Blockchain, Law, and Economics
The AMA Interview for Mr. Lee Reiners
About Mr. Lee Reiners
Mr. Lee Reiners joined the Duke Global Financial Markets Center as executive director in 2016. At Duke Law, Mr. Reiners teaches FinTech Law and Policy as well as seminars relating to financial policy and regulatory practice. His broad research agenda focuses on how new financial technologies fit within existing regulatory frameworks. His work has examined the risks associated with cryptocurrency derivatives, the rise of digital investment advice, and corporate governance failures within the financial industry.
Prior to joining Duke Law, Mr. Reiners worked for five years at the Federal Reserve Bank of New York (FRBNY), first as a supervisor of systemically important financial institutions and then as a senior associate within the executive office. In the latter capacity, he helped coordinate the FRBNY’s engagement with international standard-setting bodies, such as the Bank for International Settlements and the Financial Stability Board. While at the FRBNY, Mr. Reiners worked closely with other federal and state regulatory agencies. Reiners has previously taught corporate finance and managerial economics in the MBA Program at Saint Peter’s University. In 2004–2005, Reiners served as a U.S. Army communications specialist in Baghdad, Iraq.
AMA Interview Video
Watch our AMA interview for Mr. Lee Reiners on our YouTube channel, SciEcon.
Question 1
William:
Let’s start with your very influential Wall Street Journal Article Ban Cryptocurrency to Fight Ransomware. In the article, you wrote, “I have been studying the crypto market since its inception, and I have yet to identify a single task or process that crypto makes easier, better, cheaper, or faster.” Do you think the cryptocurrency market is completely a bubble?
Mr. Reiners:
The short answer is yes — I do think it is a bubble. My views have evolved a bit since I wrote that it would be a bubble. It would be helpful to repeat some context in terms of why I wrote that. For folks who might not be familiar, that was the aftermath of the Colonial Pipeline. Last May, there was a ransomware attack on an oil pipeline in the US, which resulted in gasoline shortages throughout the east coast here in the US. In Durham, North Carolina, people couldn’t get gasoline for about a week. My wife and I went on vacation when the event occurred. We flew back home, but we couldn’t get an Uber to take us from the airport back home because they failed to get gas. It struck me, and I started to think about the situation.
For many Americans, ransomware impacted them personally. We all certainly have read about it and heard about these incidents. Many people think that ransomware was probably made by cryptocurrency. Ransomware does predate crypto, but it was neither of the magnitude nor front-page news like ransomware is now. We are facing very real social costs and economic costs. I decided that the costs vastly outweigh the benefits. We’d better heavily restrict cryptocurrencies usage.
When I look at some crypto innovations, such as stable coins, there might be a genuine economic benefit there, but I certainly think the space is a bubble. A bubble is one of those things where it’s easy to spot in hindsight and almost impossible to predict. I think it’s clear when looking at digital assets in general. People buy them because they believe they can sell them for a higher price in the future, regardless of the economic fundamentals. And that certainly applies to why people buy bitcoin. It is not because they can use it for something since there is really limited transaction value. People expect to sell it to someone for a higher price in the future. They are relying on the greater fool theory [1].
At some point, the supply of greater fools will be exhausted. Financial goals are fueled by some narrative going back to 2008, the global financial crisis. Despite the great depression, people forgot about it. The narrative has been solidified in recent years that crypto and Bitcoin are digital gold because only 21 million bitcoins are ever put into circulation. The crypto is a hedge against the inflation rate and the broader stock market with a limited supply. It is a good store of value as well. The narrative is breaking down as we see inflation at its highest level.
The cryptocurrency prices have plummeted in recent months. People are starting to see the narrative shift a little bit to Web3 in the future: since we will all have control over data and information, cryptocurrency will be the grease to skid all of this. We will see if that comes to fruition. I am skeptical, but that was a long-winded answer there. Cryptocurrency will go away, although there’s too much talent and money investment. Therefore, there is a bubble that will burst at some point.
Beyond speculation, maybe there are still stable coins. It’s hard to predict currently, just like the Internet did not go away after the dot com bubble in the late 90s early 2000s. We still see genuine innovation, but the bubble will burst. Maybe something useful will emerge, but do we need 5000 different cryptocurrencies? It is just a matter of who will be the winners and that no one can predict right now.
William: Thank you. A quick follow-up question: I agree that bitcoin has seen very few practical use cases in reality, but what about the NFT market and digital arts? Do you think they are also part of the bubble you described?
Mr. Reiners:
Yes, I do think they are part of the bubble. There is a digital artist who did an NFT which goes off Christie’s, and it was $60 million now. Does anyone genuinely think that 10 years from now, the piece of NFT of digital art will go for $60 million or more? I highly doubt it.
I see the appeal allowing artists and other creators to monetize their work, attract fans, and deepen fan engagement. In this sense, NFT does have some staying power. NFT needs blockchain, and blockchain needs crypto. Things are changing now because rates are going up. With Russia’s invasion of Ukraine, there is heightened uncertainty in the global economy. We have been living in an extraordinary period of low interest rates that has compelled us to search for yield assets, including stocks, cryptos, NFTs. I find it funny when the Federal Reserve notes they’re going to raise interest rates, crypto goes down as if somehow they’re related. But that’s how the market is reacting.
I do think NFT has a chance of staying permanently, but I also see a major correction coming very soon.
Question 2
Zhitong:
In your paper Bitcoin Futures: From Self-Certification to Systemic Risk, you discussed the systematic risk that could be brought by Bitcoin Futures. Can you elaborate on why you think so? More generally, we are eager to know whether you think the frenzy in the cryptocurrency market will bring systematic risk to the financial system.
Mr. Reiners:
That is a good question. It was not that long ago that we had the crypto market. The regular traditional financial system was not connecting the two. The interconnections were limited. It has completely changed, and one of the pivotal moments when it did change was in 2017. Bitcoin cash and futures contracts come to market. I was very critical of the decision and will discuss more crypto regulations.
Derivatives and futures have their origins in agricultural markets. Farmers plant crops in the spring, and harvest and sell that crop in the fall. Since they are exposed to price risk, they might want to hedge that by signing a futures contract in the spring, guaranteeing to deliver a certain amount of green or corn at a certain price and a certain date. Speculators use derivative contracts and futures contracts. There are still genuine economic users and hedgers. However, the market looks quite different. They are cash-settled, and bitcoin is never exchanged at any point in these transactions. Say, William, I will sell you one bitcoin in one month, for $50,000. In one month, if the price of bitcoin rises to $55,000, then I can just give William $5,000. That is cash settle.
This opens the bitcoin market to a new set of investors. Maybe they were worried about having custody of their private key right, or they didn’t want to deal with a lightly-regulated exchange they were concerned with. But now, you can go to the Chicago Mercantile Exchange and buy a regulated futures contract. You never need to touch bitcoin and worry about those issues. It opens up the investor base, but it also creates new risks.
Broadly speaking, when we talk about systemic risks, what are the features that create them? One is the overall size of the market. Again, crypto at this point is volatile, but it’s still a 2 trillion market, which is much larger than it was in 2017. Another factor is leverage. We see increasing leverage in the crypto space offered by different exchanges. It’s hard to get leverage in the US for various reasons, but many exchanges in Asia provide leverage. Then it’s just how transparent the market is. With the light regulation, we have little visibility into space.
When combining all the factors, it’s clear that crypto could pose a systemic risk. While the market is still not big enough in that if Bitcoin and Ether go to zero tomorrow, I don’t think an average person would feel it in any meaningful way. Nor do I think it would bring down a large financial institution. But as the crypto market evolves rapidly and continues to grow, it will pose a systemic risk very soon, and it will threaten financial stability.
My background is a regulator at the New York Fed. If people want to gamble or speculate on worthless assets, that is fine. It is their issue. What I am worried about is the negative externalities. For example, what is going on in crypto could impact financial stability. We are seeing all the traditional financial intermediary functions play a role in crypto. The irony is that with all the premises on decentralization and bypassing intermediaries, the whole ecosystem is now filled with intermediaries and with the same type of concentration playing out. I think we should all be worried about the risks that are being created here.
Questions 3
William:
Prior to joining Duke Law, you worked for five years at the Federal Reserve Bank of New York, first as a supervisor of systemically important financial institutions and then as a senior associate within the executive office. There must be a moment when you got the inspiration for blockchain and law-related topics from your past experience. How do you think this experience of financial regulation has contributed to your current career success? Also, we would like to learn more about your expectation for the future of fintech and blockchain, and your thoughts regarding the impacts of the emergence of cryptocurrencies on market regulations in the future.
Mr. Reiners:
Where you stand depends on where you sit. My views on cryptocurrency are informed by the work I did at the New York FED and others’ life experiences, just as anyone’s view is informed by their life experiences. However, the real pivotal moment in my professional career was in 2008, the global financial crisis, when the U.S. financial system essentially melted down. Later, I have spent my professional career studying and understanding and trying to prevent it.
So I see so many parallels with what transpired leading up to 2008 in crypto. It starts with innovation. This innovation is going to solve some problems. In 2008, it was derivatives, mortgage-backed securities, and default swaps. It made credit more accessible. It was going to promote homeownership and all these wonderful things. And there’s no downside, so it doesn’t need to be regulated, right? You see the exact same thing play out now. Blockchain bypasses intermediary, it’s fully transparent, there’s no downside, this is the innovation, this is the future, so don’t get in the way. We’ve heard this before.
However, the collective memories are short. Unregulated financial innovation can do serious damage to our economy. Social and political issues further give rise to welfare inequality that we are all concerned about now. For middle-income and low-income folks, houses were their biggest investment when housing prices fell after 2008. However, wealthy people hold a higher percentage of their wealth in the stock market, and stock prices recovered relatively more quickly. This exacerbated wealth inequality and led to the rise of extremist politicians. People like Bernie Sanders and Donald Trump emerged as a result. There are all sorts of unintended consequences.
What does the future of crypto regulation look like? I am a bit pessimistic at this point, to be honest with you. When looking at the history of financial law in the U.S., it generally occurs in the wake of some type of crisis. In 2008, we had the mortgage market meltdown. In 2010, we passed Dodd-Frank legislation. Going back to the Great Depression, the security Act and deposit insurance corporations were created after that. History tells us that we’re not seeing any meaningful changes until the bubble of crypto bursts. One of the reasons is the political economy. Currently, many people are making a lot of money in crypto. It is hard to be the one that tries to take the punch ball away at the party. People like me, voices like mine, are being marginalized.
Another reason is that we have a very fragmented regulatory structure in the US, and no one would create a financial system like ours from scratch, which is a historical byproduct. In the US, we have separate derivatives regulators from securities regulators. Therefore, derivatives are regulated by the Commodity Futures Trading Commission (CFTC), and securities are regulated by the Securities and Exchange Commission (SEC). In most other countries, those two functions are within one agency. As for cryptocurrencies, CFTC has defined bitcoin, ether, and by extension most other cryptocurrencies to be commodities. However, they do not typically regulate those commodity spot markets. That has good reasons for other commodities. They only regulate the derivative markets. What that means is that exchanges like Coinbase, Gemini, FTX, you name it, are unregulated on the federal level. Nevertheless, no one would suggest that it’s a good idea for the New York Stock Exchange or the NASDAQ to be unregulated. That’s exactly the type of situation we have regarding cryptocurrency exchanges.
And that is completely untenable to me. There is no market, no rules, and no consumer protection rules. All the things that we use in traditional securities markets do not exist for cryptocurrency. There is a string in the crypto community that recognizes this as a gap. If you are aiming for the long term, you need investors to feel comfortable investing in an asset class like this. This is a point SEC Chair Gary Gensler has made a number of times. One reason why the U.S. has the largest financial market in the world is that investors take trust in investing in these listed companies because of regulation, so they have legal recourse if something goes wrong. Therefore, the law allows consumers to trust, which makes them more willing to invest, so the markets grow. I think that’s ultimately what needs to happen with crypto.
I know this idea goes against the libertarian ethos lying under the creation of cryptocurrencies. It is these principles that sustain Bitcoin in these years. There is tension there. But, there needs to be a change in the regulatory structure. A natural starting point is regulating these platforms, where the buying and selling of crypto occurs. There are many within the crypto market who want the CFTC to do it, but CFTC did not act much. The chair of CFTC, Chris Giancarlo, was nicknamed “crypto dad”. The inverse comes to the SEC, and I think the SEC is the agency that should be given exclusive authority over these crypto trading platforms. I think that’s where the debate lives now. It will change in the future. It is just a matter of when.
Relevant Materials
[1] The Greater Fool Theory
■ What is The Greater Fool Theory?
The Greater Fool Theory is the idea that, during a market bubble, one can make money by buying overvalued assets and selling them for a profit later, because it will always be possible to find someone who is willing to pay a higher price. An investor who subscribes to the Greater Fool Theory will buy potentially overvalued assets without any regard for their fundamental value. This speculative approach is predicated on the belief that you can make money by gambling on future asset prices and that you will always be able to find a “greater fool” who will be willing to pay more than you did. Unfortunately, when the bubble eventually bursts (which it always does), there is a large sell-off that causes a rapid decline in the asset values. During the sell-off, you can lose a great deal of money if you are the one left holding the asset and cannot find a buyer.
■ Key Takeaways
The Greater Fool Theory is a very risky, speculative strategy that is not recommended for long-term investors.
[2] Crypto Market:
■ Key Takeaways
A cryptocurrency, broadly defined, is a form of digital tokens or “coins” that exist on a distributed and decentralized ledger called a blockchain. Beyond that, the field of cryptocurrencies has expanded dramatically since Bitcoin was launched over a decade ago, and the next great digital token may be released tomorrow.
Bitcoin continues to lead the pack of cryptocurrencies in terms of market capitalization, user base, and popularity. Other virtual currencies such as Ethereum are helping to create decentralized financial (DeFi) systems.
Some altcoins have been endorsed as having newer features than Bitcoin, such as the ability to handle more transactions per second or use different consensus algorithms such as proof of stake.
[3] Great Depression:
■ What is Great Depression?
The Great Depression was a severe worldwide economic depression that took place mostly during the 1930s, beginning in the United States. The timing of the Great Depression varied around the world; in most countries, it started in 1929 and lasted until the late 1930s. It was the longest, deepest, and most widespread depression of the 20th century. The Great Depression is commonly used as an example of how intensely the global economy can decline.
Acknowledgments:
Interviewee: Mr. Lee Reiners
Interviewer: Zhitong Chen, Yinhong (William) Zhao, Prof. Luyao Zhang
Associate Editor: Jiasheng (Ray) Zhu
Executive Editors: Xinyu Tian
Advisor and Chief Editor: Prof. Luyao Zhang