Does ‘Ruin Get Crypto Right? Yes, Mostly (until the end)
Bloomberg has released, ‘Ruin,’ a documentary about the rise and fall of Sam Bankman-Fried and the bankrupt FTX crypto exchange. The former wunderkind “Crypto Fro” is on trial in New York for the stealing customer funds and using them to among other things, political campaigns and paying off pay sister company Alameda Research debts.
The program narrated mostly by Bloomberg reporters mixed in with sundry crypto players covers Bankman Fried’s rise from the privileged sire of Stanford law professors to Jane Street quant to crypto entrepreneur to the stars. Bankman-Fried’s carefully cultivated image as a devil-may-care do-gooder who played by his own rules, eschewed the trappings of wealth, and did everything for the greater good is aptly covered.
The documentary, though annoyingly overproduced, deftly reveals the disconnect between white hat image including his oft-highlighted Toyota Corolla and the reality of his multi-million Bahamas condo and private jet. In the process it exposes the ridiculousness of his “Effective Altruism” world view. For the blissfully unaware, Effective Altruism provides moral cover for people in tech to get rich as possible whilst ignoring rules and proper risk assessment for the distant promise to give away their wealth and save humanity. It’s a kissing cousin to ESG, the moral cudgel CEOs use to proclaim they shouldn’t be judged on shareholder performance because audiences laud them at international conferences for “saving the planet.”
Bankman-Fried and his merry band of altruists never gave away anything. They did, however, spend big on celebrity and political endorsements, and apparently tried to sway capital-markets nonprofits to increase exposure and sway regulators toward them and away from competitors. FTX collapsed before the latter goal came to fruition. (Bankman-Fried’s meetings with SEC Chair and fellow MIT-er Gary Gensler go unmentioned. They also have no criticism for FTX promoter Kevin O’Leary, “Mr. Wonderful” who assured the public based on his own due diligence that FTX was solid. CNBC was less deferential to Mr. O’Leary.)
‘Ruin’ gets crypto policy prescriptions wrong
Where the doc fails is with the attitude of Bloomberg itself towards crypto. Despite securing the Twitter handle @crypto, Bloomberg has consistently been anti-crypto. This makes sense given their position as an institutional organ for TradFi. A constant theme throughout the doc is crypto’s lack of regulation that makes it unsafe, dangerous. It’s inferred proper government policing could have saved this debacle.
This familiar view of finance is expected from Bloomberg even if it’s baseless. Regulations did not stop Bernie Madoff or any other scammer. Anyone thinking regulations stop fraud should visit the SEC’s website any random day and note how many of their most recent press releases involve enforcement actions against an alleged fraudster.
The beauty of crypto if it’s allowed flourish is that it can take away the element of human greed and the temptations that come from having access to boatloads of other people’s money. Indeed, DeFi can take out human management completely. Transactions can happen peer-to-peer based on permissionless, open-source code. The code, as the saying goes, is the law.
Crypto done right challenges TradFi
This is the real promise of crypto that Bloomberg doesn’t understand or care to learn. It’s not having the SEC approve a Bitcoin-ETF or BlackRock investing in a crypto fund. It’s eliminating the need for traditional finance altogether. Of course, this comes laden with its own issues, namely lurking hackers. But AI-based code auditing and insurance markets could alleviate much of that risk.
The best possible future is not to integrate crypto into the existing corrupt system run by human-beings with all their flaws and fallibility to temptation and moat building. It’s for people to be able to remove themselves from that system completely if they wish. But that would ‘Ruin’ Bloomberg’s TradFi worldview.
“In 2020, the criminal share of all cryptocurrency activity [was] just 0.34%, or $10.0 billion in transaction volume.” This finding by crypto intelligence firm Chainalysis may surprise the casual reader accustomed to dire crypto warnings from government apparatchiks and blaring headlines about crypto scams and ransomware. Yet in this supposed age of “disinformation” it fits that the opposite is true. Far from providing a pathway for clandestine transfers outside government’s view, the bigger crypto concern is its inherent transparency may need more privacy protections.
Many believe crypto only serves illegal ends
The ‘bad-things-happen-on-blockchains’ meme has lots of boosters. Anti-crypto Congressman Brad Sherman (D-CA) stated at recent hearing “Cryptocurrencies, if they succeed, will have appeal to only two groups, narco-terrorists and tax evaders.” The Treasury Department has issued similar complaints.
Ezra Klein, an opinion columnist at the New York Times, is the latest standard bearer. In a crypto deep dive following the infrastructure bill’s tax fight—described here by CEI Senior Fellow John Berlau—Klein stated: “[C]rypto currencies [are] a favored medium for money laundering, illegal purchases and ransomware. To be fair, criminals are often early adopters of new technologies, so crypto’s association with crime is likely to abate as the technology matures.”
Klein points in the right direction but his compass is off a few years. Criminals were early adopters of crypto but crime has abated and now forms a miniscule part of total activity. Criminals shunt what remains into so-called Anonymity-Enhanced Cryptocurrencies (AECs), the best known being Monero.
Crypto does not need government snoopers
In 2013, the Feds shut down Silk Road, a so-called “darknet market,” seizing 26,000 Bitcoins in the process. AlphaBay took its place but tanked in 2017. Since then, only a massive China-based Ponzi scheme called Plus Token caused an uptick. (Chinese authorities arrested six culprits.). But overall, illegal activity occurring via blockchain has drastically shrunk since Silk Road’s demise.
The reason cyber criminals have abandoned non-AEC currencies is governments have become adept at tracking crypto across blockchains. For example, the Justice Department recovered most of the Bitcoin ransom paid by Colonial Pipeline in a well-publicized cyber-attack earlier this year. Indeed, as former Assistant Secretary of the Treasury for Terrorist Financing and Financial Crimes Daniel Glaser testified in a House hearing earlier this year, “cryptocurrencies provide enhanced opportunities in certain ways for law enforcement agencies to be able to trace transactions.”
Further, the government is intent on cracking Monero. The IRS awarded two firms contracts worth $1.25 million to break Monero’s privacy protocols. This is an eventuality Monero itself warns: “There is no such thing as 100% anonymous. Monero may . . . have bugs. Even if not, ways may exist to infer some information through Monero’s privacy layers, either now or later. Attacks only get better.”
None of this means ransomware isn’t a growing problem or that cyber hackers and scammers won’t continue to ply their trade. But in the bigger picture, it is privacy and not illegal activity that should concern Klein and others toting the crypto-is-crime handbag.
Crypto’s biggest problem is lack of privacy
Blockchains by their nature are transparent. Although parties usually conduct transactions through pseudonymous public keys, the trail is permanently recorded. As a speaker in a 2018 privacy-focused conference stated: “Peer-to-peer and blockchain technologies are by design very hostile to privacy. There needs to be a lot of work.” If industry leaders are not careful crypto could produce a global super surveillance state. This would not improve the current web’s data silos—vulnerable to hacks and data sales.
As crypto evolves users should insist on privacy protections coded into transactions. Industry players should cooperate with law enforcement to nab scammers and thieves. And those complaining about crypto’s illegal activity should change focus.
A version of this post originally appeared on the blog of the Competitive Enterprise Institute on August 19, 2021, https://cei.org/blog/no-crypto-is-not-a-criminal-haven/
Does crypto currency need new regulatory disclosure mandates from Washington in order to be of service to consumers? No, but that is what Securities and Exchange Commission Chair Gary Gensler is seeking. Gary Gensler’s crypto policy is insane.
As stated in a speech on August 3, Mr. Gensler indicated he wants to double down on the same tried-and-failed approach his predecessor used. From disclosure-heavy mandates to investor-protection obsession, everything Mr. Gensler proposes is a regulatory version of insanity – doing the same things but expecting different results.
Under the guise of technology neutrality, Mr. Gensler seeks to force the crypto industry to heel to the SEC. As he stated, “I think former SEC Chairman Jay Clayton said it well when he testified in 2018: ‘To the extent that digital assets like [initial coin offerings, or ICOs] are securities — and I believe every ICO I have seen is a security — we have jurisdiction, and our federal securities laws apply.’” Indeed, one would be hard pressed to find a crypto innovation over which he doesn’t want to exert control. Stablecoins? Check. Exchanges? Check. DeFi? Check.
That hasn’t gone well so far.
SEC botched crypto policy from the start
By any account, the Commission’s crypto policy has been a mess. Former Chair Clayton seemed perpetually perplexed by such new technologies, finally appointing a crypto ‘Czar,’—career bureaucrat Valerie Szczepanik—in 2018. A year later she and Corporation Finance Director William Hinman produced a widely panned 13-page crypto “framework.” The document was so impenetrable, SEC Commissioner Hester Peirce compared it to a highly abstract Jackson Pollock painting.
The other major Clayton-era guidance came from a 2018 speech where Mr. Hinman declared ether—the currency for the second biggest crypto blockchain—was not a security. Given Ethereum’s size, success, and potential, the crypto world cheered. But in the closely watched Ripple litigation, the Commission has now disavowed that finding.
Other than these two instances, SEC “guidance” has largely come not from official rulemaking but from punative subpoenas and court appearances.
Gary Gensler’s crypto policy is failing retail investors
But even if the Commission was less scattershot, it’s not clear forcing the nascent industry into a Depression-era disclosure regime would protect those retail investors Mr. Gensler has in mind.
A review of recent Commission press releases reveals multiple enforcement cases against alleged fraudsters that were already beholden to Commission mandates. Empirical studies have repeatedly shown the federal disclosure regime does more to employ myriad compliance professionals than stop scam artists.
It is also telling that the least regulated way issuers can raise capital—Regulation D 506(b) (Reg D), which mandates no disclosures—is also the most successful. In 2019 it raised $1.5 trillion and outpaced the public markets—an impossibility if investors feared widespread fraud.
It’s too bad that securities law paternalistically blocks most investors from Reg D opportunities. Only 13 percent of people qualify because financial and sophistication thresholds limit eligibility. And they tend to cluster in America’s elite zip codes. This means the best deals go to people who need them least. Retail investors are left mostly left with post-IPO scraps. As Professor Usha Rodrigues states “Securities law . . . in theory, as in practice, marginalizes the average investor without acknowledging that it does so, let alone justifying it.” Under Mr. Gensler’s crypto leadership, SEC marginalizing will continue and where opportunities for wealth creation are greatest (perhaps in all of history).
Gary Gensler should make his crypto policy less insane
Instead, Mr. Gensler should change course and approach crypto with a measure of humility and cooperation. This would include:
Ditch the 2019 Framework.
Acknowledge the Commission’s role in creating the uncertainty surrounding crypto’s security status.
Ask Congress to update the definition of security to clearly define what digital assets fall under the Commission’s ambit and which do not.
Drop all prosecutions against nonfraudulent crypto issuers and impose a moratorium against further prosecutions until Congress updates its definitions.
Direct all crypto prosecutions against alleged fraudsters.
SEC regulators should want to give honest innovators certainty and breathing space. A more circumspect approach would also put major crypto policy questions back to Congress to decide and allow everyday Americans to explore the ingenuity crypto has to offer. And it may make the SEC less ‘insane.’
“[I]t’s not that [cryptocurrencies] didn’t aspire to be a payment mechanism, it’s that they’ve completely failed to become one except for people who desire anonymity of course, for whatever reason.” So testified Federal Reserve chair Jerome Powell earlier this month. With some in Congress and the Biden Administration itching to regulate crypto, pointing out supposed operational flaws has become the rage. In one recent hearing senators called it a “phony populist” movement run by “shadowy super coders.” Politicians revel in snarky soundbites, but it’s worth examining if the reserved chair of the Federal Reserve is right. Has Bitcoin/crypto failed as a payment mechanism or more broadly as “money
A decade plus has passed since Satoshi Nakamoto unveiled Bitcoin amid the Great Recession’s orgy of bailouts and insider deals. Since then, crypto has exploded with enthusiasts the world over developing, writing, contributing to the phenomenon. A previously unimagined decentralized future is taking shape where individuals control their online lives and are compensated for their time, attention, and data on their own terms. If the government or current tech titans don’t stifle it, an amazing new web is on the horizon.
Satoshi Nakamoto Designed Bitcoin as Money
But Mr. Powell is correct Nakamoto designed Bitcoin as money. He stated so in his introductory email, “I’ve been working on a new electronic cash system that’s fully peer-to-peer, with no trusted third party.” And despite volatility, Bitcoin has achieved “electronic cash” status despite Mr. Powell’s contrary assertion.
Throughout history money has been a social construct. It has three characteristics: unit of account, store of value, and medium of exchange. Bitcoin has met all three criteria often despite fierce government resistance.
A year after Bitcoin went live, Florida resident Laszlo Hanyecz initiated Bitcoin’s first commercial transaction. He bargained 10,000 Bitcoin for two pizzas. Since then, Nakamoto’s electronic cash has exploded as a store of value and medium of exchange.
The obvious cases are via dissidents fighting murderous, authoritarian regimes. Name a global hotspot and oppressed people are using Bitcoin as a workaround for closed or failed financial regimes. Notables include Cuba, Venezuela, China, Russia, Iran, and Belarus. Peer-to-Peer marketplaces like Paxos and Local Bitcoins have aided this transition allowing conversion to local currencies and smoothing cross-border payments.
Governments resist Bitcoin as money because of their profligacy
Podcaster Nathaniel Whittemore noted this trend with Bitcoin Google searches rising 400% in the face of Turkey’s lira crashing:
One of the remarkable things about this moment isn’t that digital assets are going to save everyone from the follies of local currency regimes. But for the first time ever in the entire span of human history there is a convenient easy permissionless off ramp from those regimes for those people that have the technical know how to do it. The number of people who have that know how is an ever-expanding group. And that means that Bitcoin and digital assets add an X factor to every single currency crisis from here on out.
What about volatility? It turns out Bitcoin is more stable than many of the world’s currencies including economic powerhouses China and India. According to Crypto Briefing, “The Emerging Market Bond Index (EMBI), issued by financial institutions, tracks the performance for 25-40 countries considered emerging markets. The one-year volatility of EMBI is 31.8%, while it is 12.4% for Bitcoin.”
El Salvador has made Bitcoin legal tender
And El Salvador recently declared Bitcoin legal tender, completing the money trifecta. Hopefully this will spark a monetary revolution in Latin America. Africa too is becoming a Bitcoin hotspot with Nigeria leading the way.
Stateside some of the biggest corporations accept Bitcoin including Microsoft, AT&T, KFC, and the Miami Dolphins. Online behemoth Amazon is rumored to be in the process of accepting Bitcoin although they’ve officially denied it, whilst searching for a blockchain guru. Finally, one Bitcoin ATM startup crossed $50 million in revenue last year.
Bitcoin became money with striking speed. Governments can’t keep up with human ingenuity and the desire for people to be free and prosper. Hungry and oppressed people aren’t interested in millionaire-senator soundbites. They just know what works. And the global desire for Bitcoin is undeniable.
The Environmental, Social, Governance (ESG) movement is coming for Bitcoin and the entire crypto marketplace. This latest foray into corporate responsibility has captured public companies and shifted priorities away from shareholder value toward a set of amorphous standards that too often serve as mere proxies for progressive policy goals. If crypto falls to ESG pressure, that will crush much of its global benefit to individuals worldwide.
ESG promoters complain Bitcoin uses too much energy.. Wall Street and other ESGers see Bitcoin’s energy needs as wasteful and dirty. Bitcoin currently consumes energy equivalent to the Netherlands, whose residents account for .22 percent of global population, according to estimates.
So nonprofits and the trade press want to “solve” the crypto industry’s alleged “social” and “governance” issues by imposing top-down control via an ESG bureaucracy the way they do with public companies.
Leading crypto publication Coindesk recently explored Bitcoin angst in ‘How the Bitcoin Industry Is Responding to Wall Street’s ESG Concerns.’ The “Bitcoin industry” response has been to placate. Ark Financial and Jack Dorsey’s Square published a white paper with promises of “clean” Bitcoins through renewable energy. Elon Musk joined in. Others are pushing carbon neutrality, carbon credits, and so on.
Bitcoin founder Satoshi Nakamoto did not care about Wall Street
If he is still alive, it would be interesting to know what Bitcoin creator Satoshi Nakamoto would think. The opening sentence of Bitcoin’s white paper abstract discusses enabling people to circumvent financial institutions –. Bitcoin’s genesis block famously references bank bailouts, so it seems unlikely Nakamoto would have cared much for Wall Street’s concerns.
In fact, Nakamoto might have offered a vigorous defense of Bitcoin’s energy-intensive consensus mechanism (a set of rules that verifies new transaction blocks and maintains blockchain integrity) as a necessary design tradeoff because Bitcoin is decentralized. Instead of a central authority, many people and entities maintain the blockchain through various nodes in a trustless system. To preserve an accurate ledger history and link new transaction blocks, powerful computers compete to solve mathematical puzzles, a system called mining. The winning mining node receives newly minted Bitcoins, other nodes verify the winner, and then the process restarts. Bitcoin’s mining system enables its consensus mechanism called ‘Proof-of-Work.’ And it consumes lots of energy.
The consensus mechanism forces decentralization as dispersed nodes interact. The blockchain has no single point of attack, thus is essentially hack-proof. Computer scientists tried to make decentralized, hacker-resistant, unique internet money for decades. Nakamoto did it and spurred an emerging new internet known loosely as Web 3.0 that is changing the world.
Nakamoto consensus gives Bitcoin its power
The benefits of Nakamoto’s decentralized vision of people transacting outside centralized institutions are everywhere. Even the worst tyrannical regimes cannot stop Bitcoin transactions like they can cash or credit card transactions. As such, Bitcoin payments provide succor to dissidents fighting persecution from Hong Kong, Russia, Belarus, Nigeria, and Iran, among others. It provides a store of value in grossly mismanaged countries like Venezuela. More mundanely it facilitates cross-border payments, bypassing the current bureaucratic quagmire. Nakamoto would likely take the tradeoff of the inordinate energy consumption equivalent to .22 percent of the world’s population in exchange for the potential liberation of the 53 percent of people languishing under oppressive regimes.
Yet Bitcoin as “freedom money,” is only the start. The future web could decentralize more than just financial transactions. Open source, permissionless protocols could rework every human economic transaction. It could change the power imbalance between individuals and institutions (private sector or government). It could reverse the technological and political “stack” by enabling people to control their data and sell it on their own terms (or not at all) instead of allowing companies to monetize it (in exchange for free services). That won’t bode well for Big Tech.
Imagine a future in which everyone controls their online data and identity, shares it only with who they want, on their own terms. If you want someone’s time, attention, or access to their following, you negotiate and purchase it with cryptocurrency. Raging debates about online ‘cancel culture’ will subside with blockchain decentralization and permeance. In fact, everyone could carry their online digital lives and followings with them from app to app or blockchain to blockchain.
ESG attacks Bitcoin because it is dangerous to our tech overseers
The current internet titans and ESG promoters don’t seek crypto control. They have promoted a different consensus mechanism called ‘Proof-of-Stake’ as an alternative to Bitcoin’s energy-heavy ‘Proof-of-Work.’ Proof-of-Stake allows anyone to buy stake in a blockchain’s currency, validate transactions, and ultimately gain influence in governance decisions. Ethereum, the second biggest cryptocurrency, is currently switching from Proof-of-Work to Proof-of-Stake. By one estimate, 57 percent of cryptocurrencies now use Proof-of-Work and the number is shrinking.
Unfortunately, Proof-of-Stake centralizes governance , which potentially threatens Web 3.0’s best attributes. Centralization provides an opening for ESG advocates to produce a crypto bureaucracy that can control, indirectly, the crypto ecosystem in the way it does with public companies. For instance, concerns over energy consumption could morph into other prominent ESG concerns like lack of diversity, banning hate speech, censorship, and the control Silicon Valley companies have on social media platforms they built and run.
ESG advocates could also attack the exchanges where crypto is sold by seeking bans on ESG noncompliant tokens. Some exchanges are already public companies subject to ESG pressure. And new Securities and Exchange Commission chair Gary Gensler is anxious to regulate all exchanges.
Time will tell how successful these endeavors will be. Perhaps technology advances will outpace would-be overseers. But it is naïve to suppose these governmental and cultural interests will stand down and let individuals roam free.
The promise of Bitcoin and indeed all of Web 3.0 as a user-driven, individual-centered world is still in beta-mode. Just know that despite rhetoric about the public interest or not “leaving people behind,’ the people seeking control have their own self-interest in mind.
A new form of consumer finance could upend the entire banking and finance system that’s plagued by expensive fees, limited “bankers hours,” public mistrust, bailouts and insider government favors.
But Congress and the U.S. Securities and Exchange Commission (SEC) may kill the movement – decentralized finance, or DeFi – in the name of our own protection. Regulators should prosecute fraud, but also acknowledge the limits of their effectiveness and allow DeFi to mature without the burden of governmental compliance.
People are on the verge of cutting out the middleman in finance. Just as Bitcoin decentralized money transfers, DeFi could decentralize all of finance, from lending, borrowing and exchanging to more exotic forms of interest collection.
DeFi applications are not banks, they shouldn’t be regulated like them
DeFi eschews heavily regulated, fee-collecting intermediaries to allow peer-to-peer money flows. In just three years, it has grown from an idea on Meetup to a $50 billion industry. Yet DeFi’s astounding growth has also attracted opportunists looking to fleece naïve newcomers. Hackers and rug pullers – developers creating new products and then absconding with the loot – have plagued the growing industry. According to one source, fraudsters stole $83.4 million between January and April this year.
Sen. Elizabeth Warren (D.-Mass.) fired off a letter asking SEC Chairman Gary Gensler what more Congress could do to empower the commission to rein in DeFi. Mr. Gensler needs no persuading. He has repeatedly made requests for additional authority to bring non-security cryptocurrencies under the SEC’s ambit. Dan Berkovitz, a commissioner at the SEC’s sister agency, the Commodities Futures Trading Commission (CFTC), recently agreed. While praising financial intermediaries, he described DeFi as a “bad idea, and “Hobbesian,” and questioned its legality.
The message from the Biden administration and its appointees is clear: Without us, scams will proliferate and retail investors will get hosed.
DeFi regulation is favored by all the wrong people
Bringing a nascent industry under the government’s thumb does have benefits for politicians and regulators. It provides politicians steady campaign contributions and lobbying perks. Regulators get employment, prestige and often lucrative post-public service landing spots. Industry incumbents use the rules to keep barriers to entry high.
But big government hasn’t been great at preventing fraud. Since the federal government started regulating the financial sector in earnest in the 1930s, the government’s track record has been downright dismal. A landmark study by future Nobel laureate George Stigler showed the rates of return in the 1950s mirrored those of the pre-SEC 1920s, dispelling the myth that 1920s Wall Street was rife with fraud and abuse.
Decades later, two scholars lamented, “[Ex]amination of the securities violations…reveals that no amount of technical exemption requirements will hinder the fraud artists from their endeavors…Fraudulent and deceptive schemes have unfortunately continued unabated and independent of formal registration or exemption requirements.”
Even Congress’s own research arm, the Congressional Research Service, is skeptical the SEC framework can remedy market manipulation.
Prosecutors should focus on fraud not DeFi regulation
Regulators should focus on prosecuting fraud and allow the industry to grow past its infancy without smothering it first with massive federal disclosure mandates. Many scams and rug pulls had glaring red flags, like anonymous developers and promises of outlandish returns like 10,000 percent interest. The market will weed these scammers out.
As the industry matures, industry gatekeepers will develop standards that imbue credibility. These standard setters will include trade associations, code auditors, insurance markets and standards bodies that provide reputation scores to counter the proliferation of bad actors.
Regulators should prosecute scams harshly. Federal courts have buttressed CFTC jurisdiction to prosecute crypto fraud. Politicians will score points and regulators will avoid blame by taking the path that gives them the most power and control. But some humility on the limits of their effectiveness would be welcome.
Previous attempts to rein in finance’s bad actors fell flat. The notorious Dodd Frank financial regulation law passed after the 2008 financial crisis has utterly failed. The push to regulate DeFi will, as well. At best, it will send DeFi underground.
Regulators should allow DeFi to flourish as it upends the decades-old order and renders entrenched industry players irrelevant. Suffocating DeFi in the name of investor protection will kill its promise and continue the entrenchment of massive industry insiders as overlords of the U.S. financial system.
