Cryptocurrency and Blockchains | Kevin Werbach

What Is Blockchain Technology and How Does It Work?

Dan Loney: The conversations around cryptocurrency and what might happen with crypto investing and regulation in the next several years are surging. But there is also blockchain, the tool that makes a lot of these digital assets possible.

It’s a pleasure to be joined here in the studio today by Kevin Werbach, who’s a professor of legal studies and business ethics here at the Wharton School. He’s also chair of the department. Kevin, you’ve done a lot of research on blockchain. Where do you think we stand right now with it?

Kevin Werbach: Blockchain technology has been around since 2008, when Satoshi Nakamoto — and we still don’t know who that is or was — issued a white paper developing the idea of bitcoin. Bitcoin is a cryptocurrency. It’s a form of digital asset, but it rides on this ledger technology called blockchain. And blockchain is actually much more general in terms of its applications.

We’re something like 16 years in to blockchain technology being widely available. It was actually built on earlier foundations. We see a great deal of interest. We see lots of experimentation. We see lots of trading activity around digital assets. We see building of distributed platforms on the vision of Web3, a kind of distributed internet powered by tokens.

We also see use of blockchain in payments. And we see companies using it as a recordkeeping technology for understanding information as it flows across their networks and between companies. We don’t yet see any real scaled use cases that are not predominantly powered by financial investment-type incentives. So, that’s really the question of how far along we are.

Loney: How do we take blockchain from where it is now to more of a larger scale use?

Werbach: It’s not clear exactly what blockchain is going to be best for. I’ve been studying this for a decade at least. I always say, there are these different application categories, these different use cases. And it may be that the significant use case is just as an investment asset. That’s really the one that has the most heft around it in terms of the activity. Or it may be that when we look back 20 or 30 or 50 years from now, we say, “This is the new rails, the underlying technology that powers the financial system as it evolved in the next stage.” Or we might say something else.

I don’t think we should assume that we know the answer. We should think about looking at applications and use cases as they develop. If it actually is a better technology, if it really has advantages, then it will ultimately succeed in the market.

Loney: It’s kind of up and down the spectrum in terms of who is trying to figure this out. You have conversations about this going on with the Federal Reserve. You have so many different companies in different sectors that are wondering, is it something that works with how they run their operation? It still feels very much a learning process right now.

Werbach: I think people don’t realize how foundational a change this technology represents. If we’re talking about the blockchain technology, if you are going to your Robin Hood account and you’re deciding whether to buy bitcoin or to buy some meme stock, it’s just another name, and you can think about it as an investment. That’s not fundamentally revolutionary. The technology, though, really is. It’s a decentralized ledger technology that provides trust without any central entity that is the administrator that everyone relies on. And that’s incredibly powerful, and that’s has implications for all sorts of use cases. It has really significant implications for finance in many ways.

That’s why we have all these conversations. Unfortunately, though, it always tends to get pulled back or influenced by this conversation about the speculative investments. Again, there’s nothing wrong with an interesting new investment asset class. But that’s really the piece that everyone gets fixated on. But when you look at what’s happening out there, we see really interesting growth of some of these other use cases as well.

Loney: Does the up-and-down nature of things like cryptocurrency have an impact on the potential use of blockchain?

Werbach: Oh, absolutely. Again, that’s what I’m talking about. That people assume that it’s inherent to blockchain, that it is highly volatile, and all about crazy, wild speculation. Also, we should mention fraud, scams, illicit activity. We saw the collapse of FTX. Celsius is another company that collapsed in fraud. The CEO just pled guilty to criminal charges. All of that gets wrapped up into this.

But when you actually talk about the ledger technology, it doesn’t necessarily have that attribute. For example, one of the major applications of blockchain technology in finance is to create what are called stablecoins. These are digital assets that are typically pegged to the U.S. dollar or some other stable reference point. They’re not volatile at all. Now, they potentially could be risky if the assets that are backing them are not truly stable, or they don’t actually have the assets they claim to. There are certain important regulatory issues. But those really aren’t at all about volatility. I think it is important to differentiate out when we’re talking about something that’s purely investment versus something else.

How Will the Trump Administration Regulate Digital Assets Like Crypto?

Loney: We’re switching administrations in the White House, and the belief is that maybe we’re going to see a shift in terms of mindset. When you think about regulation and components around digital assets, where could we potentially land?

Werbach: Look at history. Every time there has been a major, unregulated, new kind of financial instrument that is accessible to lots of people, there have been horrible abuses and fraud and crimes. Now, that doesn’t mean that those financial innovations were bad or should have been or were prohibited. But that’s why we need regulation. That’s why we had the birth of things like the Securities and Exchange Commission coming out of the Great Depression, where there was horrible abuse and fraud in financial markets.

We see that with digital assets. We see that with crypto, which doesn’t mean that it should be prohibited. Unfortunately, what happened was that the Biden administration was actually on its way to what, I think, was a really thoughtful and sensible approach to coming up with what it called responsible digital asset regulation. We want to allow this technology to exist and promote the innovation, but ensure that there were the same appropriate kinds of checks. Again, if you go to your Robin Hood account and you’re investing in a digital asset, you have the same kind of confidence that you’re getting accurate information and the person on the other side is not trying to scam you, as if you’re buying an equity that’s traded on the New York Stock Exchange. That makes sense.

What happened was, in the interim, we had the explosion of the crypto bubble and the collapse of things like FTX, which really soured a lot of people in and around the U.S, government at that time in this whole space. They really, I think, over-indexed on protecting against any harms happening. Those are true of the banking regulators as well. Unfortunately, they didn’t differentiate between the firms that were really shady and questionable, and the ones that were saying, “Tell us how to comply. We don’t understand. It’s really hard to map all of the existing rules onto this new technology. We want a path to clarity.”

They didn’t make that distinction. As a result, you got a backlash from certain loud, powerful voices in the industry and in the venture community who eventually seized on Donald Trump as the one who would bring them a new, less regulatory environment for crypto. They started supporting his campaign. Not the whole industry, but some very powerful figures. They are now part of the new administration and will very certainly take this in a very different direction.

Loney: With the growth in terms of pricing of bitcoin, Ethereum, and other assets in recent months, should we believe that there is strength building around cryptocurrency? Or is it still a wait-and-see?

Werbach: I don’t give investment advice, especially in this space where there are so many uncertainties. I think it’s really easy to come up with simple explanations. “This decision happened, and then the price of bitcoin moved this way.” When you actually understand how the bitcoin market works — very highly concentrated, fairly illiquid. There has been, historically, lots of evidence of market manipulation. It’s a kind of a meme currency. People are buying in because of their belief about the potential of the technology. That doesn’t mean that it’s not an investment that you can make money on. But it’s really not a simple answer that this happened yesterday, and the price went up or down today.

You even look at the crypto market behavior after the Trump victory. Bitcoin went up a lot. A few of the other ones, like XRP, which was associated with this company, Ripple, that had a lawsuit against the SEC and so forth, that went up a great deal. Ethereum, which is the second biggest cryptocurrency, barely budged after Trump’s election. Many of the other coins, at least right after the initial time, didn’t seem to have a big impact.

Again, these are investment assets. There are ways to invest thoughtfully. There are different ways to come up with an understandable valuation. Certainly, it is affected by the vibe. Certainly, is affected by regulation. But I think people too often just assume that that’s a simple equation when it really isn’t.

Loney: For a while, there was a conversation about whether or not we were going to see digital assets used as currency by different countries. But then you hear commentary from [Federal Reserve Chairman Jerome] Powell about, it should be more tied to gold than to traditional currencies. Are we past the point of believing that it’s something other than an investment of that type of nature?

Werbach: That’s different. That’s what are called Central Bank Digital Currencies, or CBDCs. Going back to what I said before, blockchain is the underlying technology. You can use it to issue these tokens, which are not really backed by anything, and are volatile, and essentially are investment assets, or they’re used for payments. Bitcoin — the whole idea is that it’s a store of value independent of governments, and it’s a new kind of means of payment. Or you can think about having them be stable assets. Either privately issued stablecoins or publicly issued digital currencies.

China has issued a central bank digital currency. None of these are on exactly the same kind of totally decentralized blockchain technology as assets like bitcoin and ether. But they have a similar kind of ledger technology. The European Union is fairly far along in a digital euro. The U.K. is somewhat far along. They’re still skeptical, but trying to come up with the foundations for a digital pound. The Federal Reserve has done a good deal of research on a digital dollar. But it is true, they have been fairly skeptical that we should implement this. The question is always really, what problem does it solve? So much of the currency is already digital. And what problem does it solve that these private stablecoins, which create this new decentralized platform, are not already solving in the marketplace?

What Is the Future of Blockchain?

Loney: Where do you think we head with blockchain technology so that it becomes something greater than what it is now?

Werbach: One thing is that the technology is maturing. For a while, there were serious issues about scalability. There’s been a lot of progress on that. There’s been a lot of progress on privacy and other aspects. There is also development in that marketplace, once you get beyond bitcoin, which is kind of a unique thing. There are questions about different platforms. Ethereum, for the longest time, has been the second most valuable and the most prominent digital asset for these other kinds of uses of blockchain. There are other platforms, like Solana, that have certain advantages that seem to be maybe catching up.

There are all of these questions about maturation. But I think, ultimately, we do need a good, clear regulatory environment so that we can put that to the side, and we can address these appropriate concerns. The concerns about investors, the concerns about fraud and crime and sanction violations. Very real issues that need to be addressed. It’s not just a matter of deregulating. It’s a matter of regulating and having a clear framework, which will almost certainly take legislation to address these issues. We need that first.

And then we just need time. Because again, just to take one of these for use for payments in the financial system is re-architecting the pipes of global finance. There are trillions and trillions of dollars at stake here. This is not something that’s going to happen overnight. I believe it’s going to happen. It’s just fundamentally a better technology than the accumulation of things that we have now underlying the financial system. But that’s a period of many years to really realize that potential.