How to regulate cryptocurrencies

by Paolo Savona

Cryptocurrencies: the complete speech of the economist Paolo Savona, president of Consob, at the Festival dell’ Economía in Trento

At the current state of the debate, the condition of the cryptocurrency market is that of its "substantial self-government of quantities through prices, which imposes its own regulation to ensure financial stability". So the president of Consob, Paolo Savona, during a conference on cryptocurrencies as part of the Festival of Economics in Trento. "This condition - he adds - can perhaps be reached after November 2022, when the 18 + 8 American institutions involved with the ordinance signed by the President of the United States will respond to the questions he posed; they invest a wide spectrum of issues raised by the birth and circulation of cryptocurrencies and their hybridization of traditional instruments, going so far as to consider the geopolitical and geostrategic implications of their development".


The expansion of the quantities and the different forms of the so-called cryptocurrencies (more beyond CC) has been such that the integration of this new reality of the market into the existing legislation is imposed; in order for it to be done on a rational basis, it is necessary that the operation of the set of these virtual instruments be placed in the known economic theory. This is not an intellectual quirk, but a necessity that, for any monetary and financial phenomenon, has historically required the development of an explanatory theory of how the relative market works. To avoid the uncertain meaning of the Italian term "economia", which indicates both theory and economic reality, we will use the English term economics, followed by with cryptocurrency, but for brevity we will use CC-economics [1].

The definition embraces a field that has become quite wide of virtual instruments of a securities nature and accounting methods in crypto and decentralized form, with particular attention to the "chained to blocks" (blockchain). In this field, we are witnessing a proliferation of definitions coined to grasp the ongoing evolution of this new reality of the market. For instruments, an elementary division between cryptocurrency and cryptoassets is used  to distinguish their monetary or financial use; for accounting methods the more general term DLT-Distributed Ledger Technology. In a broader framework, reference is made to DeFi-Decentralized Finance, which embraces the universe of decentralized accounting operations of all kinds, or to FinTech, which considers transactions and operators who incorporate or propose technological innovations in financial matters.

I will avoid entering into the complexities of this new market area so as not to weigh down the exhibition, in the belief that the audience will understand what is being talked about at a first level of abstraction from reality.

The use of CC has affected the functioning of the money and financial market at a global level and has led the authorities of many countries to study and propose an integration of the current legislation. We are well aware of the ability of the market to find ways of circumventing existing rules and, in this case, to reap the benefits of the absence of public regulation quickly; private operators have taken the lead of the CC, first developing them in quantities and forms, then hybridizing them with "traditional" activities (credit concessions in mixed form or only CC, derivative contracts with collateral only in CC or mixed with traditional instruments, insurance contracts with CC or other contractual combinations).

Interest in all forms of CC has increased as a result of the close connection created between traditional money and finance to face the global financial crisis of 2008 and has increased following the increased use of computers induced by the lockdown for health reasons. However, the real boost came from the expectations of gain that the CCs showed they had or only promised, with Bitcoin playing the role of "coachman fly" of La Fontaine's well-known fairy tale.

Some aspects of this new economics have already been highlighted, but not framed in an overall vision of national and global money and financial markets; it has been discussed mainly whether CCs have the nature of money or financial instrument, without reaching a common conclusion, neither at a private nor official level. Their monetary use is rather modest, but they act as a unit of measurement (numerary) for all the trades in which they are present; that is, they perform a traditional function of money, together with that of a store of value, even if outside the theoretical context defined in centuries of crisis and corrective experiments. In fact, given their price variability and the absence of regulation, they are peculiar stores of value, but they are not real units of measurement, because their expression refers mainly to the US dollar, which remains the dominant numerary even at a global level. They are also not a legal means of exchange or discharge of debts, not having legal tender (legal tender). In this regard, the warnings of the supervisory authorities, replacing the necessary regulatory standards, have proved to be ineffective, as evidenced by the recent events of the fall in the values of the CC. Massive sales of stablecoins (plus SC) guaranteed by Bitcoin (more than BC), other CCs or shares of companies in the sector or traditional, whose market values are falling and make the stability guarantees obsolete, have created difficulties for some intermediaries in the sector, who have reacted by warning customers that,  if they had caused their collapse by accelerating sales, they would have lost their savings. I do not think we can be clearer than this about the consequences of the absence of regulated legal protection in this market. Theoretically, the effect is similar to that which is determined on bank deposits in the event of their absconding, if there is no lender of last resort or an institution performing such a function.

In choosing, even alternatively, the monetary or financial use of cc, those who own them do not refer to the existing legislation, but to the conventions that are established between the members of the virtual circuit, to which they attribute practical value higher than the legal one. In fact, the absence of legislation represents one of the main risks of operating in this market area, which reverberates in the traditional area hybridized by CC. What matters for traders in virtual instruments is the interchangeability (or liquidability) between their different forms and with traditional money, financial and real market instruments.

Having clarified this aspect, the theoretical framework of CCs in a new economics requires that the elaboration be placed within one of the main traditional schools of monetary thought:

(i) the one that claims to entrust the market with the creation and self-government of the quantities of money and interest rates (which sees the ideas of Friedrich Hayek among the most cited by his supporters, although not perfectly in line with those expressed by him);

(ii) to assign to the monetary authorities the independent exercise of creating and controlling the quantities of money and/or interest rates (whose supporters refer to John Richard Hicks, to quote only one important master, since his ideas are common to many other economists);

(iii) the one that suggests setting golden rules, rigid rules of monetary creation, leaving the market to set interest rates (with Milton Friedman considered head of school).

These schools of thought are considered part of classical, Keynesian, and neoclassical theories. The choice between these options can only be made by assuming that the economy works in one way rather than another. On the subject, economists have produced rivers of "evidence", which are not such because an empirical verification has not been arrived at that puts everyone in agreement, but only at a set of logical arguments in favor of one or the other interpretative hypothesis. The only conclusion that can be drawn from this vast scientific production is that from time to time, from country to country, economies function as if one of the three schools had practical validity, but only contingent.

The first theory hypothesizes that markets, left free to operate, have an intrinsic capacity to self-regulate, where prices are the prevailing reference of operators and full employment is always guaranteed, being enclosed in the concept that it consists in the level that should be used.

The second, that markets pay primary attention to quantities and do not have the capacity to use all available labour and capital resources, imposing public intervention to achieve cyclical stability of the economy and full physical employment of resources, especially labour.

The third recognises the usefulness of recourse to private market initiative and state intervention for infrastructure purposes, but suggests a rigorous, if not rigid, monetary policy and a public budget based on economic developments, structurally balanced.

At the current state of the debate, the condition in which the CC market finds itself is that of its substantial self-government of quantities through prices (close to the classical version), which imposes its own regulation to ensure financial stability; this condition can perhaps be reached after November 2022, when the 18 + 8 American institutions involved with the ordinance signed by the President of the United States will answer the questions he posed; they involve a wide spectrum of issues raised by the birth and circulation of CC and their hybridization of traditional instruments, going so far as to consider the geopolitical and geostrategic implications of their development [2].

Considering that the creation of CC, which does not have in the face of reserves of traditional instruments in whole or in part, alters the distribution of income and wealth, because it creates purchasing power from scratch, albeit on conventional bases, the three explanatory models indicated must also be integrated by evaluating the effects they have on the distributive variable and,  consequently, on the social balances or imbalances that are determined on the market as a whole.

The definition of a more complete economic theory, however, will take longer, since it depends, we repeat, on the knowledge of the morphology that the monetary and banking system will assume, to decide what to do on an overall rational basis. This ideal world, however, is rare to find and, therefore, decisions can only be made in conditions of uncertainty, like every fact of economic life.

Faced with such a broad and complex scenario, attention has so far been devoted to examining Gresham's law, answering the question of what could be the bad currency capable of driving out the good one. The usual disagreements have arisen whether the official currency, such as the dollar or the euro, will prevail over the private one (the CC) or whether the opposite will happen, as claimed by many scholars whose ideas are shared here. The only doubt is related to the persistence with which private individuals will continue to consider on conventional bases that CCs find a guarantee against the risks of the absence of legislation and the wide volatility of their quotations in the high expectations of gain that they place in them. However, it is not a practical answer that should be sought, but an arrangement that is as stable as possible in theory, jointly assessed in the light of a monetary policy that proceeds in a manner consistent with the principles that inspired it up to the most recent choices to give greater weight to financial stability and real growth than to a strict control of inflation.

For some years there has been debate about whether the solution of the problem that has arisen with the developments of the CC can and should come with their replacement, it is not yet clear whether total or partial, with a public "digital" currency, called CBDM-Central Bank Digital Money (CBDC is also used replacing M-Money with C-Currency); however, this solution also raises problems of an institutional and technological nature. In fact, if digitalization consisted in the expansion and refinement of this form already widely used in current payments to create a cashless society, a society without physical currency, only the problem would arise of indicating which DLT accounting will be used and of drawing up a program of regulatory-technological transition towards the new monetary regime. If, on the other hand, the CBDM were a currency that competes with the CC, the main problem would consist in guaranteeing the authorities access (called "node") to the information accounted for on the Blockchain, distinguishing the case of Bitcoin, closed to participants outside the holders (at least at the current state of known techniques), from that of the other CCs (Ethereum, Ripple XRP,  Litecoin, etc.), potentially open, with decentralized methods to be able to exercise their supervisory activity.

If the CBDMs were to replace the CC in full, problems of reorganization of the current banking regime would arise, as the deposits would leave the monetary circuit. This change would limit the activity of banks in the financial circuit, that of the mere management of savings and payments, raising problems of defining the common rules of government:

a) the creation and circulation of digital currency within countries and in international trade, establishing a new exchange rate regime along the lines decided by the Bretton Woods Agreement of 1944, valid until 1971, in which the possibility of re-proposing the creation of a keynesian memory digital bancor [3] should be re-examined;

(b) the internal and international securities market, embracing all traditional and virtual instruments, establishing the characteristics of the technologies to be used for decentralised accounting.

In the context, central banks would maintain direct financing relationships with banks and, where permitted by their statutes, with states and the economy (businesses and households), in a position of monopolists of monetary creation. Today's monetary base would disappear and the CBDM would have the form of fiduciary money, similar to that once created by banks alone, with a public guarantee for holders much stronger than that which current bank deposits have.

Gresham's Law would find a practical answer as bad money would disappear, not under the pressure of the market, but from the will of the authorities; if, however, they, as it seems from their statements, were willing to recognize the legitimacy of stablecoins even for those created by banks, the problem would remain unresolved. It is true that the CS would be subject to an authorization process to maintain control over the governance of the total quantity of money, but this choice would still complicate the conduct of a monetary policy aimed at financial stability if the management of the reserves necessary to ensure the stability of these peculiar CCs were partial and not total,  as well as composed of different forms of CBDM. If this were the case, as we hear repeated, the advantages of the distinction – repeatedly invoked by Irving Fisher and the Chicago Plan of 1939 to get out of the Great Recession and resumed with greater analytical precision by Hyman Minsky to end the banks "serves two masters" – the stability of money for the part in the form of deposits and a greater use of savings for growth would be lost.

If the CBDM coexisted with the CC and, even more so with the CCs, the definition of an interconnection between the digitized, centralized open and closed accounting bases would be indispensable, standardizing the technologies in order not to lose the information necessary for economic policy choices. However, a prior examination of how a two-tier market works, a market where two forms of the same good coexist (private money and official money); of this form the negative effects have been known since fiduciary coinage was implemented by several private sources, especially banks, at the turn of the nineteenth and twentieth centuries, with a last experience made to avoid the collapse of the Bretton Woods monetary regime,  when it was decided to isolate gold trading on the official market from those on the private market, which lasted only a few months before the collapse of the gold convertibility of the dollar at fixed prices already mentioned. The coexistence between a currency whose quantities would be controlled by the authorities and one controlled by private individuals can be considered difficult to implement, if not really impractical, especially if the private one was of international origin and penetrated into national systems.

Having ascertained that the redefinition of a CC-economics requires closely related decisions on the institutional and technological level, it is possible to trace its main components to arrive at a collective work agenda. The task is so vast and burdensome that it requires the repetition of the experiences made in the early 1960s with the MIT-PENN-FED Econometric Model under the guidance of Franco Modigliani, Albert Ando and Frank De Leeuw, which saw Guido Carli's Bank of Italy follow with equal speed and no less intelligence to develop its M1BI. These models are now obsolete, not only because of the lack of consideration of the CC universe, but because they fail in their predictive use of probabilistic matrix, which requires continuous changes in results, undermining their own function of aid to choices. This is all the more true, in a world that has become rather complex due to the countless interconnections between thousands of variables that need to be treated using artificial intelligence methods, with a paradigm shift from the deductive method, typical of econometric models, to the inductive one, but on new scientific bases, as correctly argued by Rainer Masera in the text already cited [4].

At this point of knowledge of the problem of CC, the research path of a CC-economics should be enclosed in a work agenda divided into three phases.

A first, which consists in the review of existing econometric models, introducing the quantities of CC created or existing and, alternatively, their prices in order to:

a. redefine the known functions on the behavior of real investments and savings to changes in quantities and prices;

b. assess the quantity and price effects of CC on exports and imports;

c. identify the mechanisms for transmitting the effects on prices and portfolio balances (distinguishing inflation on real goods and inflation on financial assets);

d. decide on the use of tools for economic, monetary and fiscal policy choices, elaborated over centuries of reflection.

A second, certainly more challenging, which aims to identify the probable corrections to economic theories as known today, overcoming the vision so far limited to individual aspects (such as Gresham's law and the two-tier market of which it has been said), hypothesizing:

i. the existence or not of a private currency, the CC, accepted on conventional grounds by the parties, but without public recognition;

ii. the existence or not of a condition of free convertibility between public and private currencies and of free movement of finance, in the presence of a market that records trade even unofficially;

iii. the presence or absence of a WTO to regulate global trade.

To reach a third phase, the one that elaborates new models based on the application of artificial intelligence methods that involve the exit from deductive logic based on objective (or subjective) probabilities, to enter into an inductive logic based on the processing of thousands of data available to obtain more satisfactory forecasts. The most reasonable expectations are that changing the model from that used by econometric models would provide a better understanding of the effects, but not of the causes that determine them. We should therefore be content to foresee better, renouncing, at least initially, to pursue the aims of knowing the causes of the economic phenomena typical of the economic research pursued so far.

These profound changes in the ways in which all markets are already moving and, even more so, will move, also entail a review of the tasks assigned to the existing institutions and the organisations they will have to undertake to carry them out. This will depend on the solution that will be decided for the architecture and forms of the currency, for similar decisions concerning intermediaries and market supervision, as well as corporate governance. These are all decisions that must be taken to assign to the competent units the objective of pursuing the financing of productive growth and limiting the area of finance for finance, which represent the most effective forms of protecting savings, understood as the indispensable basis of the social stability necessary for orderly development.

Raising problems without indicating solutions rightly leaves those who wonder what the future of their savings is. The cognitive premises for giving an answer have so far been indicated. Since they have not yet been clarified at European level and, even less, at this stage of knowledge it is still possible to proceed, as is being done, according to the lines of supervision and application of regulations established for traditional instruments, which encounter, however, legal and practical obstacles to their application. The current regulation is however the basis for welcoming a good functioning of the market of any type of activity in which cryptocurrencies are present, which is supervised by specialized bodies capable of ensuring compliance with the legislation that will be decided, the transparency of the operations that are carried out on the market, the rapid execution of authorization processes and sanctioning mechanisms,  all activities to be examined in the new technological context.

[1] I made this proposal in a Lectio magistralis held at the University of Cagliari on 1 October 2021, the text of which was published in Bancaria ("Theoretical and practical features of an economy with cryptocurrencies", n. 10, 2021, pp. 2-11); a summary in English is being published in the journal Economia Internazionale.

[2] I examined this order issued on 9 March 2022 in my speech to the Bank of Piacenza on 2 April 2022 entitled "Some reflections on scientific and technological progress at the service of finance".

[3] I draw this reference in a wide-ranging paper on the topics covered in these reflections edited by Rainer Masera of 6 February 2022 entitled "New risks and regulation of cryptocurrencies".

[4] I examined the evolution of the method for scientific research in my latest work for the types of Rubbettino (Soveria Mannelli 2022) entitled The progress of science improves the fate of humanity? A review of the changes in the methodology of scientific research from Roger and Francis Bacon to the present day.

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