I’ve heard this argument and a related one: that these experienced investors know what they’re getting into and aren’t asking for protection because they think they don’t need it. Given all of this, the argument is: why should anyone introduce regulation into a space that doesn’t demand it?

Let’s focus on crypto-asset users, who are a very different group than just a few years ago. The most recent from the Federal Reserve Household Economic Decision-Making Survey found that 12% of adults have used or held cryptocurrencies in the past year, and more than 90% of these adults have held them for investment rather than payment.4 The Pew Research Center put the number of users even higher at 16%, and other polls up to 20%.5 Some of these users are seasoned professional investors, but others, of course, are not – they are drawn into a new and complicated market out of curiosity, stories of newly minted crypto billionaires, or promises of high returns and reliable in their lives. savings.6

New retail users, by definition, do not have a background in crypto. They don’t know how to independently purchase a crypto asset, how to obtain and protect a private key, how to transact on a DeFi protocol, or how to write a smart contract. They need help, and for a price, a range of fast-growing exchanges, wallet providers and other intermediaries are ready to provide it. But while intermediaries can potentially help monitor and manage risks, they cannot eliminate them. In such a volatile market, any user still has a significant chance of losing their money.

What happens as a result of these losses? At the individual level, one possibility is a dispute between the intermediary and its clients regarding poor due diligence, poor financial advice, poor management practices, etc. Resolving these disputes individually can be costly. It is therefore not surprising that intermediaries ask them for some sort of protection – standard rules of conduct which, if followed, create at least some presumption of good conduct. As a result, intermediaries may possibly require regulation to protect themselves.

From a social point of view, there is another possible result when the losses become widespread: these losses become practically, politically or morally intolerable. When ordinary investors start losing their life savings, for no other reason than wanting to participate in a booming market, demands for class action can mount quickly. History shows that there will be demands to make individual investors “whole” by socializing their individual losses. We saw this just a few weeks ago after what can only be described as a run on the Terra ecosystem, when everyday users were seeking restitution and even experienced DeFi players were discussing ways to compensate retail

This brings us to the main reason, in my opinion, why society wants to regulate new and poorly understood markets for financial products. This is not to protect wealthy investors, but to protect society from the often irresistible pressure to socialize the losses of investors with limited resources and to limit the spread of financial stress.8 The desire for a backstop can emerge even in an isolated failure — let alone a system-wide event — when uncertainty or private information shifts stress from one asset class to another. others. By definition, these financial externalities — which central banks, including the Fed, are watching closely — can create losses that innocent parties never underwrote and could not have controlled.9 This is the kind of loss the public is often asked to cover – and when it is, very often the public also asks for new oversight and new regulations, so the same mistakes don’t happen again. .

In summary, financial regulation is generally required (1) by financial intermediaries as a form of liability protection and (2) by the taxpayer to prevent the socialization of individual losses. This is not to protect sophisticated, experienced and knowledgeable investors. On the contrary: large-scale losses can easily occur even if these investors get the information they need to make decisions and otherwise play by the rules. If we want to enable broad access to the crypto ecosystem, the question is not what the experienced users of this ecosystem want, but what the rest of the public needs to have confidence in the security of the ecosystem. , and for better or worse, you can’t program trust. This question does not always have a clear answer and involves real and difficult trade-offs. But it’s a question every new, fast-growing financial product has to answer if it’s going to last very long.


1. International Organization of Securities Commissions, IOSCO Decentralized Finance Report (PDF) (Madrid: OICV-OICV, March 2022), 3. Back to text

2. Debora L. Spar, Governing the Waves: From the Compass to the Internet, a History of Business and Politics along the Technological Frontier (New York: Harper Business, 2003), 9. Back to text

3. Christopher J. Waller, “Reflections on Stablecoins and Payments Innovations” (remarks at the Financial Stability Conference, Cleveland, OH (via webcast), November 17, 2021). Return to text

4. Board of Governors of the Federal Reserve System, Economic well-being of American households in 2021 (PDF), (Washington: Board of Governors, May 2022). Return to text

5. Thomas Franck, “One in Five Adults Have Invested, Traded, or Used a Cryptocurrency, NBC News Poll Finds,” CNBC, March 31, 2022, news-21percent-of-adults-have-traded-or-used -crypto-nbc-poll-shows.html; Andrew Perrin, “16% of Americans say they have ever invested, traded or used a cryptocurrency”, Pew Research CenterNovember 11, 2021. Back to text

6. Anthony Cuthbertson, “’I lost my savings’: Terra Luna cryptocurrency crashes 98% overnight,” Yahoo! News, 11 May 2022, ; Muyao Shen, “DeFi App Promising 20% ​​Interest on Stablecoin Deposits Raises Concerns,” Bloomberg, March 23, 2022, de-20-challenge-return-raises-sustaining-concern. Return to text

7. See, for example, Alexander Osipovich and Caitlin Ostroff, “TerraUSD Crash Led to Vanished Savings, Shattered Dreams”, Wall Street Journal, 27 May 2022, -aux-économies-disparues-rêves-brisés-11653649201; Taylor Locke, “Ethereum co-founder says every ‘average small miner’ impacted by Terra stablecoin crash should be healed, cites FDIC $250,000 as ‘precedent,’” Yahoo! News, 15 May 2022, Back to text

8. David Andolfatto makes this argument for cases other than cryptography in his article “A Theory of Inalienable Property Rights” Journal of Political Economy, flight. 110(2), (April 2002): 382-93. Return to text

9. Board of Governors of the Federal Reserve System, Financial Stability Report (PDF) (Washington: Board of Governors, May 2022). Return to text

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Governor Waller’s Speech On Risk In Crypto Markets

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