Editor’s Note: Howard Fischer is a lawyer practicing in New York and former senior trial counsel with the Securities and Exchange Commission. The opinions expressed in this commentary are his own. Read more opinion at CNN.
For some of those skeptical of the cryptocurrency world, it’s hard not to characterize the guilty verdict against Sam Bankman-Fried, co-founder of crypto exchange FTX, as a kind of morality play against the world of digital assets.
The trial certainly had all the hallmarks of high theater: a precipitous collapse of a major player in the cryptocurrency market, billions of dollars in losses and a high-flyer brought down not only by his own hubris, but also by the testimony of his accomplices and former colleagues (including an executive with whom he once had a romantic relationship).
But we should avoid the temptation to script an even larger drama from the trial that has played out in New York federal court these past few weeks. The guilty verdict is not an indictment of the digital asset economy in its entirety, or a harbinger of its eventual failure. After all, such business implosions and criminal consequences have long afflicted more traditional financial and corporate sectors as well, and the collapse of companies like Enron or Bernard L. Madoff Investment Securities has not been the end of the industries in which those entities operated.
Instead, the verdict is, in addition to what it means for Bankman-Fried, a denunciation of the current state of play in regulation and the failure of US legislators or regulators to develop a national standard for cryptocurrency businesses. While criminal misconduct was obviously a key driver in FTX’s downfall, that collapse was also facilitated by the lack of transparency into its operations that permitted bad actors like Bankman-Fried to treat customer assets like a private piggy bank.
This verdict represents a clarion call for greater certainty in the form of regulation. Instead of a comprehensive regulatory scheme, we have a series of enforcement actions by the Securities and Exchange Commission (SEC) trying to squeeze cryptocurrencies into the standard regulatory box, regardless of how uncomfortable that fit might be. As a result of treating almost all crypto transactions as subject to the securities laws, the SEC is placing enormous hurdles in front of cryptocurrency enterprises and users, even if digital assets do not share all of the attributes of traditional securities. Right now, the actions of governmental agencies are creating significant uncertainty as to whether and how cryptocurrency entities can operate in the US.
Regardless of what one thinks about the advisability of investing in digital assets, the government should not be in the business of picking winners or fostering instability. What it should be doing instead is establishing the rules of the road, both to promote stability, and to protect investors.
It is not hard to conceive of a regulatory framework that would have constrained Bankman-Fried from vaporizing billions of dollars’ worth of investments. These rules could include, perhaps, requirements that crypto entities pick a lane, so to speak, and decide whether they are going to offer tokens, serve as an exchange or a clearing agency, invest in digital assets on behalf of customers, or operate as a broker-dealer. They could also include mandated audits by reputable firms of assets and reserves, risk management metrics and capital at risk. They should involve transparency into operations and how customer assets are treated, and require separation of firm assets and customer assets.
In large part, Bankman-Fried was felled not necessarily because he engaged in an inherently risky enterprise (although that did play a role), but because of his own dishonest choices. There is nothing inherent about the digital asset world that required Bankman-Fried to create a secret back door into FTX for a supposedly independent hedge fund, Alameda Research (as trial witnesses testified), or, as the jury found, to take outsized gambles with other people’s assets, or to lie about FTX’s risk management to investors and to customers. Regulation (and enforcement to ensure that regulations are followed) can never entirely eliminate risk, but it can limit it. While regulation cannot and should not protect customers from their own informed choices, it should protect investors and customers from having their assets be the subject of the outsized gambles of others.
Bankman-Fried’s appetite for risk was demonstrated by his deciding to take the stand in his own defense and expose himself to a broadside from the prosecution, a bold gamble few criminal defendants take. As with other times in his life, he demonstrated his willingness to take an outsized risk with a substantial downside. Only this time he was not gambling with investor funds or customer assets, but his own freedom. It was his last desperate roll of the dice — and it came up snake eyes.
Government regulators and Congress should work together to create a framework that protects investors, promotes transparency into cryptocurrency operations, and ensures that gatekeepers like auditors monitor and validate the representations of digital asset entities. Only in this way can we ensure that in the future, customer assets are protected from the self-interested misconduct of the entity, and cryptocurrency entities are only playing with their own stakes — and not that of their customers.
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