Crypto gives lessons in emerging tech regulation

A crypto exchange filing for Chapter 11 is an absolute oxymoron. Seeing a freewheeling, “break something,” cryptocurrency exchange in a federal court, where strict rules are the order of the day, is a contradiction in terms. Of course, now there have been many crypto cases in court but this one is especially shocking because it is so classically a bank run.

Voyager failed because of the default of one major customer, Three Arrows Capital, which resulted in Voyager’s stock losing 98% of its value. Runs on banks are perfectly predictable. They were a regular feature of US banks before our current system of regulation and remain a constant threat to the banking system.

The underlying reason for the collapsing crypto institutions is the little, light or no regulation of the space. The crypto industry often promoted this regulatory schema to prevent regulation from stifling an innovative technology. The idea was noble but failed to understand that a regulatory void in finance can be a magnet for fraud.

That said, our concern here is not the regulation of cryptocurrency. That is coming. It is the security of the blockchain technology itself which needs to concern us now. It is the technologies emerging to compete with the blockchain, particularly quantum computing, which need to be on our horizon as we design crypto regulation.

Crypto is a test run

The market’s experience with blockchain technology is a sample of the regulatory challenges to come. It is essential that we continue to advance our understanding of quantum computing. We do not want to slow down its development with unnecessary rules. However, when we consider crypto rules, we should be aware that there is an extremely high probability that quantum computers will overwhelm all but the most carefully designed blockchains.

Blockchains are an old technology at this point coming from the 1990s when the first ideas of a cryptographically secured chain emerged. The crypto world, however, usually traces its origins from the work of Satoshi Nakamoto in 2008, which gave rise quickly to Bitcoin.

Quantum computing is a much newer technology, and in many ways still emerging. It is not, however, science fiction as it once was. Most users of quantum computers will never know the underlying physics any more than they know how their PCs work. By the way, their PCs are now known as classical computers. All that they really need to understand is that the quantum computers in test phase have the capacity to solve the very puzzles which in a sense make crypto go. The quantum computers can open the locks that the public and private cryptocurrency keys so preciously secure. There are ways to make the keys immune from quantum attacks when they come, and the attacks will come will.

Several of the most advanced developers of quantum systems are countries including Russia and China, which have been involved in significant Internet hacks. We should not expect them to announce ahead of time when their quantum computers can hack blockchains.

For the current regulatory debate, the quantum threat should inspire an effort to have monetary block chains managed by sophisticated players, probably central banks. In the end, CBDC is likely to be the only reliable structure.

Technology trumps agency

The current regulatory fight over which Federal agency, the SEC, or the CFTC, oversees the lion’s share of cryptocurrency regulation is likely to be irrelevant. Blockchain technology is not immune from the technology being developed in quantum computing or other yet to be identified areas. The regulation of blockchain technology needs to be based on technical skills with emerging, competing technologies such as quantum computing, not politics.

Investor Implications:

1. The current unwind of leverage in cryptocurrency will be managed by the courts. They already have authority.

2. New regulations are coming too slowly to solve the market’s liquidity problems.

3. Any new regulation must be technically competent to solve today’s emerging challenges.

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