For about a decade, financial regulators have been grappling with the rise of fintech and the ways it disrupts financial regulation.  But something is often lacking in these policy conversations. In a new draft article, I argue that financial regulators need to engage more critically with the “tech” aspects of fintech.  In particular, they need to ask whether it’s even possible for technological innovations to address the deep-seated and complex problems that fintech’s proponents say they can solve.

The article explains in detail why many fintech offerings (particularly crypto) are unable to solve problems like financial inclusion: Where problems are not technology problems to start with, then technology alone will not fix them.  Unfortunately, many people are unable to see fintech’s limitations because they are blinded by the shiny promise of technological innovation – and that blindness is encouraged by the venture capital and tech industries that profit from it.

“Techno-solutionism” is a pejorative way of describing the techno-optimism and innovation worship that are so often characteristic of Silicon Valley.  A pejorative term is warranted because there are real dangers for public policy when complex structural problems are oversimplified and reduced to purely technological puzzles. When we start with the tech industry’s favored tools and then ask how to solve complex problems using those tools – rather than starting by defining the problem to be solved – it can distract policymakers from supporting real, structural solutions.  Techno-solutionism can also deter policymakers from interrogating the limitations, and regulating the harms, of the proffered technological solutions.  Indeed, whether intentionally or not, policymakers themselves often entrench techno-solutionism through their uncritical rhetoric about the promise of particular technological innovations.

Fintech inflicts many harms – to consumers, to investors, and potentially to the stability of our financial system. My article explores fintech’s harms as well as its limitations, and in doing so surfaces the fundamental question that so often goes unasked: Why do financial regulators sometimes nurture fintech innovations at the expense of their mandates to protect the public from harm – or at least, why are they so fearful of impeding those innovations?  The article draws on technology scholarship and financial regulatory scholarship to show how venture capitalists and technologists engage in strategies of cognitive capture, regulatory arbitrage, and regulatory entrepreneurship to ensure that they are able to profit from their fintech innovations – even when those innovations harm the public.

Blockchain technology – that quintessential solution in search of a problem – serves as an excellent case study for highlighting these dynamics.  It’s important to understand from the outset that the crypto industry, which relies on blockchain technology, didn’t just evolve organically, but was intentionally built by venture capital funds to maximize profits in a low-interest rate environment.  VC funds typically have a term of 10 years – this means that VCs have only a decade to identify investments that will demonstrate explosive growth, invest, exit, and pay back their own investors.  It’s often easier to achieve that explosive growth when there’s no need to build infrastructure or engage in testing – in the right circumstances, crypto tokens with nothing backing them will be the perfect VC investment, because they cost nothing to produce, and explosive growth can be driven purely by sentiment.  VCs have therefore had incentives to build hype around crypto investments to capture the imagination of the public – as well as to convince policymakers that the underlying blockchain technology should be nurtured so that it can improve financial inclusion, efficiency, competition, and privacy (in reality, as the article explains, blockchain technology does none of these things very well).

When it comes time to exit their investments, it’s easier if VC funds can sell their interests directly to the public.  When a fund invests in a startup’s stock, public sales will be limited by the securities laws.  But when a VC investment takes the form of a crypto token, that token can be sold to the public on a crypto exchange quickly and easily (that is, so long as the SEC doesn’t crack down on crypto exchanges for violating securities laws).  Unfortunately for investors, these kinds of tokens are often Ponzi-like, eminently manipulable, and have been central to so many of the crypto failures over the last two years.  The SEC has therefore started to crack down on unregistered offerings of crypto tokens and unregistered securities exchanges – endangering the regulatory arbitrage strategies that have made crypto a golden goose.

We are now at the stage where the crypto industry and the VCs that support it are seeking to harden this regulatory arbitrage into durable permissions.  Andreessen Horowitz (often referred to as “a16z”) has been the most prominent VC involved in crypto , investing billions of dollars in crypto ventures. A16z’s first crypto investment was in the crypto exchange Coinbase, which the SEC alleges is operating as an unregistered securities exchange. A16z and Coinbasehave both been extremely active in lobbying for legislation that would curtail the SEC’s jurisdiction over crypto.  Coinbase is considered the “foremost crypto lobbyist in Washington,” and crypto lobbying expenditures rival those spent by the defense and pharmaceutical industries.

My article discusses the crypto industry’s favored legislative proposals in some detail, but this issue is also playing out in the courts.  While the SEC has notched a series of enforcement wins (and one partial win in the Ripple case), a loss in the DC Circuit to the crypto firm Grayscale did result in the SEC begrudgingly approving spot Bitcoin exchange-traded products earlier this month – legitimizing retail investments in a market that is rife with manipulation.  As SEC Commissioner Caroline Crenshaw concluded in her dissenting statement, “I fear that our actions today are not providing investors access to new investments, but instead providing the investments themselves access to new investors in order to prop up their price.”

Crypto lobbying and litigation are ongoing, but since the end of 2022, a lot of VC interest has pivoted away from crypto and towards AI.  As my article explores, once again promises are being made – about financial inclusion, about efficiency – that the technology seems ill-suited to delivering on.  Once again, the deployment of AI in financial services could harm consumers (through discrimination, for example), investors (by making errors in portfolio management), and financial stability (if the errors in portfolio management are widespread and correlated).  The public interest will suffer if policymakers are too susceptible to techno-solutionism as they formulate policy around the use of AI in financial services.  My article urges financial regulators in particular not to forget their own area of expertise and to maintain contextually informed skepticism as they are barraged with promises about AI’s revolutionary potential.

This post comes to us Professor Hilary J. Allen at American University’s Washington College of Law. It is based on her recent article, “Fintech and Techno-Solutionism,” available here.