Eric Maskin: Why Governments Should Regulate Cryptocurrency

At the Fourth Annual Conference of Government and Economics, held virtually on April 26, 2022, audience members viewed a lecture from Eric S. Maskin on the dangers of cryptocurrency, particularly with regard to countercyclical monetary policy. What follows is a transcript of his lecture that has been lightly edited for clarity. Eric S. Maskin is a 2007 Nobel Laureate in Economics, the Adams University Professor at Harvard University, and Co-President of SAGE.

Hello everyone. I'm very glad to be participating in the annual conference of SAGE. It's a great honor for me to be leading this organization together with my old friend and student, Daokui Li.

Before I get going with my talk, I'd just like to say how pleased I am at the success of the society so far. We've been having these annual conferences and there is much research on the topic of the interaction between government and the economy going on.

And perhaps most exciting of all, we have launched a new journal, which has now published five issues. I think the fifth is just about to come out, with some stellar authors, including Joe Stiglitz, Mike Spence, Ned Phelps, Nick Stern, and many others. So, I think we are doing what deserves to be done for this important topic of the interaction between government and the economy.

For my talk today, I would like to talk about cryptocurrency such as Bitcoin, which has been a very fashionable phenomenon in the last two years. What I'm going to say, though, is primarily negative about such cryptocurrency.

The first thing that has to be asked about Bitcoin is: What benefits does it bring that we don't already have? It's not as though before Bitcoin, we didn't have money. We have many different types of money. We have Dollars, we have Euros, we have RMB. So, one important question to ask is, why do we need another?

Now, the standard reply to that question is: well, these old-fashioned forms of money aren't as easy to transfer as Bitcoin. And there's a sense in which that's true. With Bitcoin, for example, you don't need to go through a bank. You can transfer money person-to-person.

But of course, there's no reason why, in principle, we couldn't create a digital form of the standard central bank currency, such as the RMB and the Dollar and the Euro. So yes, there is a current advantage that Bitcoin might have, but there's no reason why that advantage should persist.

And of course, there are a number of ways in which old-fashioned money is considerably better than Bitcoin. Central-bank-created money is not subject to big speculative swings that we've seen with Bitcoin and other private cryptocurrencies. You don't need a crystal ball to predict the value of the RMB or the Dollar reasonably well. You have some idea of how much to hold in your portfolio, but with Bitcoin, who knows how much it will be worth next week, let alone next year. Volatility may be good for speculators, but it's not good for society.

Another important point is that Bitcoin and other cryptocurrencies are often used for illegal transactions, and the reason is that it's easier to make these illegal transactions than with old-fashioned money, which after all, is regulated and monitored.

But quite apart from the illegal transactions, there's a sense in which ordinary money is liquid in a way that cryptocurrency, such as Bitcoin, is not. You can use RMB or Dollars to buy almost any good, but at this point, most people won't accept Bitcoin or other cryptocurrencies in exchange for their goods, and this defeats one of the most important purposes of money.

Money was invented, in the first place, to make the exchange of goods easier. If I have apples and I want to buy some of your oranges, if we're going to do this in a world without money, you must want some of my apples in order for trade to occur. And we'd be lucky if I want your oranges at the same time you want my apples. That's what's called a double coincidence of wants, and it's not likely to occur.

So, without a double coincidence of wants, we can't have trade without money. Money solves the problem, because instead of paying for your oranges with apples, I can pay for it with money. And you're willing to accept money, because you can use it later to buy what you want.

Unfortunately, with Bitcoin, we move back in the direction of primitive barter. Unless you're willing to accept my Bitcoin, I can't buy your oranges. And as I already said, most people are not willing to accept Bitcoin.

Now, there's a related reason why you might be willing to accept RMB or Dollars for your oranges when you're not willing to accept Bitcoin, which is that RMB and Dollars are backed by the governments.

In fact, most governments around the world require people who are selling their goods to accept money in exchange for those goods. On the US banknote, is the phrase “this note is legal tender for all debts, public and private,” which means that the recipient has to accept it in exchange for his goods. Now, there's no similar requirement for Bitcoin.

Now, so far, I've mentioned some reasons why ordinary money is superior to Bitcoin. But I want to go a step farther than this and suggest that cryptocurrency can actually be harmful, and in particular, there are two ways in which it is potentially harmful.

The first has to do with monetary policy—countercyclical monetary policy. An important tool in every responsible government’s toolkit, is the availability of monetary policy to on the one hand, fight recessions, and on the other hand, to fight inflation.

When the economy is struggling, the government, by which I mean the central bank, will increase the money supply. This makes getting credit easier. Entrepreneurs can carry out more projects, their projects expand output and expand employment, and this helps lift the economy out of recession. But when the economy is booming, the government needs to do just the opposite: to prevent the economy from overheating, and to prevent inflation, the central bank must contract the money supply.

Now, countercyclical monetary policy has been very important in the US, Europe, and China. One particular example of this was the Great Recession of 2008 and 2009. If you remember, that was recession caused by a serious financial crisis. At one point, the credit markets almost completely shut down. Banks were reluctant to make any loans whatsoever, and this meant that entrepreneurs couldn't get funded, and the world economy, as a result, experienced the worst recession since the 1930s.

But fortunately, the US Federal Reserve, the European Central Bank, and the Chinese Central Bank took corrective action and greatly expanded the money supply, and that was a critical reason why that recession did not become another Great Depression.

The problem with cryptocurrencies is that they can potentially interfere with good monetary policy. If people are using private money like Bitcoin, the effect of monetary policy will be correspondingly smaller, and we may find it much more difficult to get out of recessions. So that's the first reason why I think cryptocurrency is actually dangerous.

Another reason has to do with banking. It’s sometimes been suggested by people who promote cryptocurrency that it eliminates the need for banks. People can send money safely without banks. They can save money without banks. Now, actually, this isn't entirely true, because there have been some Bitcoin break-ins, but let's grant what they claim and suppose that Bitcoin transactions and Bitcoin savings are safe.

Nevertheless, this ignores a critical role that banks play, which is to evaluate and make loans to entrepreneurs. How does the banking system work? Well, there are entrepreneurs who have ideas but not enough money to finance these ideas, and there are banks, on the other hand, who do have money, and critically can evaluate ideas and lend money to good ideas.

Now, a given bank may not have enough money for all the good ideas that it comes across, so what banks will typically do is to borrow money from other banks in order to make leveraged loans to entrepreneurs. And this leverage enables more good ideas to be funded, and it's good for the whole economy.

Of course, the risk of leverage is that if it gets to be too big, then a small banking failure can be amplified. If one bank fails and it owes money to other banks, they may fail, too. And we can have a domino effect of banking failures. But that's why it's important that along with the banking system, government regulates banks.

But now let's imagine that we're in a cryptocurrency world without banks. Well, then there are two possibilities. First, let's suppose there isn't anyone around who does the specialized evaluation that banks do. So, then the question is, how are entrepreneurs going to get funded?

We could have crowd funding, of course, but crowd funding is a very inefficient way of supporting entrepreneurs, because the crowd funders are typically not experts. They don't know good ideas from bad ideas, so a lot of bad ideas are going to be funded as well as the good ideas. That's going to be an impediment to growth.

The other possibility, if we eliminate banks because of cryptocurrency, is that new institutions develop, that like banks, can evaluate projects. But of course, these new institutions will do just what banks do and make leveraged loans, because typically they will not have enough money themselves to make all of the loans to good projects that they would want to make. And in this latter case, the leverage can get the economy into trouble unless it is regulated the same way that banks are.

Now, in the ordinary banking world, we have regulation in place to prevent too much leverage. In the United States, there's the Dodd-Frank Act. In Europe, there are the Basel Rules. But there's no such regulation in the cryptocurrency world. So, there is the potential for serious financial crises.

I've been interested to note that at this point, the Chinese government has effectively banned cryptocurrency. Actually, I think that was a very good move on their part, and I wish that the rest of the world would follow suit. But if they don't follow suit, I worry about the future of our financial system if cryptocurrency becomes too popular. And I very much hope that governments around the world, if not outright banning cryptocurrency, will at least start seriously regulating it, because I think it's a danger that we cannot ignore.

Thank you very much.