For months, there’s been a debate over what should count as infrastructure. Roads and bridges, sure. But what about preschool and health insurance and child care? Democrats say yes; Republicans say no. With the exception of broadband access, however, there’s been almost no discussion of the infrastructure underpinning the digital economy. But right at the end, that changed, when a meltdown over cryptocurrency regulation almost derailed the bipartisan infrastructure bill’s passage in the Senate.
I’m going to try to do a few things here. First, I want to explain why crypto matters, even if you think Bitcoin is just goldbuggery for nerds. The technology is evolving to be much more than a digital currency, and Silicon Valley sees it as the digital infrastructure atop which the next internet will be built. Then I want to trace the fight that consumed the final days of the bill, because this was just an early skirmish in what will be a much longer campaign.
“Crypto started in 2009 with Bitcoin,” Fred Ehrsam, a co-founder of both Coinbase and Paradigm, a crypto-focused investment firm, told me. “Many people still relate to it as a speculative phenomenon focused around digital money. That was certainly true for the first few years of crypto’s existence. But now we’re moving far beyond that.”
Ehrsam described crypto as having three distinct phases. In the first phase, the technology was used to develop digitally native currencies — Bitcoin, Ether, Dogecoin and so on. The cryptocurrency market is now worth around $2 trillion, which is astonishing given that it didn’t exist in 2008.
Here’s where it gets complicated. The currencies play a dual role in crypto. They are, in the first place, currencies, and people buy and sell and trade them — and occasionally use them to buy and sell and trade goods. But they’re also the way crypto networks pay for development and upkeep: You get bits of cryptocurrency for adding to the system, and that makes the massive, decentralized computing forces these networks need possible.
There’s a dark side to this: The promise of unlocking bits of cryptocurrency by solving computationally intensive math problems, coupled with the need to log every transaction on countless different computers, is driving the disastrous energy consumption that has made some of the crypto networks into a climate threat. According to Digiconomist, Bitcoin and Ethereum together consume about as much electric energy annually as Indonesia. (One way you know the infrastructure bill is not a climate bill is that it completely ignores crypto’s energy use.)
What’s more, the proof of concept for these innovations was, and often still is, illegal activity. The point of a crypto transaction is that it’s “trustless” — it’s secure even when you don’t know or trust the other party. That’s made crypto currencies a favored medium for money laundering, illegal purchases and ransomware. To be fair, criminals are often early adopters of new technologies, so crypto’s association with crime is likely to abate as the technology matures. But part of that evolution might require the kinds of regulation that the crypto community currently fears, as has been true with other technologies.
The future of cypto isn’t currency — it’s ownership
Once you have crypto networks up and running, with currencies pulling in users, you can build all kinds of things on top of them. So the second phase of crypto has followed from the first: Now that there really is digital money, where anyone can verify the transactions, shouldn’t there be truly digital financial services, built around contracts anyone can write, enforced by code rather than banks or law?
That’s the theory behind decentralized finance, or “DeFi.” The hope is you can replace financial intermediaries like banks and title insurers with self-executing contracts built atop the various crypto network ledgers. According to some estimates, there are about $100 billion worth of assets being held in DeFi applications right now, up from almost nothing just four years ago.
“I think we’re one-tenth of 1% into the development of DeFi,” Ehrsam told me.
But it’s the third phase when crypto advocates become most starry-eyed: They believe crypto is the basis for a better internet, what some now call Web 3.0.
Think about it this way: The internet we have allows for the easy transfer of information. We costlessly swap copies of news articles, music files, video games, pornography, GIFs, tweets and much more. The internet is, famously, good at making information nearly free. But for precisely that reason, it is terrible at making information expensive, which it sometimes needs to be. What the internet is missing, in particular, are ways to verify identity, ownership and authenticity — the exact things that make it possible for creators to get paid for their work (for more on this, I highly recommend Steven Johnson’s article “Beyond the Bitcoin Bubble”).
That’s one reason the riches of the web haven’t been more widely shared: You get rich selling access to the internet or by building companies that add convenience and features to the internet. So Facebook got rich by building a proprietary infrastructure for identity and Spotify created a service in which artists could eke out payment from works that were otherwise just being pirated. The actual creators who make the internet worth visiting are forced to accept the exploitative, ever-changing terms of digital middlemen.
This is the problem that the technology behind crypto solves, at least in theory: If the original internet let you easily copy information, the next internet will let you easily trade ownership of digital goods. Crypto lets you make digital goods scarce, which increases their value; it lets you prove ownership, which allows you to buy and sell them; and it makes digital identities verifiable, as that’s merely information you own. Together, they unlock the potential for a true economy for digital goods, where creators actually get rewarded for what they make. I will admit to some skepticism that this is how it’ll play out, because many of the financiers funding crypto also founded and sit on the boards of the companies that set the terms of today’s internet, but we’ll see.
To the extent this new economy for digital goods is visible now, it’s in the strange, frothy market for NFTs — non-fungible tokens, like the digital art being sold for tens of millions of dollars. But as people begin to spend more and more time in online “metaverses” — yes, all these sentences are as weird to write as they are to read — we’re going to see an explosion of online economies with goods and services that no one can currently predict. The key words there, however, are “going to.” These are nascent technologies. Regulating them would be, in the eyes of the crypto community, disastrous. And some in Congress agree. Which brings us to the fight over the infrastructure bill.
Who trusts the Treasury Department?
“Let’s recognize if we gathered all 100 senators in this chamber and asked them to stand up and articulate two sentences defining what in the hell a cryptocurrency is, that you would not get greater than five who could answer that question,” Sen. Ted Cruz, R-Texas, said Monday.
His point was simple: Congress doesn’t understand crypto, so it shouldn’t regulate it.
I’ll be generous and say Cruz has this one half right. Congress doesn’t have the expertise to directly regulate the crypto markets, but then, Congress isn’t proposing to directly regulate the crypto markets. It’s empowering the Treasury Department to do so. Tucked inside the trillion-dollar infrastructure bill is a provision reinforcing the Treasury Department’s authority to force tax compliance from the “brokers” who are part of those transactions. This was a rare bit of tax policy members of both parties could agree on. It was added to the legislation by Sen. Rob Portman, R-Ohio, and backed by the Biden administration.
“The tax enforcement agenda the president has put forward is focused on — and this is basic — having people pay the taxes that are owed under current law,” David Kamin, a deputy director of the National Economic Council, told me. “Disproportionately, there is evasion when it comes to those at the top, often because their sources of income are more opaque.”
And no market is more opaque right now than the crypto markets.
Portman’s proposal gave the Treasury Department broad authority to define “brokers” in the crypto markets, and compel them to issue 1099s and comply with the tax code. The proposal was too broad, in the eyes of the crypto community, which mounted a furious lobbying effort against it.
“I don’t know how Treasury will use that authority,” said Jerry Brito, executive director of Coin Center, a pro-crypto advocacy group. “I fear they’ll use it in a way that has unintended consequences because they don’t understand the technology.”
Sen. Ron Wyden, D-Ore.; Sen. Cynthia Lummis, R-Wyo.; and Sen. Patrick Toomey, R-Pa., agreed and fought to sharply narrow who could be defined as a broker.
“If 20 years ago everyone would’ve come in with all this inept regulation, you would have lost some of the real opportunities to have the internet grow and prosper,” Wyden told me. “I think the same thing is true here.”
But many in Washington, far from feeling like they’re regulating crypto networks too soon, think they’re entering, if anything, too late.
“We spent, to my memory, no time on crypto at the White House from 2009 to 2017,” Jason Furman, who led President Barack Obama’s Council of Economic Advisers during his second term, told me. “I’m sure there were conversations happening within Treasury and within the regulators, but virtually nothing came out of them. So Washington is really behind in dealing with this industry.”
The financial crisis shaped crypto — it also shaped Ccypto’s regulators
For all the gauzy stories of what crypto could become, there’s the simple reality of what it mostly is right now: A financial market in which highly volatile assets are traded, where scams and hacks and broken promises abound, and with DeFi, where complex derivatives and financial instruments are being invented and swapped. One worry many in the government have is that these markets are thriving through the avoidance of taxes and regulations.
This is a story we’ve seen before: Amazon got an early advantage by dodging sales taxes for years, and Uber and Lyft evaded transportation and labor regulations until they got powerful enough to essentially rewrite those rules themselves. But there are particular dangers to financial instruments designed to skirt oversight. Anyone who lived through the 2008 financial crisis knows the threat of shadow banking sectors.
“It is untenable to allow an unregulated, unlicensed derivatives market to compete, side-by-side, with a fully regulated and licensed derivatives market,” Dan Berkovitz, the commissioner of the Commodity Futures Trading Commission, said in a June speech. “In addition to the absence of market safeguards and customer protections in the unregulated market, it is unfair to impose the obligations, restrictions and costs of regulation upon some market participants while permitting their unregulated competitors to operate wholly free of such obligations, restrictions and costs.”
Still, when I talked to staff members at the Treasury Department, they seemed a bit shellshocked by the past week. To them, the mobilization against Portman’s language was a bizarre overreaction to a modest provision that would be followed by a multiyear rule-making process, where the crypto industry would have plenty of say. The language of the bill was expansive not because the Treasury Department wants to force everyone who touches a blockchain to produce a 1099, but because it doesn’t want to prejudge how the crypto networks were structured. Crypto advocates keep saying that they shouldn’t be regulated until they’re better understood, but that’s precisely, from the Treasury Department’s point of view, why Congress shouldn’t tie its hands before it can go through a full regulatory process.
Of course, the crypto world saw the effort differently.
“The language was overbroad, and it still is,” Katie Haun, a co-chair of the venture capital firm Andreessen Horowitz’s crypto fund, told me. “It could be read to encompass software developers and miners. A possible reading — and where there’s a possible reading, it chills activity — is whether, on every transaction, you’d have to make a filing. Treasury says that’s not what they were intending to capture, but that left uncertainty, and uncertainty chills innovation and moves it offshore.”
The oddity of reporting this story is that all sides swear they want the same things. All the people I spoke to in the crypto universe agreed that there needed to be tax compliance; they just didn’t want to see software developers or blockchain miners caught up in an IRS dragnet. All the people I spoke to on the government side said that they were just trying to get the information necessary for tax compliance, and that they had no intention of bothering software developers and blockchain miners who weren’t actually brokering transactions.
I am, of course, being a bit purposefully naive here. The truth is that there’s some mixture of misunderstanding, mistrust and regulatory jockeying on all sides. The crypto industry wants to be lightly regulated and undertaxed, just as every industry does, and many of its key players are deeply hostile to the government — the genesis of the technology, after all, is an effort to wrest the control of currencies away from governments, even if the money flooding into the sector has ensured that crypto will be intimately entwined with governments.
The federal government, for its part, wants broad authority, in part because it believes that carve-outs will be used for tax and regulatory avoidance. It fears a future in which crypto is big enough to pose risks to the financial system, and it doesn’t have the tools or reporting to see and manage those risks, just as was true in the derivatives markets in 2007.
There is an irony in this. The cryptocurrency boom was partly a reaction to the collapse in trust toward governments that followed the financial crisis. But that same sector is now going to be scrutinized by governments that, after the financial crisis, have become much more skeptical of young whiz kids who are making wild profits from new, highly complex and volatile assets and financial instruments.
“You have to ask yourself: Do you think, in general, finance is an area that’s over or underregulated?” Furman told me. “Are you more concerned all sorts of cool products don’t exist because of regulation or are you worried people are being ripped off and taken advantage of? I know which side of that I’m on.”
The bill ultimately passed the Senate with the crypto language unchanged. There was a compromise proposal that both sides supported, but for procedural reasons too inane to go into here, it needed unanimous consent, and Sen. Richard Shelby, R-Ala., blocked it in order to try to get $50 billion in unrelated military spending added to the bill. Shelby failed, but he took the crypto compromise down with him. As I’ve said before: The Senate is a ridiculous institution, run by ridiculous rules. But this is the beginning of what will be, for better and worse, a long relationship between the government and the crypto community. After all, this was just about tax compliance. How to track and minimize financial risk in the crypto markets is going to be much harder, but that fight is still to come.
“What I like about the infrastructure bill is this showed a recognition on the part of the 67 senators who voted for the bill that crypto is here to stay,” Haun told me. “This is an industry that’s maturing. It’s not in the shadows.”
This article originally appeared in The New York Times.