On January 4, AEI hosted an event on the technical underpinnings and political future of cryptocurrency and blockchain technologies. We dedicated the first half of the event to defining complex crypto-related terminology; the second half largely surveyed the policy issues posed by these technologies. For this discussion, I was joined by former Commodity Futures Trading Commission Chairman J. Christopher Giancarlo, Jerry Brito of Coin Center, Kara Calvert of Coinbase, and Miller Whitehouse-Levine of the DeFi Education Fund.
Below is an edited and abridged transcript of key highlights from our discussion, including excerpts of Giancarlo’s keynote address. You can re-watch the full event on AEI.org and read the full transcript here.
Giancarlo on the state of American financial infrastructure:
An observation I have coming from my time in public service is that America’s physical infrastructure, bridges, tunnels, airports, and mass transit systems that were cutting edge in the last century have been allowed to age and deteriorate in the current one.
Sadly, the same is true about much of our financial infrastructure, both in the United States and in developed Western economies. By that, I mean systems for check payment and settlement, shareholder and proxy voting, investor access and disclosure, and even financial system regulatory oversight. Once state-of-the-art and global models from the 20th century have fallen behind the times in the 21st century — and in some cases, embarrassingly so.
This aging financial system puts developed economies, like ours in the United States, at a competitive disadvantage to the likes of China, which is building new financial infrastructure from scratch with 21st-century digital technology. For example, it typically takes days in the United States to settle and clear retail bank transfers, while in many other countries it takes mere minutes, if not seconds. Nothing better reveals the limits of our existing financial system than the US government’s initial financial response to the COVID-19 pandemic in the spring of 2020. Tens of millions of Americans had to wait a month or more to receive relief payments by paper check, and more than a million payments were made to people who were dead.
Giancarlo on a potential US central bank digital currency (CBDC):
Today, over 80 percent of the world’s central banks are considering a CBDC for several reasons including access to citizens’ economic data, financial infrastructure modernization, and geopolitical influence. Another important reason is values. Money has always been as much a societal construct as it is a government construct. As such, money carries with it social values. In the case of the analog US dollar, those values have been free enterprise, free trade, convertibility, stability, and, crucially, economic privacy for legal transactions.
Money has always been as much a societal construct as it is a government construct. As such, money carries with it social values. In the case of the analog US dollar, those values have been free enterprise, free trade, convertibility, stability, and, crucially, economic privacy for legal transactions. In the future, a well-functioning CBDC should be private. People should be able to use a US CBDC without making themselves subject to inappropriate government surveillance, censorship, or economic restrictions. It should be secure. A CBDC should improve — not degrade — people’s security against theft, hacking, illegal seizure, unauthorized data mining, or fraud. It should be accessible. It should improve Americans’ and global dollar users’ access to financial services. And finally, a US CBDC should be transparent. It should be run on systems that are operationally transparent so the public can assure themselves about its technical functioning, security, and resistance to impermissible monitoring.
Jim Harper: If we consider a blockchain a ledger, a block is a page in this ledger. But what exactly is mining — the process through which cryptocurrency is created, and what does it have to do with blocks?
Jerry Brito: Mining is the process by which you add blocks to a blockchain. Generally speaking, there’s a new block added to the bitcoin blockchain about every 10 minutes on a peer-to-peer network of everybody who’s on the network.
Suppose that I’m one of the peers, and I say, “I want to send $100 worth of bitcoin to Jim.” I sign that message with my private key, then I broadcast this message on the network. This essentially means that I am forwarding this request to my nearest peers that I’m connected to, and then they further it on, and pretty soon, everybody on the network is seeing this.
Some of the nodes on the network are what we call “miners,” and these are special nodes that dedicate computer capacity to collecting all the transactions that they see over the last 10 minutes. You’ve got thousands of miners around the world all doing this, racing to be the first one to solve a cryptographic puzzle. And if they are the first one, their block is the one added to the ledger. They choose the order of transactions — a very important element.
There are two additional, important things I want to say about mining. First, the purpose of mining is to validate the transactions and add them to the chain in a secure way. Miners are basically being PayPal, except they’re being PayPal only for the next 10 minutes. They get to say, “These are the valid transactions, and they’re here in this order when we add them to the block.” But they have to have an incentive to expend so much work to take on this role, so they are rewarded with bitcoin — the second important component.
Some ask, “Why don’t you just get paid in dollars?” The answer is: If you introduce dollars into the system, you’ve removed everything that makes this ecosystem permissionless and open, because you’ve introduced all the strings attached to the US dollar.
What precisely is a decentralized autonomous organization (DAO)? If it is both “everywhere and nowhere,” how can it be subject to any jurisdiction?
Miller Whitehouse-Levine: A DAO is kind of an amorphous concept. I think about it as a group of folks over the internet who are collectively trying to accomplish some shared goal, be it the provisioning or maintenance of a computer program, smart contract, or collection of money to go buy the replica of the Constitution. You can also think about it as an internet-native corporation. It’s permissionless, meaning that anyone may participate in the DAO.
Kara Calvert: Wyoming is actually addressing this issue as they’ve talked about how a DAO would become a limited liability company (LLC). In fact, they have laws on the books that allow that to happen. While many DAOs are interested in remaining fluid and nebulous, many actually want to accomplish something, and they want to do it in a compliant and legal way. DAOs have governance structures, ways to make decisions, and a legal path forward to become an LLC — at least in Wyoming. Other places are trying to catch up with that, including at the federal level.
How has the IRS tried to tax cryptocurrency? What are the main problems with its current approach?
I think we need more clarity from the IRS on whether crypto is property or currency. An even bigger challenge that we’re seeing in Congress is the lack of education on how all of this works. Until you understand this technology, it’s going to be hard to understand how to tax it, and some of the big questions we have had are: Who should be reporting for things like DAOs, decentralized finance, mining, and staking, and who should be providing these services?
At Coinbase, we want to be in compliance. We provide lots of tax services for our customers to know when they bought, when they sold, how much they made, and how they can comply. But the challenge of working with the IRS is helping them understand how to tax cryptocurrencies and implement — or change — certain rules in a way that enables innovation and allows people to be tax compliant.
Critics point out bitcoin’s energy consumption as a major pitfall. What are your thoughts?
Miller Whitehouse-Levine: Any negative about a system has to be balanced with a positive. Every system that provides societal good can also have negative externalities. Moreover, critics of mining’s energy consumption might be inherently less convinced about the potential societal benefits of cryptocurrencies broadly, so they hone in on the downsides.
Yet, both mining and proof of work are critical to the operation and security of these decentralized ledgers, so we can’t just get rid of them. Additionally, over time, a lot of this is going to follow Moore’s Law. Everything will get more efficient, and we’re going to create more energy in a sustainable way.
Kara Calvert: We’re actually using energy more efficiently in the state of Wyoming to provide some of these mining services. We’re capturing natural gas and burn-off, but we’re also using wind. There are all sorts of ways that we’re actually leveraging renewables to do this mining, even though it does use a lot of energy. But we’re finding ways to do it.