Don’t let FTX’s fall discredit blockchain

Congress’s frustration with the cryptocurrency industry was on full display last week when the House Financial Services Committee held a hearing to investigate the collapse of FTX. Lawmakers on both sides of the aisle are fed up with fraud and malfeasance among crypto companies, making it all but certain that Congress will take action to regulate the industry next year. 

But in the haste to call FTX founder Sam Bankman-Fried to account, Congress should take care to craft legislation that distinguishes bad actors and scams from the promise of continued innovation in blockchain technologies. 

Once an industry darling, Bankman-Fried is now being charged with defrauding millions of investors out of billions of dollars. Last month, information came to light indicating that FTX and Alameda Capital—a venture capital firm also founded by Bankman-Fried—were commingling customer funds, leading to a run on the exchange and eventual bankruptcy. In the aftermath of the collapse, court filings and other watchdogs claim that he misappropriated customers’ deposits to make investments, including the purchase of real estate and options trading. Only a fraction of FTX’s assets have been secured by its new management, and millions of creditors are likely to experience a total loss.   

Lawmakers are understandably incensed and demand answers about Sam Bankman-Fried, who is now the poster child for hubris and fraud within the crypto industry. Rep. Maxine Waters (D-Calif.) was one of the first to act, calling for Bankman-Fried to testify before the House Financial Services Committee, which she chairs. Bankman-Fried agreed to testify until he was arrested by Bahamian authorities at the request of federal law enforcement.

Fortunately, Bankman-Fried is not the only individual capable of giving Congress insight into the collapse. FTX’s new CEO, John J. Ray III, did appear before the committee and his testimony was as eye-opening as it was damning.

After over 40 years of experience in corporate restructuring, including management of the Enron bankruptcy, Ray has seen his fair share of corporate malfeasance. “But never in my career have I seen such an utter failure of corporate controls at every level of an organization,” he told the committee.

Many members of the committee used this opportunity to criticize the crypto industry and blockchain technologies as a whole. Rep. Jesús Garcia (D-Ill.) opined: “FTX isn’t an anomaly; its collapse isn’t the case of one corrupt guy stealing money. It’s about an entire industry that refuses to comply with existing regulation, that thinks it’s above the law.” Rep. Juan Vargas (D-Calif.) went further: “I really don’t get the point of blockchain and cryptocurrencies … other than if you’re a terrorist or someone who wants to hide money.”

Reports that the Department of Justice is also weighing the possibility of filing charges against Binance—another major crypto exchange—and its CEO, Changpeng Zhao, for money laundering and criminal sanctions violations only exacerbate the industry’s image on Capitol Hill.

With numerous pieces of legislation already circling the halls of Congress, the FTX collapse and possible fall of Binance makes it more likely that lawmakers will take action to regulate cryptocurrencies and other blockchain-based technologies next year. Unfortunately, the understandable outrage at FTX also increases the likelihood that Congress will miss the forest for the trees.

The collapse of FTX was clearly caused by corporate malfeasance, hardly a crime unique to crypto. It is appropriate that Ray is managing the restructuring of FTX since its collapse has been compared to that of Enron. The difference here is that, in Ray’s own words, the Enron fraud was “highly orchestrated financial machinations by highly sophisticated people,” while the FTX fraud was “old-fashioned embezzlement” and “not sophisticated at all.” 

Corporate malfeasance of this type can and should be handled through targeted regulation. Establishing new transparency requirements for centralized exchanges and clarifying enforcement authority over cryptocurrencies and stablecoins would go a long way toward preventing the next FTX. However, Congress must also distinguish bad actors and scams within the crypto industry from the underlying technology.

Both the White House and Congress have independently recognized that blockchain technologies have enormous potential for positive innovation. Ironically, the transparency of public ledgers makes it easier for Ray and his team to track many of Bankman-Fried’s activities. In the hearing, several members praised blockchain-based technologies for their ability to increase the efficiency of transactions, ease legitimate cross-border payments, and establish novel organizational governance structures, among other things.

There have already been cases of poorly drafted provisions creating more confusion than clarity for the many stakeholders who build, operate, and facilitate the use of blockchain technologies. Any new legislation should clearly define which sectors of the crypto industry are being regulated and avoid sweeping generalizations. Now, as lawmakers move toward regulating crypto, they should avoid unnecessarily obstructing the innovation that so many of them appear to recognize.

Luke Hogg is policy manager at Lincoln Network.