Crypto is under fire, but its Wild West survives

The era of effusive venture capital and freewheeling fraudster success has reached a turning point

Crypto is in trouble. After an overheated year of billion-dollar valuations, A-list celebrity endorsements and a Super Bowl crawling with cryptic crypto ads, companies are struggling.

FTX, the former second-largest crypto exchange, collapsed spectacularly in November. The major exchange Coinbase announced Tuesday it’s laying off about 20% of its staff; on Thursday, the Securities and Exchange Commission charged Genesis Global Capital and Gemini Trust, a crypto lender and exchange, respectively, with offering unregistered securities. The “crypto winter” continues as investors withdraw coins in record numbers. Crypto’s heyday of unregulated businesses largely fueled by effusive venture capital and fraudsters seems to be waning.

But no one should be too quick to proclaim crypto’s end. Like another fast-burning set of internet businesses that rose before — online gambling and betting platforms — crypto will most likely keep spreading, including along the dark edges of the economy. And unless consumers, politicians and prosecutors remain vigilant, the crypto industry will continue to produce wealth for a narrow few at the expense of the vulnerable.

In gambling, the house always wins. But in crypto, the house not only holds all the cards, but also creates them — in the digital tokens and coins that form its currency — through an opaque process with little oversight.

The industry’s pitch to the public has been that it cuts out the middlemen of traditional banking by allowing consumers to trade through decentralized online exchanges. Instead, these exchanges and other crypto platforms operate as a new class of middlemen focused on their own profits, not on ensuring the safe transfer of assets.

Take crypto golden boy Sam Bankman-Fried, who is now being prosecuted, accused of building a house of cards at FTX reminiscent of Bernie Madoff’s multibilliondollar scam in which seemingly secure returns vanished into thin air. The former head of Alameda Research, Bankman-Fried’s trading firm, testified that Bankman Fried committed fraud. He came close to admitting as much himself, acknowledging to a reporter last spring that the crypto industry was effectively a Ponzi scheme. That scheme briefly made Bankman-Fried the 41st-richest person in the world, before leaving investors out billions.

FTX is hardly the only crypto company to treat customer deposits as a piggy bank. The cryptocurrency playing field is littered with devastating losses for retail investors from frauds, scams and rackets big and small around the world. Some companies are getting help from the courts: Celsius landed itself in big debt, but because a bankruptcy court ruled that it owns most of the bitcoin deposited on its platform under its user terms and conditions, investors likely won’t get all their money back.

Despite the ongoing exposure of fraud and misconduct, some continue to believe in the fantasy that crypto inherently exists beyond government oversight. But in fact, most crypto companies meet the legal definition of “money services businesses.” Such companies have strict compliance obligations to track the money traded on their platforms and to know who is trading that money. When there is reason to be suspicious, these companies need to file paperwork, known as Suspicious Activity Reports, to alert federal authorities to questionable transactions. Many crypto companies have simply not followed through on their obligation to register as money services businesses, nor lived up to their compliance obligations.

Regulators are putting out fires where they can. Coinbase recently agreed to a $100-million settlement with New York’s anti-money-laundering regulator. Robinhood’s crypto arm was also fined $30 million by New York state for allegedly violating money-laundering regulations within the last few months. Crypto exchange Bittrex faced a nearly identical fine from the federal Financial Crimes Enforcement Network (FinCEN) for similar conduct. BlockFi had to pay $100 million to the SEC and state regulators for failing to register its lending product.

More enforcement by state agencies, the SEC and FinCEN may curtail current strategies for exploiting crypto exchanges. The robust SEC whistleblower program, and a recently expanded whistleblower program specific to money-laundering and sanctions evasion, should also help regulators manage the risk as insiders continue to come forward with information about crypto fraud.

But as with any laws that depend on compliance, enforcement will mean an ongoing game of whack-a-mole across a playing field too crowded for regulators and prosecutors to stop all bad actors. Online gambling offers a warning on these challenges.

When the Supreme Court ended the federal ban on state authorization of sports betting in 2018, it paved the way for a legal gambling industry of tightly regulated websites and casinos. But by the time the government stepped in, a wide-reaching illegal industry had already grown up alongside online gambling, making billionaires out of money launderers. And legalized gambling hasn’t stopped Americans from illegally wagering an estimated $511 billion a year, far exceeding the more than $125 billion bet legally in the years since regulation. Clearly, these shadow industries are virtually impossible to eliminate.

Anyone concerned about crypto’s potential risks to society and the economy — and at this point, that should include most people — should not look away now. The industry is likely here to stay, in some form or another, finding loopholes, creating new shady offshoot industries and outrunning regulation — just as much of the online gambling industry continues to do.

But this “crypto winter” moment does create opportunities to push the industry’s excesses onto a less destructive path. The government must keep working to remove fraudsters from the marketplace and making clear that crypto is not above the law.

Consumers, meanwhile, should refuse to support exploitative ventures. Only through those dual paths can we tamp down the ongoing wildfires set by the crypto industry that have stolen savings and hopes from people across the country — and, more critically, stop new fires from sparking.