Lessons for Congress from the FTX Collapse
By Mark Hays, senior policy analyst on fintech at Americans for Financial Reform and Demand Progress
This week, the Senate Banking Committee and House Financial Services Committee are each holding hearings to discuss the fallout from the collapse of the major crypto exchange FTX: what happened, why, and what should be done about it. There is a real opportunity here for Congress to reset crypto policy discussions and focus on first principles. To do that, Congress should keep the following points in mind:
The digital asset industry faces widespread systemic problems.
The speed and scope of the FTX collapse and ensuing scandal have overshadowed the fact that Sam Bankman-Fried is only the latest former crypto tycoon fallen from grace. South Korean arrest warrants have been issued for Do Kwon, founder of Terra/Luna, the collapsed stable coin which precipitated the initial crypto crash in May. Kyle Davies and Su Zhu, founders of overleveraged crypto hedge fund Three Arrows Capital, brought low by the Terra/Luna collapse, are facing actions from multiple regulatory agencies and are posting on social media from countries that don’t have extradition treaties with the United States. Bankrupt Voyager’s former CEO has settled negligence claims with the company’s board, while the judge presiding over Celsius’ insolvency recently appointed an examiner to explore allegations of misconduct against the company and its executives.
Crypto boosters allies in Congress want to paint FTX as an aberration and FTX executives as outliers. While it’s true that much of what’s been learned about FTX smacks of criminal behavior, it also reflects broader patterns in the industry itself, a point skeptics have made for years. The digital asset industry features volatile and speculative assets which have no real underlying value, the scams and patterns of predatory financial inclusion, the use of crypto platforms for money laundering and tax evasion, a reliance on offshore jurisdictions to evade oversight, regulation and taxes, and more. It’s an environment where bad behavior is arguably not only permitted but encouraged. The wrongdoing that led to FTX’s collapse is hardly a surprise.
Congress should prioritize protecting consumers, investors and financial stability over promises of innovation from a technology that has yet to deliver lasting, widespread, scalable use cases.
Washington has recently been flooded with breathless PR campaigns touting the nearly unlimited potential of digital assets and blockchain to not only transform finance, but the web itself and anything it might touch. The central claim? Since crypto is destined to be transformative, policies to regulate crypto must not hinder such potential. Applying the standard financial regulatory regime to crypto was at best, not necessary, and at worst, a mismatch based on a misunderstanding of the technology. Anyone who thought otherwise was ignorant.
Now, it’s clearer than ever that these claims were marketing strategies to advance light-touch regulatory approaches that would enable the crypto industry to exploit regulatory gaps, secure additional funding and go more mainstream.
No one, certainly not the crypto industry, has a crystal ball. At some point in the future, a technologist could solve some of what appear to be intrinsic limitations or flaws in blockchain technology. Or a crypto firm could demonstrate it’s capable of creating a business model that can compete against other financial products and services while meeting robust regulatory standards and not collapsing overnight. Robust regulatory standards can foster real innovation by pushing out bad business practices and improving standards.
Congress needs to take a sober look at this industry – not what it might be, or is hyped to be, but as it is now – and prioritize policy that protects consumers, investors and financial stability from the real and present threats from digital assets.
Congress should bolster regulators’ existing authority and capacity to oversee the digital assets industry. Any legislative proposals must, at a bare minimum, not weaken that authority.
The digital asset industry is re-learning the last hundred years of lessons learned from financial crises and regulatory responses in the course of a decade or so. Though there is still more to understand about the FTX collapse and the subsequent digital asset market contraction, some lessons are clear: basic investor protections that exist in traditional finance can help prevent, mitigate, or remedy harms like those we’ve observed in the digital asset marketplace.
These standards are meant to apply to a wide range of financial products and services, regardless of the technology used to provide them or the way in which they are marketed and sold and apply as much to activities and actors as they do the assets themselves. Regulators must apply them and have the resources to do so well. Indeed, there’s a case to be made that, despite political pressure and the limitations of jurisdiction, a number of federal regulators were able to use such powers to prevent the FTX collapse from spreading further, in part by distancing a risky industry from the more traditional banking and finance sector.
Unfortunately, some in Congress, egged on by voices in the crypto industry, are now trying to blame the same regulators they spent months or years criticizing for being too heavy handed with digital asset firms.
It is worse than disingenuous for industry and Congressional critics who spent months attacking regulators for overreach to turn around and lambast them for doing too little. While the FTX implosion is big by crypto standards, the scope of federal regulators’ jurisdiction goes well beyond the crypto markets to encompass tens of trillions of dollars of assets and financial activity. In those spaces, regulators are facing well-funded industry efforts to derail regulations to protect investors and consumers and defund agencies altogether. It would be the worst of all topsy-turvy worlds to let big finance and big tech and their friends on the hill use FTX’s misdeeds as fuel for undermining needed regulatory authority across the board.
If Congress wants regulators to do more to fight crypto abuses, they should provide regulators emergency funding to bolster their capacity at this critical moment in time, and make sure they have adequate resources to do their jobs long-term. Previous legislative proposals offered during this Congressional session to create or clarify regulatory standards for digital assets have largely advanced approaches that would have created more permissive, less rigorous oversight and accountability standards for digital assets, actors and activities, and would have threatened to undermine existing regulatory authority for federal regulators and regulatory standards for traditional finance as well.
The urge to pass something and fix it later often emerges in crises like these, out of urgency or expediency. Sometimes, incrementalism can be the best option. More often, however, policymakers (with industry voices just offstage) too often squander the political capital such crises generate to advance lasting solutions to these problems, and instead either fail to solve the problems or create conditions for the next crisis. Reform efforts to correct these flaws then face years-long uphill battles.
Members of Congress, bearing in mind what this moment truly means and not what the industry wishes it does, should be focused on getting the policy right, as opposed to just getting it done. But that can only happen if Members see the FTX collapse for what it is: not a blip but the inevitable outcome of a speculative bubble built more on hype than on tangible value.