By Ali Karamali.
Following the 2008 financial crisis, cryptocurrencies (crypto) began attracting interest by offering a new way to manage money with greater independence, transparency, and security. Based on a theory of decentralization, crypto operates on networks not controlled by any single institution, allowing users to directly and securely transact without relying on banks or government oversight. Now, as crypto rapidly gains a following, governments are eager to join the market.
The Collision of State Authority and Decentralized Finance
Arizona stands at the forefront of a trend toward state-backed cryptocurrency investment. The Arizona Legislature and Senate passed two bills earlier this year, SB 1025 and SB 1373, which represent the state’s attempt to invest in digital assets. However, the Governor vetoed both bills due to the risk that volatility in crypto markets poses to public funds.
SB 1025, known as the “Arizona Strategic Bitcoin Reserve Act,” would have permitted up to 10% of public funds, which are managed by the state treasurer and state retirement systems, to be invested in digital assets. SB 1373 would have created a “Digital Assets Strategic Reserve Fund” that pools appropriated state funds with cryptocurrency seized in criminal cases.
Arizona has enacted other crypto-related legislation, including HB 2749, which established a pool for unclaimed crypto assets, and HB 2387, which imposed higher risk-disclosure requirements on crypto kiosks. HB 2749 does not pose the same risks to public funds that led to the veto of AZ SB 1025 and 1373, and HB 2387 actually reduces some of the consumer risks typically associated with crypto. Although AZ SB 1025 and 1373 were vetoed, it is beneficial to discuss the risks associated with investing public funds in crypto, as government institutions continue to show interest in entering the crypto market.
The Decentralization Contradiction
Arizona’s SB 1025 would have mandated that the state treasurer manage cryptocurrency holdings and, if established by the United States Secretary of the Treasury, store them “in a secure segregated account within the strategic Bitcoin reserve.” This is the type of centralized control point that cryptocurrency was designed to circumvent. Public sector investment could create dependencies between the state and crypto markets, blurring the line between financial innovation and state-backed speculation.
Imagine a state’s crypto reserve loses 20% of its value due to an overnight sell-off. The state might face pressure to intervene and help stabilize the market by introducing the centralized forces that crypto was designed to avoid. The contradiction raises a serious question: should public funds be invested in digital assets intended to function outside of state control, especially if doing so could increase financial risks rather than mitigate them?
Legal and Regulatory Implications
State crypto bills come amid evolving federal regulation, and Arizona’s approach could have created regulatory gaps and jurisdiction conflicts. Although supporters argued that establishing a crypto reserve would prepare Arizona for an inevitable federal regulatory framework, acting prematurely could have resulted in costly disconnects with future national standards.
Consider a scenario where Arizona launched a state crypto reserve which invested in a diversified portfolio of Bitcoin, Ethereum, and XRP before clear federal guidelines were established. If the federal government later imposes regulations that limit public crypto reserves to investing only in Bitcoin, the state may be forced to divest its Ethereum and XRP holdings. The federal regulation and sudden sell-off could cause significant market volatility and losses to public funds, raising serious doubts about launching a state crypto reserve without federal guidance. Even if Arizona challenged the federal regulation in court and did not divest, the broader market would likely adjust, causing digital assets excluded from federal regulation to decline in value.
Economic Stakes for Arizona Citizens
The state general fund manages $16.2 billion, while the state retirement system holds $55 billion. Under the vetoed legislation, up to 10% of these funds could have been invested in digital assets.
The inherent volatility of crypto markets poses a significant potential risk to public funds, especially in the short term. Digital assets can experience rapid and dramatic price swings in response to regulatory announcements, shifts in market sentiment, or speculative trading. The fluctuations are unpredictable and can drain investment portfolios within a matter of hours. While crypto advocates highlight potential growth opportunities, it is reasonable to question whether such volatility is appropriate for public funds that serve essential governmental functions.
Beyond volatility, there is a question of crypto’s intrinsic value. Unlike stocks or bonds, which derive value from company earnings or interest payments, crypto largely derives its worth from market demand. Some digital assets, such as Ethereum, offer utility through smart contracts that automatically execute digital agreements once set conditions are met. However, this utility has not necessarily translated into stable or predictable value. If a state invests public funds in assets lacking a clear, fundamental valuation model, it raises tax payer concerns about whether this is a prudent investment. While digital assets may have a promising future, their highly speculative nature makes them a risky and potentially unsuitable investment for public funds.
Further complicating this issue is the prevalence of pump-and-dump schemes, resulting in market manipulation of digital assets. The schemes involve artificially inflating asset prices before quickly selling and leaving unaware investors with significant losses. When government funds are invested in crypto, it can signal legitimacy and financial stability. Although the state would avoid investing in these scams, its investment in the general crypto market could amplify consumer interest and increase retail investment in fraudulent digital assets. Without proper education and safeguards for citizens, state investment in digital assets could exacerbate the vulnerabilities and place individuals at risk.
Looking Ahead: The Future of Cryptocurrency & State-Backed Digital Assets
A growing number of states are considering the creation of crypto reserves. Texas and New Hampshire have passed legislation to create crypto reserves; both are limited to investing only in crypto with a market capitalization of over $500 billion (currently, only Bitcoin meets this requirement), and New Hampshire caps investments at 5% of public funds. While Texas did not implement a cap, its legislators have noted they expect to invest a “very modest amount.” The only other enacted crypto reserve was through Arizona’s alternative legislation, HB 2749, which will not invest public funds but will instead pool unclaimed digital assets into a crypto reserve. Many other states have tried and failed to enact various crypto reserve legislation, but it seems evident that states will continue to try.
Large-scale state-backed investments could fundamentally alter the nature of crypto, transforming it from a decentralized alternative to traditional finance into another asset class controlled by powerful institutions. This shift would raise questions about whether government involvement signifies an evolution or a contradiction to the original purpose of cryptocurrency. If states become major stakeholders in cryptocurrency, will enhanced legitimacy come at the cost of independence? Can cryptocurrency retain its distinctive features when integrated into traditional government financial strategies?
For now, Arizona is proceeding cautiously and focusing on addressing some of the consumer risks mentioned above. Nonetheless, as Arizona and other states continue to consider crypto as an investment option, policymakers should heed Governor Hobbs’s warning upon vetoing AZ SB 1025: “Arizonans'[s] retirement funds are not the place for the state to try untested investments like virtual currency.”
Ali is a second‑year law student interested in IP strategy and transactions. He graduated magna cum laude in chemical engineering from Kansas State University before spending three years advising federal and state agencies on cloud infrastructure, database management, identity‑access systems, and financial analysis. His projects spanned the public and private sectors—from government technology modernization to financial due diligence for major institutions. He spent the summer after his first year of law school externing at The Law Offices of Timothy M. Collier. In his free time, Ali enjoys playing golf and tennis and watching musicals.