There’s an irony in the rise of Bitcoin and other cryptocurrencies. They were supposed to usher in a new paradigm of finance, obviating the need to trust centralized institutions. Yet people are increasingly interacting with them through precisely such institutions. Hardly a week goes by without news of some financial intermediary — some well-known such as Fidelity or Goldman Sachs, others less so — delving into the largely unregulated realm, seeking to profit from the speculative fervor.

In principle, there’s nothing wrong with the entrepreneurial drive to give people what they want, even if what they want is to throw their savings away. That said, some defenses are urgently needed to protect the uninitiated and the broader economy from the consequences.

Crypto was supposed to render governments and banks obsolete. In their place, software protocols would issue money in the form of digital tokens, and a voluntary network of computers would maintain a public ledger — or blockchain — that allowed people to transact directly, using cryptographic keys to demonstrate ownership. Yet this brave new world has its own problems. Security is a constant issue, as this week’s $600 million hack of the PolyNetwork protocol spectacularly demonstrates. There’s no help desk to contact if you send tokens to the wrong address, or if your keys are lost or stolen. Wild price swings render cryptocurrencies such as Bitcoin largely useless for saving or purchases, other than the illegal kind. The computing power required to maintain the blockchain — aside from accelerating climate change — makes transactions slow and expensive, particularly for smaller amounts.

Amazingly, none of these flaws has dampened enthusiasm for crypto. On the contrary, they have presented opportunities for the financial intermediaries they were supposed to disrupt. For traders, digital tokens are the ultimate speculative vehicle — “assets” created out of thin air, with no connection to any cash flow or commodity. For institutional investors such as foundations and pension funds, they’re a way to potentially goose returns. For exchanges, banks and a host of other outfits, just helping people buy and sell can generate outsized fees and attract new customers. For traditionally conservative custodians, which specialize in safekeeping, the complications of holding crypto offer a new line of business.

Examples abound, from upstarts to established firms. The director Spike Lee is touting ATMs that will, for a significant fee, turn what he calls systematically oppressive dollars into “positive, inclusive” bitcoins. Payment services PayPal and Cash App have become purveyors to retail customers, reaping commissions on both sides of the trade. Fidelity is among several firms seeking regulatory approval for an exchange-traded fund, which would allow retail investors to trade bitcoins like a stock. At the other end of the spectrum, JPMorgan Chase, Morgan Stanley and Goldman Sachs are all reportedly offering or planning to offer crypto investments to wealthy clients. In one recent survey, more than half of institutional investors said they already owned digital assets. Major custodians Bank of New York Mellon and State Street are expanding into the market, alongside smaller crypto specialists.

Such services can be less cumbersome and costly than engaging with the blockchain, and can reduce risks for people who choose to speculate in crypto. But they intersect with a regulatory netherworld: Neither the Securities and Exchange Commission nor the Commodity Futures Trading Commission has the authority to oversee cryptocurrencies such as bitcoin, which is classified neither as a security (the SEC’s turf) nor a derivative (the CFTC’s). As a result, dealing with institutionalized crypto often demands far more trust — one might even say blind faith — than the traditional financial services that crypto was supposed to displace.


Consider Bitcoin ETFs. If approved by the SEC, they could make crypto trading as easy and cheap as investing in stocks. But to access bitcoins and to determine the prices of their shares, they must rely on specialized crypto exchanges such as Coinbase and Kraken. These don’t fall under the purview of the SEC, and so don’t face the requirements for safety and soundness, conflicts of interest, and much more that securities operations must meet. There’s little but reputation to prevent them from manipulating prices or otherwise taking advantage of customers.

PayPal is another example. When its customers buy bitcoins, they don’t receive any actual tokens. Instead, their balance reflects their share of PayPal’s account at a crypto exchange run by a limited-purpose trust company called Paxos, which in turn says it holds bitcoin in custody to back customer accounts. The New York State Department of Financial Services chartered Paxos and sets some regulatory standards, but it’s not clear what these are, much less how effective they will be. NYDFS doesn’t require the company to publicly disclose its holdings or even the capital, liquidity and other specific requirements it must meet.

Similar services could soon be coming to a community bank near you. “White-label” trading would allow people to buy, sell and hold crypto via the mobile apps or websites of banks across the country, helping the latter stem the flow of client funds to services such as Coinbase. Behind the scenes, the customers would actually be doing business with another of the small group of specialized NYDFS-chartered trust companies, which would be neither covered by federally backed deposit insurance nor overseen by any federal banking regulator. Such companies are also behind many of the crypto-investment vehicles being offered to the wealthy.

The more money flows into this gray area, the greater the systemic risks. Suppose an attempted exodus from Bitcoin overwhelmed crypto exchanges, rendering trading impossible: Investment funds might have to sell other assets to meet redemptions — a dynamic that can destabilize markets, particularly when leverage is involved. Or suppose a problem at Paxos stranded crypto balances at PayPal: The rush to pull money out might cripple such payment services — which, by the way, have no bank-like regulation or direct FDIC insurance backing tens of billions of dollars in customer cash balances. To the extent banks offer similar trading services, they might also suffer a broader run in the event of a glitch.

Current and former regulators, including SEC Chair Gary Gensler, are well aware of the dangers. Ideally, Congress would grant the SEC or the CFTC clear authority over cryptocurrencies, along with the resources needed to exercise it. This would allow them to subject exchanges and custodians to requirements commensurate to the risks.

If Congress fails to act, regulators can still make progress. As Gensler has noted, the SEC can expand its authority by designating digital tokens as securities, where appropriate. It can also use its power to approve ETFs — granting approval only if they interact with exchanges meeting SEC-like regulatory requirements. That would apply pressure to comply on the exchanges concerned.

Bank supervisors, too, have a role to play. For one, they can require that any holdings of volatile cryptocurrencies be financed entirely with loss-absorbing equity, as the Bank for International Settlements has suggested. Beyond that, to address the risks of white-label services, they can issue a warning: Unless providers meet certain standards for safety, soundness and disclosure, the assets will be treated as if they were on the banks’ balance sheets, with all the attendant capital demands. Bank supervisors might also take a closer look at PayPal and Cash App, which increasingly offer bank-like services but aren’t regulated accordingly.

For all the irrational exuberance they’ve inspired, digital assets and the blockchain may yet have valuable applications, and help transform finance in desirable ways. But if they’re to realize this potential without doing unnecessary damage along the way, some new regulation is going to be needed.