Trump is set to usher in a wave of speculation.

Written by: Annie Lowrey

Translated by: Block unicorn

Dennis Kelleher, president of the nonprofit organization Better Markets, told me, "The countdown to the next catastrophic collapse has already begun."

In recent weeks, I have heard this or similar sentiments from economists, traders, congressional staffers, and government officials. The incoming Trump administration has promised to support cryptocurrency regulations and may relax strict restrictions on Wall Street institutions.

They believe this will usher in an unprecedented era of American prosperity, maintaining the U.S. position as the global leader in capital markets and the core of the global investment ecosystem. "My vision is to make America dominate the future," Donald Trump said at a Bitcoin conference in July. "I am developing a plan to ensure that America becomes the global cryptocurrency capital and the world's Bitcoin superpower."

Financial experts expect a different scenario. First, there will be prosperity, perhaps a major boom, with the prices of Bitcoin, Ethereum, and other cryptocurrencies soaring; financial firms raking in profits; and American investors basking in newfound wealth. Second, there will be a downturn, perhaps a major depression, with companies going bankrupt, the government being called upon to stabilize the markets, and many Americans facing foreclosure and bankruptcy.

Having written about Bitcoin for over a decade and reported on the last financial crisis and its long-lasting aftermath, I have some understanding of the factors that could lead to both prosperity and collapse. Crypto assets tend to be extremely volatile, far more so than real estate, commodities, stocks, and bonds. With Washington's encouragement, more Americans will invest in cryptocurrencies. As funds pour in, prices will rise. When prices fall, individuals and institutions will be hit hard, and this is inevitable.

The experts I spoke with did not dispute this view. But they told me that if this is indeed the case, America and the world should consider themselves fortunate. The danger lies not only in the fact that regulations supporting cryptocurrencies could expose millions of Americans to scams and market volatility. The real danger is that this will lead to an increase in leverage across the entire financial system. This will exacerbate opacity, making it harder for investors to assess the risks of financial products and price them accordingly. Moreover, this situation will occur while the Trump administration cuts back on regulations and regulatory agencies.

Cryptocurrencies will become more mainstream, while traditional financial markets will resemble cryptocurrency markets—more chaotic, more opaque, more unpredictable, and potentially leading to trillions of dollars in consequences that will last for years.

"I worry that the next three or four years will look quite good," Eswar Prasad, an economist at Cornell University and former International Monetary Fund official, told me. "The real challenge will come afterward, when we will have to clean up the mess from all the speculative frenzy triggered by this administration's policies."

For years, Washington has "waged an unprecedented war on cryptocurrencies and Bitcoin," Trump told cryptocurrency entrepreneurs this summer. "They are targeting your banks. They are cutting off your financial services… They are preventing ordinary Americans from transferring money to your exchanges. They are slandering you as criminals." He added, "I have faced this too because I said the election was rigged."

Trump is not wrong; cryptocurrencies do exist in a separate parallel financial universe. Many crypto companies are unable or choose not to comply with U.S. financial regulations, making it difficult for ordinary investors to use their services. (The world's largest cryptocurrency exchange, Binance, is even reluctant to disclose its registered jurisdiction, instead directing U.S. customers to a branch in the U.S.) Companies like Morgan Stanley and Wells Fargo often offer very few crypto products and invest almost nothing in cryptocurrencies and related businesses. The issue is not that banks do not want to participate; rather, regulatory rules prevent them from doing so, and regulators have explicitly warned them against it.

This situation limits the amount of money flowing into cryptocurrencies. But this practice is wise: it prevents company bankruptcies and wild price fluctuations from disrupting the traditional financial system. Kelleher pointed out that cryptocurrencies lost $2 trillion of their $3 trillion market value in 2022. "If any other asset experienced such a massive financial collapse, it would inevitably trigger contagion. But that did not happen because you have parallel systems that are almost entirely disconnected."

Upcoming regulatory measures will tightly integrate these systems. Admittedly, no one knows exactly what laws Congress will pass or what laws Trump will sign. However, the Financial Innovation and Technology for the 21st Century Act (FIT21) provides a good reference. The bill, which passed the House last year but stalled in the Senate, became the focus of cryptocurrency advocates who raised significant funds for lobbying, including $170 million for the 2024 elections. This legislation is essentially a wish list for the industry.

FIT21 designates the Commodity Futures Trading Commission (CFTC) as the regulatory body for most crypto assets and businesses, rather than the Securities and Exchange Commission (SEC), and requires the CFTC to collect far less information about the structure and trading of crypto products than securities firms provide to the SEC.

In addition to the relaxed rules, financial experts also expect enforcement to be lax. The CFTC primarily regulates financial products used by companies for hedging and trading among traders, rather than those sold to individual investors. The CFTC's budget is about one-fifth that of the SEC, and its staff is only one-seventh that of the SEC. Overall, Washington is expected to ease restrictions, allowing traditional banks to incorporate cryptocurrencies into their books and allowing crypto companies access to U.S. financial infrastructure.

According to Prasad, this regulation would be a "dream" for cryptocurrencies.

Trump and his family have also invested in cryptocurrencies, and the president-elect has proposed the idea of establishing a "strategic" Bitcoin reserve to prevent the influence of certain countries. (In reality, this means using billions of taxpayer dollars to absorb speculative assets with no strategic interest.) How many members of a certain country would invest in cryptocurrencies because Trump invested in them? How many young people would put money into Bitcoin because Trump's son Eric said its price would soar to $1 million, or because the Secretary of Commerce said it was the future and invested in Bitcoin?

Any measures being considered by Congress or the White House will not reduce the inherent risks. Cryptocurrency investors will still be vulnerable to hacking, ransomware, and theft. The research group Chainalysis reported $24.2 billion in illicit transactions in 2023 alone. If the U.S. government invests in cryptocurrencies, the incentives for countries like Iran and North Korea to intervene in the market will multiply. Imagine a country launching a 51% attack on the Bitcoin blockchain, taking over and controlling every transaction. This scenario is a security nightmare.

Americans will also face more scams and fraud. The U.S. Securities and Exchange Commission (SEC) has taken enforcement actions against dozens of Ponzi schemes, charlatans, and frauds, including the $32 billion fake exchange FTX and some shoddy token companies. No one expects the CFTC to have enough power to do the same. Moreover, FIT21 leaves many loopholes for various unscrupulous profit-making activities. Crypto companies could legally operate exchanges, trade assets themselves, and execute orders for clients, despite conflicts of interest, all while remaining legal.

Simple volatility is the biggest risk facing retail investors. Prasad emphasizes that cryptocurrencies, tokens, and other coins are "purely speculative." "The only thing that can support their value is investor sentiment." At least gold has industrial uses. Or, if you bet on the price of tulip bulbs, at least you might get a flower.

But in the world of cryptocurrencies, you might end up with nothing, or even incur losses. Many cryptocurrency traders borrow money to speculate. When leveraged traders lose money on their investments, their lenders—usually the exchanges—will require them to provide collateral. To provide collateral, investors may have to liquidate their 401(k) accounts. They may have to sell Bitcoin during a market downturn. If they cannot raise cash, the company holding their account may liquidate or seize their assets.

A report released last month by the Office of Financial Research, a government think tank, clearly pointed out how dangerous this situation could be: some low-income families "are using cryptocurrency gains to obtain new mortgages." When cryptocurrency prices fall, these families' homes will be at risk.

Many individual investors seem unaware of these dangers. The Federal Deposit Insurance Corporation (FDIC) had to remind the public that crypto assets are not protected by it. The Financial Stability Oversight Council (FSOC) also raised concerns that people do not realize that crypto companies are not regulated in the same way as banks. However, how serious is this if Trump is also investing in it?

However, regulators and economists are primarily concerned not about the damage this new era will cause to individual families. They worry that the chaos in the cryptocurrency market will disrupt the traditional financial system—leading to a credit collapse and forcing government intervention, just like in 2008.

Once, Wall Street viewed it as fool's gold, but now it sees it as a gold mine. Ray Dalio of Bridgewater Associates called cryptocurrencies a "bubble" ten years ago; now he considers it "an extremely great invention." Larry Fink of BlackRock once referred to Bitcoin as "an index for money laundering"; today, he sees it as "a legitimate financial tool"—his company has begun offering this tool to clients, albeit indirectly.

In early 2024, the SEC began allowing fund managers to sell certain cryptocurrency investments. BlackRock launched a Bitcoin exchange-traded fund (ETF) in November; a public pension fund has already invested retirees' hard-earned money in it. Barclays, Citigroup, JPMorgan, and Goldman Sachs are also trading cryptocurrencies. Billions of dollars in traditional financial capital are flowing into decentralized finance markets, and with regulatory easing, even more funds will pour in in the future.

Will there be any problems? If Wall Street firms accurately assess the risks of these high-risk assets, then there will be no problem. If they do not assess them well, then everything could go wrong.

Even the most seemingly stable instruments are fraught with danger. For example, stablecoins are crypto assets pegged to the dollar: one stablecoin equals one dollar, making them a medium of exchange, unlike Bitcoin and Ethereum. Stablecoin companies typically maintain their peg by holding ultra-safe assets (such as cash and government bonds) equivalent to each stablecoin issued.

This was the case until the spring of 2022, when the widely used stablecoin TerraUSD collapsed, its price plummeting to just 23 cents. The company had used algorithms to maintain the price stability of TerraUSD; as long as enough people withdrew funds, the stablecoin would lose its peg. Tether, the largest crypto asset by trading volume globally, claims to be fully backed by secure deposits. However, the U.S. government discovered in 2021 that this was not the case; furthermore, the Treasury was considering sanctions against the company behind Tether for allegedly serving as a funding channel for "North Korea's nuclear weapons program, Mexican drug cartels, Russian arms companies, Middle Eastern terrorist organizations, and manufacturers of fentanyl chemicals in certain countries," as reported by The Wall Street Journal. ("It is outrageous to suggest that Tether somehow assists criminals or evades sanctions," the company responded.)

If Tether or another major stablecoin encounters problems, financial chaos could quickly spread beyond the cryptocurrency market. Concerned investors would sell off stablecoins, leading to a "self-fulfilling panic redemption," as three scholars noted when simulating this possibility. Stablecoin issuers would sell government bonds and other safe assets to provide redemptions; the price drop of safe assets would impact thousands of non-crypto companies. These economists estimated at the end of 2021 that the risk of a run on Tether was 2.5%—not exactly stable!

Other disasters are also easy to imagine: bank failures, exchange collapses, massive Ponzi scheme bankruptcies. However, the biggest risk of cryptocurrencies has little to do with the cryptocurrencies themselves.

If Congress passes FIT21 or a similar bill, it will create a new asset class called "digital commodities"—essentially any financial asset managed on a decentralized blockchain. Digital commodities will not be regulated by the Securities and Exchange Commission (SEC), and "decentralized finance" companies will also fall outside its regulatory scope. Under the FIT21 bill, any company or individual can self-certify a financial product as a digital commodity, and the SEC has only 60 days to object.

This loophole is large enough for an investment bank to exploit.

Wall Street has already begun discussing "tokenization," which involves placing assets into programmable digital ledgers. The nominal reason is capital efficiency: tokenization can make the flow of funds easier. Another reason is regulatory arbitrage: blockchain-based investments will no longer be subject to SEC jurisdiction and may face fewer disclosure, reporting, accounting, tax, consumer protection, anti-money laundering, and capital requirements. Risks will accumulate within the system; the government will have limited means to control companies.

Gary Gensler, the soon-to-be former chairman of the SEC and the number one enemy of the crypto industry, believes that crypto regulation could ultimately undermine "the broader $100 trillion capital markets." "It could encourage non-compliant entities to try to choose the regulatory regime they want to be subject to."

We have seen similar plots before, not long ago. In 2000, President Clinton signed the Commodity Futures Modernization Act as he was nearing the end of his term. The law imposed strict limits on exchange-traded derivatives but did not regulate over-the-counter derivatives. As a result, Wall Street created trillions of dollars in financial products, many backed by mortgage income streams, and traded them over the counter. These products bundled subprime loans with prime loans, obscuring the true risks of certain financial instruments. Subsequently, consumers bore a heavy burden under the pressures of rising interest rates, stagnant wage growth, and climbing unemployment rates. Mortgage default rates rose, and home prices fell, first in the sunbelt and then spreading nationwide. Investors fell into a panic. No one even knew what was contained in those credit default swaps and mortgage-backed securities. No one could determine the value of anything. Uncertainty, opacity, leverage, and mispricing contributed to the global financial crisis, ultimately leading to the Great Depression.

Today's cryptocurrency market is poised to become the derivatives market of the future. If Congress and the Trump administration do nothing—still treating the SEC as the primary regulator of cryptocurrencies and requiring crypto companies to comply with existing rules—then the chaos will continue to be isolated. After all, there is no reasonable basis for treating digital assets differently from securities. According to a simple standard used by the government for over a hundred years, almost all crypto assets should be considered securities. However, Washington is creating loopholes instead of enacting laws.

As cryptocurrency supporters like to say, "Hold on tight, don't let go." Jamie Dimon of JPMorgan said at a conference in Peru last year, "A lot of bankers are dancing in the streets." Perhaps they should be. Bankers will never be the ones to take the blame.

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