The 2022 cryptocurrency downturn saw a staggering two trillion dollars in value disappear. Despite this massive loss, the traditional banking system remained remarkably stable. Michael Hsu, then acting Comptroller of the Currency (OCC), attributes this resilience to a proactive approach that emphasized safety, soundness, and fairness for any banks engaging with crypto. The OCC’s message to banks was clear: while crypto activities weren’t strictly forbidden, they had to be carefully managed and transparent. This stance discouraged many banks, particularly those “crypto curious,” from diving in headfirst due to the perceived complexities and risks. This cautious approach, according to Hsu, effectively contained the potential for contagion, preventing the kind of widespread financial instability that occurred in 2008 with derivatives and structured investment vehicles (SIVs). In essence, he believes the approach shielded the broader public, who have no affiliation with crypto, from suffering the negative consequences of crypto market volatility.
Crypto: Speculation versus Utility
Beyond his regulatory actions, Michael Hsu presents a nuanced perspective on cryptocurrencies, categorizing them into two distinct aspects: speculative and innovative. He acknowledges the speculative element of crypto as being akin to gambling or sports betting, acceptable as long as all rules are adhered to. He also recognizes that “the rules” are still being defined which can lead to questions on what rules would apply. However, Hsu also identifies crypto’s potential for innovation. He envisions that crypto technology might offer a way to resolve long-standing issues in financial markets, particularly in securities settlement and cross-border payments. He believes that applying crypto tech at a wholesale or institutional level shows significant promise. For example, securities settlement which currently can take as long as two days could become instant with technology like a DLT, and the fees to conduct business could drop dramatically.
Hsu is firm in his belief that these two aspects should remain separated, and is critical of "crypto advocates" who champion specific technologies rather than focusing on the actual problems that need solving. For example, if you were to build a system for cross-border payments, a good first step would be to define pain points and identify what technology is the best fit. Instead, Mr Hsu perceives that many crypto enthusiasts advocate for a specific technology before even articulating the problem they wish to address. Hsu sees a potential conflict of interest, particularly when key company executives hold the specific cryptos linked to the blockchain a company is promoting. There’s a concern that these “skin in the game” holdings could subtly drive technology adoption, rather than a sincere evaluation of its usefulness.
Can You Separate Crypto Utility from the Speculative?
Separating these two aspects, however, is proving to be a difficult task. Over the past years multiple companies have formed consortiums in an attempt to accelerate the adoption of DLT. These closed consortiums, often comprised of several major firms that may compete with each other, have failed to live up to the hype. Open permissionless solutions have shown more promise. It has become increasingly clear that many institutions are drawn to the idea of permissionless blockchains like Ethereum as a pathway to a larger global financial market. Though Ethereum itself struggles with privacy, it presents a path to an open, global ecosystem, which represents the most pressing issue facing many firms: scaling up the customer base or sales potential of the product.
The key is the potential inclusion of the global pool of retail investors, with the possibility of including institutional investors in the future. In this context, the crypto token inherent to the blockchain becomes an essential component to facilitate transfers within that ecosystem. Therefore, the very design and function of open blockchains inherently intertwines the speculative and innovative applications of crypto technology.
A Stablecoin Fan or Not?
Hsu’s views on stablecoins present a complex picture. When asked about the potential for Big Tech firms to adopt stablecoins and disrupt traditional banking, he avoided addressing the Big Tech element instead, focusing on the merits of any system – whether it improves the experience for consumers and is safe, sound, and fair. At first glance, this may sound like an endorsement of stablecoins, but his subsequent comments, which are very critical, suggest the opposite.
While acknowledging the technological merits of stablecoins, he also raised concerns, he believes many stablecoins are favored by bad actors. He finds their use problematic. Also, he believes the claim that these systems are faster is not true, questioning the logic of replicating every transaction across thousands of nodes when a centralized ledger is arguably more performant. Hsu asks “What problem does it solve?”. It’s clear that he has a critical eye for the claimed benefits of stablecoins, seeing potential issues that outweigh their utility.
Stablecoin Pros and Cons
The debate around stablecoins encompasses both their societal merits and potential drawbacks which are not always discussed. One of the often overlooked advantages of stablecoins is their ability to bypass interbank settlement, which provides several key elements. The speed they potentially bring to transactions is significant. This is because conventional payment methods involve a two-step process: banks transfer funds between clients, and then settle up amongst themselves. This second step is eliminated by stablecoins. And importantly, the speed of near-instant settlement reduces risk. A wholesale Central Bank Digital Currency (CBDC), could make interbank settlement faster, it would still be a second step of the transfer.
However, concerns about the use of stablecoins by bad actors often come with potential infringements upon civil liberties such as limitations on the use of stablecoins and the use of self-hosted wallets. Curiously, the appeal of self-hosted wallets is partly based on people’s experience which shows that the anti-money laundering (AML) measures are often flawed.
The disadvantages of stablecoins rarely make it into mainstream discourse. While the current number of stablecoins is constantly growing, payment network effects suggest that in the future, there will be far fewer stablecoins compared to the current number of banks. This will lead to a centralized ecosystem of stablecoins as only a few, well-capitalized companies dominate. While this is advantageous to the stablecoin issuers, in the long run, this could negatively impact competition and consumers.
Does Tokenization Need a Blockchain?
Hsu’s argument extends beyond stablecoins. He believes that tokenization, the process of converting an asset into a digital token, could be implemented using centralized ledgers instead of distributed ledger technology (DLT). But, again, we have to ask Mr Hsu’s question “What problem are we trying to solve?”. Today’s financial institutions each have their own costly and cumbersome infrastructure, which demands considerable effort and resources to reconcile which makes doing business increasingly expensive and less efficient. Both a centralized shared ledger and DLT can create cost efficiencies in reconciliation, because they avoid the cumbersome need to reconcile data between different and separate systems.
Similar to the advantages of stablecoins, security and other types of tokens can transfer seamlessly with the added benefit of programmability, allowing for more complex transactions. However, if we look at why different institutions have their own separate technology, it’s because of the need for total control which includes protecting trade secrets. With the advent of quantum computing which will disrupt current encryption methods, the risk of shared data on a centralized ledger, even encrypted data, does not inspire trust. This fear undermines the utility of a centralized system, particularly in an age of rapidly evolving technology making data security paramount.
A similar challenge exists with some types of DLT architecture as well. Especially those that replicate all the data across nodes. In both these situations, institutions are inclined to share only a minimal amount of data, which diminishes the overall value of these technologies even if they are designed to solve some other problem.
We contend that while tokenization doesn’t necessarily need a DLT, it needs some form of shared infrastructure to unlock its full potential. We also believe decentralization is needed so that institutions can maintain control. DLTs happen to address both of these requirements. While other technologies can achieve similar goals, they often suffer from the same shortcomings as centralized ledgers. In conclusion, centralized ledgers appear not as the optimal solution for tokenization.
Summary
Michael Hsu’s perspective on crypto is pragmatic and emphasizes risk mitigation. He played a key role in preventing a major banking crisis during the 2022 crypto downturn by setting up guardrails around banking activity in crypto. He believes there is a place for the speculative side of crypto, but it should be separated from its innovative potential. Hsu identifies problems that crypto technology could solve such as inefficiencies in securities settlement and cross-border payments. But he also questions some of the claims of crypto proponents like the speed of stablecoins. Hsu does not think of open blockchains as the only solution, as his concern is focused on utility and efficiency. While he does not expressly ban the use of specific technologies, his comments suggest his view is not the same as some crypto advocates. His core message is that any technological adoption should be driven by the problems it solves, not by an affinity to any specific technology. Ultimately, he believes technology should be used to the benefit of consumers and for a purpose.
FAQ
Q: What is Michael Hsu’s view on crypto?
A: He views crypto as having both speculative and innovative uses. He believes the speculative aspect is acceptable as long as rules are followed, and the innovative is potentially useful for financial improvements like fast and cheaper payments.
Q: Why was the banking system unaffected by the 2022 crypto crash, according to Hsu?
A: He attributes it to the OCC’s proactive approach, which mandated banks to engage with crypto cautiously and transparently. This approach curbed excessive risk-taking, preventing contagion within the broader banking system.
Q: Does Hsu support stablecoins?
A: His stance is nuanced. While he acknowledges their potential merits, he has deep concerns about the prevalence of illicit use and their purported efficiency which he questions.
Q: Does Hsu believe tokenization must be done via a blockchain?
A: No. Hsu thinks it could be implemented on a centralized ledger, but his overall position is focused on the best technological solution given the problem that needs solving.
Q: What is the main takeaway from Hsu’s perspective?
A: Hsu emphasizes the importance of problem-solving as the driver for technology adoption, not advocacy for specific technologies. He believes any technology needs to be beneficial to the consumers and should be fair and safe.
References
IntraFi podcast. (n.d.). OCC’s Hsu on unfinished business, reg restructuring, dangers ahead.