Reflections on Crypto’s Dodd-Frank Moment: Trust, but Verify

Keynote address by Dante Disparte given on January 27, 2023 NYU Stern Vincent C. Ross Institute of Accounting Research and the NYU Stern Volatility and Risk Institute conference on Governance, Regulation and Accounting for Digital Assets

Thank you Professors Shehata and Berner for giving me the occasion to make a triumphant return to my alma mater. Here in the venerable halls of the NYU Stern School of Business, as I earned a masters degree in risk management, I learned that you cannot buy insurance when your house is on fire. Crypto’s house was on fire in 2022 and the fire brigade was a blend of responsible, regulated actors, good governance, regulation and accounting. In short, 2022 was a systemwide stress test and, as the Bank of England’s Sir Jon Cunliffe noted, the companies that survive this particularly dark and frosty crypto winter may very well be the Amazon’s of the future.

Circle is a leading regulated digital financial services firm and the issuer of a dollar digital currency known as USDC. Over the course of USDC’s 5 years in circulation, we have not only demonstrated the art of the possible with programmable and composable digital currencies, we have connected the dots between the analog and traditional financial system, and an always-on internet of value. That internet of value is still in its dial-up phase, but progressing rapidly according to Moore’s law and advancing courtesy of the time, talent and treasure of millions of developers around the world towards broadband, high-speeds and operating resilience. Indeed, it is not long before the use of constantly upgradable open infrastructure (aka public blockchains) approximates Visa-scale transaction throughput, with settlement finality in microseconds, and the global reach of the internet. Indeed, already today, USDC-enabled digital wallets are active in more than 190 countries creating an era of internet money for Thomas Friedman’s hot, flat and crowded world. We should take great heed with the increasingly loud calls to let “crypto burn” or to relegate it to a form of internet gaming like trading JPEGs, rather than real value. This would be the equivalent of halting the development of the internet because of the frustrations and slow pace of the worldwide wait era of dial-up and the lascivious or criminal nature of the dark web.

With more than $43 billion of USDC in circulation, which has cumulatively processed over $9 trillion in transactions, we have learned a thing or two about trust, transparency, disclosure, and accountability over Circle’s 10 year history. Indeed, as the dollar faces a digitize or die moment, as some argue the U.S. is pitted in a fierce digital currency space race with adversarial countries and companies. Our experience with USDC tells a powerful counter narrative that the U.S. is in fact in the lead and the dollar is the currency of the internet as much as it is the reserve currency in the world.

While the physical U.S. dollar is emblazoned with the words in God we trust, well-regulated and trusted digital dollars would say, in code we trust. Yet, as we learned in 2022, perhaps in code we trust is not enough. Borrowing from our friends in the cyber resilience domain, we also need defense-in-depth when it comes to trust, transparency, and accountability in fast moving, fast evolving digital finance. Ironically, by today’s regulatory and compliance standards, if you proposed a financial innovation called cash it would likely not be approved for its opacity, limited transmissibility and for being a vector for spreading disease and financial crime. During the onset of the COVID-19 pandemic, some countries even resorted to “laundering” their physical money or imploring the public to put more of it into circulation.

Last year we learned some painful lessons in the digital assets industry, and hopefully along the way those who care about consumer protection, modernizing regulation, as well as promoting responsible innovation in financial services will be spurred to action. Chief among those lessons is that promissory statements on Twitter do not make for durable business models, let alone durable competition in often stranded financial services that are stuck in the 1700s. We have to remember the original thesis with the advent of digital currencies and Bitcoin 14 years ago, was that it was supposed to be a correction to many of the misdeeds, the greed, and the fear of missing out that was the tinderbox giving rise to the 2008 global financial crisis. And, while a $2 trillion haircut in the digital assets economy does not kill a novel sector, especially not when most of the failures have human causes not technological ones - it is nonetheless a hefty down payment on both demonstrable real-world value and trust. It is also a reminder that like banking, crypto is not monolithic.

How many crypto and digital asset projects, particularly stablecoins, would withstand the ultimate test? What I call the Jerry McGuire test - show me the money? As the accounting professionals and professors in the room will tell you, it is not merely enough to show someone the money, it must also be accounted for. Last year, the beginning of the end of the speculative phase in crypto was triggered by an interesting cast of characters and key events - proving yet again that technology did not fail, people did. For example, the stable-in-name-only digital derivative Terra-Luna, whose braggadocious frontman Do Kwon made light of billions of excess financial risk and losses, including playing a game of catch me if you can on Twitter with Interpol. 

Demonstrating the limitations of trust without verify, in my fair city of Washington, D.C., the baseball stadium carried Terra-Luna’s name on all of the seats, and emblazoned throughout the arena - just the same as there was a stadium in Miami carrying the scarlet letters FTX. Both monuments to unchecked financial alchemy, fear of missing out and alleged fraud. However, it begs the question: was this a failure of underwriting and regulation, or was this a failure of people succumbing to paycheck persuasion, and believing that everything that glitters is digital gold? The difference between risk in crypto versus traditional finance, perhaps driven by the speed of information sharing in digital assets and the proverbial digital breadcrumbs they leave behind (which has given rise to a cutting edge crypto forensics industry), is in its discoverability. Terra-Luna’s $60 billion collapse occurred over a weekend, just as the pyramidal structure of FTX was toppled with a tweet. Meanwhile, as much as I hate false equivalencies, Bernie Madoff made off with billions in an undiscovered Ponzi scheme lasting decades. The discoverability of risk, illicit activity and ne'er-do-wells in the crypto economy is a powerful feature, not a bug. Anyone armed with a magic internet looking class is a part of a collective tripwire system, with the boundaries of internet privacy being an emerging challenge.

If I were alone in a room with one of you and gave you a $20 dollar bill, aside from raising eyebrows and questions, accounting for the transaction would be your word against mine. Since you are all accounting geniuses, you would likely prevail in a double-spend scenario or a dispute. Now, by contrast, if I gave Professor Shehata $20 on stage in front of this live audience and the hundreds watching on the internet, dispute resolution and transaction accounting is validated by collective witness. This feature of blockchain-based financial services works with profound societal and market implications. It has not, however, made auditors and accountants irrelevant - rather, it has given them another layer of reasonable assurance through which we can irrigate the wellspring of societal trust, which as Edelman has reported for the last 20 years with their Trust Barometer, runneth dry.

Herein, 2022 in the digital assets market was a hybrid between the dot-com bubble, and the greed-fueled excesses of Wall Street in the lead up to the 2008 financial crisis. Perhaps crypto’s Dodd-Frank moment will follow as regulators and policymakers seem poised to end their wait-and-see observation period finally laying out a level playing field for responsible development of digital financial services. This is not only a matter of national security and competitiveness, it is a matter of extending beyond the physical limitations of brick and mortar banking and analog payment rails, which have reached a point of diminishing returns as COVID-19 has shown us. For example, in the U.S. the mobilization of more than $6.6 trillion in government to citizen payments and other forms of pandemic relief was hampered by the void of trusted, real-time, auditable and corruption-resistant payment systems. This may have contributed to the loss of anywhere between $75 and $400 billion due to “mysterious disappearances” in the banking and payment system. Tragically, the pandemic has exacted the highest costs from those who can least afford it, including reducing the flow of typically recession-resistant remittances by more than $200 billion.

Trust is the real currency in financial services if they are to be utilized every day in a durable manner. This much holds true for analog banking and financial services, as it does for their digital twins. Blockchain is often referred to as the trust engine, or the trust machine. I once wrote that blockchains record trust like an atomic clock records time - it is inexorable and irrevocable. But is this trust broken and is the word “crypto,” short form for cryptography now a vulgar, untouchable term? Or like all forms of novel, emerging technologies, are the real stewards of its utility value those with steadier hands and regulation first approaches. For example, in the stablecoin segment, for which we generally reject the term as a catchall that dangerously lumps together responsible digital currencies, and their stable-in-name only namesakes, there are a few key pillars of trust that matter. 

For example, turning back to the Jerry McGuire test of show me the money, at Circle, we have opted for a race to the top on transparency, trust, disclosure and accountability. That alone, however, is not enough, as we have also implemented an asset-liability management model on par or better than the world’s global systemic banks - all without the perilous fractionalization or rehypothecation that necessitates a public backstop in the form of FDIC insurance and bailouts, resulting in the privatization of gain and socialization of trillions in losses. Some very large stablecoin issuers are still failing this test and in many cases are relying on the same troublesome blend of promissory statements on Twitter and half hearted attempts at transparency and accountability. Sunlight is the greatest disinfectant and while we should be encouraged that some crypto projects are embracing transparency and accountability, Circle and USDC were born in it.

For example, many stablecoin projects have failed by ignoring the pre-existence of money transmission, electronic stored value or e-money regulations around the world. These rules not only require national licensing, annual examinations and basic conformity with operating requirements, including critical financial integrity norms on combating illicit finance. They also include fiduciary standards that protect and preserve customer funds, including by preventing the type of financial alchemy we saw with Terra-Luna. Indeed, while state money transmission rules in the U.S. present a national mosaic of fintech regulation and opportunity - amounting to the proverbial financial laboratories in our country - they are not giving rise to an era of internet funny money or Wildcat Banking contrary to some views. Unlike Europe’s e-money frameworks, which saw the collapse of Wirecard due to opacity and other risks, large U.S. money transmitters and payments companies have not faltered under the watchful eye of state banking regulators. Thus, the U.S. competitiveness gap is not domestic, it is in expressing, exporting and harmonizing these standards for digital dollars around the world.

Trust is the sum of the parts, just like governance, regulation and accounting. Trust compounds, accrues and, like national or corporate value systems, it matters most during periods of duress or stress. The “verify” part of “trust but verify” is where the audit and accounting profession steps in to provide added layers of assurance, independence and oversight. While there has been some definitional debates about the differences between an audit, which is typically carried out on an annual basis for firms or activities that are designed to be auditable and are not afraid of disclosure or accountability, and attestations, which are designed to provide routine and ongoing assurances on specifically reviewed items. For example, ever since the first USDC entered into Circulation, Circle has issued third party attestations from leading global auditing firms about the sufficiency of USDC’s dollar-denominated reserves to meet all demands for USDC in Circulation. From the first dollar, to $43 billion today, this process has evolved every month (down to daily reporting U.S. treasury CUSIP numbers), like the second hand on a clock, and has exceeded the transparency, accountability and disclosure of comparably regulated, household names in global payments. 

We do this, so you do not have to take our word (or Tweets) for it, and to solve the buyers’ and spenders’ remorse that has plagued crypto over its maiden decade.

I’m grateful to Professors Shehata and Berner for the occasion, to all of you for your attention and to NYU Stern for the stage. Thank you.