Crypto and the Muni Market: Why Are Some States Investing in and Promoting Crypto?

This article will describe the ways cryptocurrency has entered the municipal market, the general risks associated with utilizing cryptocurrency, and the risks this creates for market participants.

The Crypto Creep

A number of states have permitted state funds to be invested in cryptocurrencies. In New Hampshire, the state may invest 5% of its public funds in precious metals and digital assets as long as the asset has a market capitalization of over $500 billion. Bitcoin is presently the only cryptocurrency that qualifies. Texas has passed a very similar law. Arizona establishes a process for the state to seize digital assets which qualify as abandoned property. A number of other states, including Massachusetts, Michigan, North Carolina, and Ohio, have introduced laws similar to New Hampshire’s, some of which would allow up to 10% of public funds to be invested in cryptocurrency.

In addition, the New Hampshire Business Finance Authority is seeking to issue $100 million of taxable bonds secured by bitcoin, $150 million of which will be put in a statutory trust to both pay debt service on and secure the bonds. If the value of the bitcoin goes below a specified level, the trust will liquidate to redeem the bonds and mitigate loss. If the bitcoin appreciates over a specified level, the bondholders will share in the upside.

Risks of Cryptocurrency

Cryptocurrency is a very speculative, volatile investment. There can be dramatic price swings and large quick changes in value. Liquidity can also be an issue.

In 2022, there was a cryptocurrency collapse that resulted in about a $2 trillion market value loss. A number of large crypto-industry entities filed for bankruptcy, including FTX, one of the largest crypto exchanges. Fraud was exposed as a prevalent problem in the industry.

Crypto assets are generally not treated as registered securities. In the main they do not benefit from US Securities and Exchange Commission (SEC) or Securities Investor Protection Act (SIPA) protections that apply to investments like bonds and stock. Consequently, there is a meaningful risk of bad actors succeeding in scamming people through sales of fake coins and Ponzi schemes. While there were efforts in the past of the SEC to regulate cryptocurrencies, under the present Administration all such efforts have ceased.

Risks for States, Taxpayers, Public Workers, and Investors

Investments of state funds have historically been safe, prudent investments. States authorized to invest state funds in cryptocurrencies have significantly diverged from that prudent standard. What could this mean for states, taxpayers, public workers, and investors?

There are many downside scenarios. One scenario is that the cryptocurrency market takes a nosedive in the context of a serious recession. Assume a state takes losses on its general investments on account of the recession and faces significant losses due to the collapse of the cryptocurrency it invested in. It would also presumably face revenue raising challenges during a severe recession.

In such a scenario the state would be forced to impose an austerity budget, which would reinforce the recession. A significant loss of its investments from a crypto-collapse could be the decisive event paralyzing the state from proactively combatting the recession. And worse, if the state was forced to raise taxes to balance its budget, this would impose an additional burden on taxpayers.

Of course, the state could issue general obligation bonds to soften the blow as is often the case during recessions. Some states use general obligation proceeds to fund operating deficits to avoid raising taxes or cut spending in order to balance its budget. This questionable fiscal practice creates an additional debt burden to be paid in the future by taxpayers.

Public workers are also impacted by these crypto investments since some pension funds are now authorized to invest in cryptocurrencies. Pension fund investments should be made prudently in liquid safe investments. This new cryptocurrency policy emerging in some states is a form of gambling with the retirement funds of public workers.

Investors should closely monitor crypto investments by states and state entities to determine the overall credit risk created by these speculative investments. While at any point in time these investments may be lucrative, they create a risk that must be considered when evaluating the credit of a state.

From a public policy perspective, the bitcoin transaction in New Hampshire which promotes speculation in cryptocurrency is totally inappropriate. Not only does it not serve a legitimate public purpose, but it encourages investors to partake in an unpredictable risky industry that adds little value to the economy or society.