As Sam Bankman-Fried fences with prosecutors, and profiles of him are produced nearly weekly, it has become easy to vilify him. The previously canonized “king of crypto” has met reality in the harshest of ways. And so have his investors and crypto customers.
But to some extent we should be thanking him. Because of Bankman-Fried and his now-bankrupt company, FTX, the crypto balloon crashed to earth before the industry could become so large or integrated into the traditional financial services business that contagion from its collapse could cause the economy to implode.
No matter the explanations or excuses now offered for it, this crypto winter should have been seen coming a mile away. Sophisticated money experts may take refuge in the fact that FTX is likely just another story about corporate fraud and mismanagement, and crypto is not the villain.
Having dealt with the failures and been involved in the investigations of many of the largest financial collapses in American history, I thought a story like FTX’s was inevitable. But too many people suspended their financial judgment and replaced it with the economic euphoria of the moment, despite some notable tells.
First, hype can never outrun reality. When vast amounts of money chase an asset that becomes over-valued and hyped beyond what the fundamentals suggest, expect a crash. Flares should have initially gone up because in just 13 years, more than $10 trillion flowed into an industry built on financial hope — there simply was no there, there.
Its size equaled the amount of mortgage debt outstanding in America, but with no underlying value to anchor it such as the homes that ultimately collateralized even the worst mortgage-backed securities in 2008.
Second, anyone who uses other people’s money to make money must be watched. We have learned that lesson the hard way over the last two centuries, and that is why there is financial regulation.
But our regulatory system has become structurally myopic as markets have changed and it hasn’t. All aspects of what a bank does – particularly its capital and liquidity – are closely monitored. But none of those requirements apply to nonbanks such as cryptocurrency companies.
That leaves 100 percent of our oversight resources focused on banks that are already highly regulated, while high-risk endeavors like crypto gravitate to sectors of the economy that are largely unregulated. And yet, no new laws were enacted in the last 13 years to protect consumers or the economy as crypto expanded. Perhaps Congress was concerned about stifling innovation, maybe it was mesmerized by the vast sums of crypto profits flowing into politics or maybe it just didn’t understand what was happening. Whatever combination of excuses are packaged for public consumption, it should have acted when so much financial risk was being piled up outside the boundaries of any oversight.
Third, people who safeguard our money must be honest and have strong financial skills. Financial history is littered with the bones of hucksters who have stolen, pyramided and used insider advantages to cheat their way to transferring our money into their pockets.
It is for that reason that financial institutions and their executives are subject to a blizzard of rules and regulations. Someone wishing to own just 10 percent of a community bank must submit to a grueling regulatory examination of their integrity and experience. But a convicted felon can potentially start a cryptocurrency business today, no questions asked.
Finally, the more leverage plays a role in the mania that occurs, the more likely that when the music stops, there will not be enough chairs for everyone looking for financial refuge. After 13 years of unregulated crypto mania, the amount of leverage that had insinuated itself into crypto purchasing, investing, trading and the creation and marketing of crypto derivatives, and the vast sums of intra-crypto-company lending was guaranteed to be a problem given the absence of anything other than consumer confidence. FTX’s bankruptcy will prove that point.
Given these warning signs, crypto holders and investors should not now be surprised by what has happened at FTX. If there was fraud, it should have been expected. Tens of billions of dollars were put in the hands of people whose characters had endured little if any scrutiny and, as we are learning, allegedly had very little organizational, governance or record-keeping skills. That is a hallmark of every financial crisis in history, and, yet, somehow we missed it — again. So, hats off to Bankman-Fried for forcing us to pay attention and saving the economy.
Thomas P. Vartanian is a former bank regulator who represented parties in 30 of the 50 largest financial failures in American history. He is now executive director of the Financial Technology & Cybersecurity Center and author of “The Unhackable Internet: How Rebuilding Cyberspace Can Create Real Security and Prevent Financial Collapse” (Prometheus Books).