The collapse of FTX shows the urgent need for clearer regulation of the crypto industry
The worst of crypto’s great crash of 2022 seems to be over, and thankfully it wasn’t 1929. Sam Bankman-Fried, the head of the scandal-ridden and now-bankrupt exchange FTX, has been arrested, released on $250 million bail, and confined to his parents’ California home. Two of his former senior executives have pleaded guilty to fraud. The company, once worth an estimated $32 billion, has all but evaporated, leaving more than a million customers and creditors in the lurch.
Other crypto firms also suffered massive setbacks this year, losing as much as $2 trillion in value since the boom of 2021. But the panic that engulfed the crypto world never quite spread to the traditional banking system, as some analysts had feared. A few small banks that held deposits for or lent money to FTX’s customers took significant losses. But by and large, the global financial system seems relatively unscathed despite the cratering of cryptocurrencies.
But just because the alleged mismanagement and corruption at FTX didn’t trigger a global recession the way Lehman Brothers’ bankruptcy touched off the stock market crash of 2008 shouldn’t be cause for celebration. It is just a reminder that the still-nascent business remains relatively small and walled off from the mainstream financial system. For now, most bankers seem to agree with Jamie Dimon, the chief executive of JPMorgan Chase & Co., that cryptocurrencies are “decentralized Ponzi schemes.”
Will crypto remain a niche investment? Many American regulators aren’t so sure, predicting that the largely unregulated industry could destabilize the broader economy as more and more investors — small individual and large institutional ones alike — dip into digital assets. Indeed, a year before FTX’s implosion, the head of the Securities and Exchange Commission, Gary Gensler, warned that “right now, we just don’t have enough investor protection in crypto. Frankly, at this time, it’s more like the Wild West.”
What then to do?
Investigators are now picking through the rubble of FTX trying to discern what went wrong. The company was among the largest crypto exchanges — the firms that help investors trade digital assets, including using fiat money. And virtually up until its precipitous fall, it was considered among the best run. No longer: Congressional hearings and court filings paint a picture of a company with crude and disorganized bookkeeping practices, where Bankman-Fried may have misappropriated investors’ money to finance risky investments, campaign contributions, and his own luxurious lifestyle.
Those revelations may have given momentum to efforts in Washington to toughen crypto regulations and push federal agencies, including the SEC, to be more assertive with the industry. “Power is worthless if the cop on the beat won’t use it,” Senator Elizabeth Warren said in a Wall Street Journal op-ed following FTX’s demise. “The SEC has brought some enforcement actions related to fraudulent and unregistered crypto offerings over the past few years, but it has fallen far behind as the crypto industry has drawn in millions of new investors.”
In December, Warren proposed legislation with Senator Roger Marshall, a Republican of Kansas, that would extend anti-money laundering rules to the digital asset market. A central goal would be to make it harder for criminals or terrorists to use anonymous accounts to finance their activities.
Though some experts have raised concerns that the bill would impose burdens on small operators, it seems a good first step toward bringing the industry into the sunlight. The measure does not, however, address ways to protect investors from fraud and malfeasance of the sort Bankman-Fried is charged with; Congress should turn its attention to that task in 2023 as well.
Some in the crypto world, where anti-government libertarianism runs strong, have attacked Warren’s bill as “an unconstitutional assault on cryptocurrency.” But the reality is that many companies would prefer a modicum of regulation, hoping to bring greater stability — and an aura of legitimacy — to their services. The big question in Washington is: Who would do the regulating, and how much regulation would be appropriate?
This was a lobbying battle Bankman-Fried had vigorously engaged before his company went belly up. Spending tens of millions in campaign contributions, he and other crypto firms were pushing for Congress and the Biden administration to regulate their industry with a relatively light touch. But Warren and other crypto-skeptics in Congress have pushed back, and FTX’s collapse may have strengthened their hand.
True-believer crypto fans are fond of repeating a mantra: came for the gains, stayed for the revolution. Or, as Peter McCormack, who got rich on Bitcoin and created a popular podcast devoted to crypto, said recently: “Stop buying Bitcoin to get rich. Anyone who goes out there to buy it to get rich will probably fail.”
Such advice might work for the disciplined, longterm, mission-driven investor. But as financial crises over the centuries have proven, most investors are indeed looking to get rich, and quick, whether via tulips or Bitcoin. Once memories of this dismal year fade, crypto speculation is likely to soar again.
The FTX scandal has shown that a clearer and tougher regulatory structure is needed before the next crypto crisis sends the broader economy into a tailspin — and ever greater numbers of people lose their savings. Financial calamity in the traditional markets may be useful to the revolutionaries, but it won’t be good for the rest of us.
As financial crises over the centuries have proven, most investors are indeed looking to get rich, and quick, whether via tulips or Bitcoin.