Prices on cryptocurrency platforms Bitcoin and Ether have been volatile in recent weeks after China’s central bank recently stated that all cryptocurrency-related activities were illegal. That is widely seen as the county’s effort to curb currency manipulation, flight of capital, and technology-related risks it perceives in cryptocurrencies. But it would be “dangerous” to assume that the decline and volatility in cryptocurrency prices are a result of China’s ban, according to Kevin Werbach, Wharton professor of legal studies and business ethics.
In a recent interview on the Wharton Business Daily radio show on SiriusXM, Werbach pointed to numerous other factors that shape cryptocurrency prices. The evolution of cryptocurrencies will be shaped by choices countries make on how to use them (e.g., as a digital asset or as a currency, or both) and the attendant regulation, he said. They are not about to become globally accepted as yet, even as some countries have embraced them; recently, El Salvador adopted Bitcoin as its currency and Switzerland cleared the way for more trading of Bitcoin and other digital assets in the country.
An edited transcript of the conversation follows.
Wharton Business Daily (WBD): How surprising was it to hear about the People’s Bank of China banning cryptocurrency transactions?
Kevin Werbach: It was not surprising at all. China has been strictly regulating and limiting cryptocurrency activity for a number of years. In 2017, it banned exchanges operating in China. It also banned initial coin offerings where companies were offering tokens and raising large sums of money all around the world. And various regulatory agencies in China have made a series of statements over the years that they are very concerned about cryptocurrencies and digital assets leading to scams and financial manipulation.
Also, China just a few months ago cracked down on Bitcoin and cryptocurrency mining in the country; it had been the most significant area of such mining in the world. There had been a number of earlier suggestions that [China’s] government agencies were concerned about mining, but they took a serious turn earlier this year and most of the major mining operations have left China. So, this new announcement was in line with that saying, “We are really serious. We mean it.”
WBD: How does that impact the overall process of mining Bitcoin and other cryptocurrencies as we move forward?
Werbach: China for a long time has had the highest concentration of cryptocurrency mining activity, but that mining industry is now a multibillion-dollar industry around the world. Many operators, networks, and pools based in China had for a number of years been developing operations overseas. When it became clear that Chinese authorities were serious about cracking down on mining, they started literally unplugging the mining machines and shipping them to other locations, including to the U.S. So there was a period of time where the overall level of mining activity dropped sharply.
“It’s dangerous to think that [there is a] relationship between the China announcements and what we saw in the price [of cryptocurrencies].”
The way Bitcoin works is that the difficulty of mining ratchets up as there are more people mining…. That difficulty level dropped very sharply when all the mining activity went offline in China. It has since come back in significant ways as other mining operations have compensated and many of those mining machines that were in China have moved elsewhere.
WBD: Is the expectation that the volatility and price declines are temporary?
Werbach: Digital assets – cryptocurrencies — have historically been extremely volatile, but it’s important not to get too caught up in trying to explain what is behind any particular move. [Wharton professor of legal studies and business ethics] Brian Feinstein and I published an academic paper that did a quantitative analysis and found in general that regulatory announcements did not affect the volume of transactions on cryptocurrency networks.
Clearly, it’s possible that China’s announcement had effects on the price, but there are so many other things that go into the price of Bitcoin and other cryptocurrencies as well as real concerns about how those prices are artificially manipulated that it’s dangerous to think that [there is a] relationship between China’s announcements and what we saw in the price.
WBD: Can you have an overall cryptocurrency market that reaches its peak without having the Chinese economy in the mix?
Werbach: Oh, sure. Facebook does not operate in China and still manages to have almost 3 billion users around the world. It’s not that holding cryptocurrency is illegal in China. What we don’t really know is the extent to which still large holders of cryptocurrency in China are still transacting overseas through virtual private networks and in other ways. Again, China cracked down on cryptocurrency trading a number of years ago, and yet surprisingly, a number of exchanges that were founded in China, largely operated by mainland Chinese citizens, nominally offshore, not doing business with China, were still huge participants in the market.
That seems to be finally starting to change, but it’s clear there is still a lot of cryptocurrency that is held by Chinese citizens in China that somehow is making its way into the market. But even if that does get closed off, China is not the entire world, and as we have seen with mining, it’s certainly possible for the digital asset market to grow without China.
A Growing Momentum
WBD: In terms of adoption and use of cryptocurrency, it seems like the momentum continues to grow when you see a country like El Salvador adding it into its mix of currency. How quickly could we see other countries take a similar approach?
Werbach: Overall, yes, the momentum continues to build. But I am very skeptical about the El Salvador announcement. I think it’s largely a political announcement by the authoritarian leader of El Salvador, making a formal determination that Bitcoin is legal tender. [That, coming from] a country which uses the U.S. dollar and not its own currency, is symbolically important. But it doesn’t necessarily mean that there is any good reason why people in El Salvador — on their own, without a government mandate — will want to transact using these cryptocurrencies. It might happen, but we’ve had more than a decade of Bitcoin and other cryptocurrencies being around. The price has gone up tremendously, so there’s no question these are valuable assets for trading.
But the amount of transactional activity for payments, [or] the situations where it’s cheaper, better, or easier to take out your digital wallet and pay for something with Bitcoin and Ether instead of picking up your credit card are still pretty limited. Now, that doesn’t mean that they are nonexistent or they will inevitably be nonexistent, but I would urge people to be careful to not go too far, saying [that after] El Salvador, all countries will take Bitcoin, and then suddenly that means all transactions will change over.
“The situations where it’s cheaper, better, or easier to take out your digital wallet and pay for something with Bitcoin and Ether instead of picking up your credit card are still pretty limited.”
There is a tremendous and exciting development [relating to cryptocurrency] in the blockchain and digital asset space, but it’s critical to separate whether we’re talking about using it to buy things or trading it as an asset using blockchain networks as the foundation for applications and service. That is the part I’m most excited about, which doesn’t depend at all on [cryptocurrency] prices.
Regulatory Trajectory in the U.S.
WBD: In the U.S., the discussion around regulating cryptocurrency is still going on and probably we will hear more about that over the next several months.
Werbach: Oh, absolutely. I’ve been very involved in many discussions with regulators in the U.S. and around the world. If you believe in cryptocurrency and you think this is the future of financial services, then you want to have a good regulatory regime. You want to have a situation where those you’re dealing with are not going to scam you and steal all your money. You want to have a situation where you can trust there isn’t market manipulation and a situation where this is not widely and easily used by criminals for things like money laundering. We need to address these regulatory issues and address the bad actors to allow the legitimate activity – which is considerable – to grow.
Unfortunately, this debate in the U.S. has fallen into the same kind of partisan tropes that we see with so many other issues. And that would be unfortunate. Because there are really thoughtful and hardworking people in the U.S. government and in other governments around the world that I’ve talked with who are trying to work through these issues and create something that allows the innovation and allows for people to use these new technologies, but appropriately addresses the real challenges.
WBD: What role do you see for cryptocurrency in the U.S. economy over the long term?
Werbach: It’s hard to say because it depends how broadly one defines cryptocurrency. So many governments around the world – China being probably the leading one among the major economies – are moving towards deploying what are called central bank digital currencies (CBDC). The U.S. Federal Reserve is looking at this, but [the U.S.] is not one of the most aggressive countries in moving forward on it.
A CBDC is like a cryptocurrency. It’s a fully digital asset but it’s [also] a fully digital version of the national currency. Most of these don’t use the decentralized blockchain architecture that Bitcoin and Ether and the other cryptocurrencies use, but they would have many of the same features and be within the control of the government in terms of managing the currency.
That to me suggests that these distributed digital networks will be the basis of money and finance in the future. Certainly there are opportunities where a decentralized system where no one’s in control is a better system. It’s potentially a more open system, a more secure system, a more global system, and a more flexible system. I have no doubt that that will be a significant piece of the overall financial landscape.
“You want to have a situation where those you’re dealing with are not going to scam you and steal all your money.”
But again, the question will be: Is it really better for what people want to do? We’re starting with a clean slate and not touching any existing system. There are lots of areas where we’re starting to see that, but it’s still very early. The basic technologies are still evolving to be mature enough to take on that significant role in the financial system.
A Global Approach Is Imperative
WBD: How would countries have to work together to be able to have the most effective cryptocurrency?
Werbach: Cryptocurrencies are global. These are decentralized networks that are not within the boundaries of one country, so they cannot be addressed from a regulatory standpoint purely by individual countries. At some level, though, this is similar to the debate we had 20-plus years ago about the internet. The internet is also global, it’s also decentralized. And we had people and governments saying “Oh no, the internet has come along, it can’t be regulated, and governments can’t implement their policies.” Or “It shouldn’t be regulated. We should just let anyone do whatever they want. If they’re going to use the internet to engage in illegal activity, there’s nothing that can be done about it because you can’t shut down the internet.”
What we saw over an extended period is governments finding ways to address appropriate concerns, or the concerns that they have. China took a very restrictive policy towards the internet, built this massive Great Firewall infrastructure, and has very significant limitations on speech that I, as an American citizen, don’t like and am not comfortable with. But I understand that the government of China is entitled to decide what the policies are for Chinese citizens living in China.
We will see a similar [evolution] with digital assets or cryptocurrency. We’ve already seen that start. For example, there’s a group called the Financial Asset Task Force, which has been working on rules and mechanisms for disclosures to address financial crime with cryptocurrency. There are lots of conversations, some of which I’ve been hosting here at Wharton among regulators from the U.S., Europe, and Asia.