A jury didn’t have much trouble this month convicting cryptocurrency wunderkind Sam Bankman-Fried. Some say the conviction proved that the industry has always been little more than a combination of sham and scam. Others say his brand of criminality is just as common in traditional markets as in newfangled ones. We say, why not both?
Crypto can seem complicated, but what SBF, as Mr. Bankman-Fried is known, did was simple. He took the money customers deposited on the FTX exchange, where they bought cryptocurrencies such as bitcoin in the hope their value would rise, and gave it to a trading firm that he also owned. The firm, Alameda Research, funneled those funds into bets — on existing crypto tokens as well as on illiquid assets that were affiliated with FTX and SBF (“Samcoins,” some called them). Oh, and some of the money went toward bankrolling political campaigns, buying Bahamas real estate for the FTX inner circle and boosting the company’s profile through celebrity endorsements.
So is this an indictment of crypto or a testament to the ease with which fraudsters navigate the world of finance? Yes and yes.
What happened to FTX occurs in traditional markets. Sometimes, leveraged institutions make bad bets; those bad bets, combined with poor risk management, can result in a run on deposits or mass sell-offs of stock that the institution can’t afford. This can happen even when companies aren’t acting illegally. When they are acting illegally, by failing to meet reserve requirements, or self-dealing, or running pyramid schemes, calamity is all the more likely.
FTX was self-dealing, and it failed to maintain sufficient cash reserves to cover its deposits. Crypto might seem beside the point: The firm broke the law, and it did not matter that the assets in which it self-dealt were cryptocurrency coins. That view isn’t wrong, exactly. But FTX’s identity as a crypto company does matter. The nature of the industry helped bring about its downfall.
FTX didn’t have many rules to follow when it came to liquidity, conflicts of interest or much of anything else. And it didn’t have a designated regulator tasked with looking over its shoulder. Committing crimes is a lot easier with no oversight.
There’s more. FTX couldn’t pay customers back because Alameda couldn’t pay FTX back, and Alameda couldn’t pay FTX back because its funds were tied up in those so-called Samcoins. Sure, this kind of market manipulation isn’t a new concept. Yet the tens of billions of dollars of these coins were worth, according to Alameda’s assets sheet, suddenly transformed into zero dollars for a reason: The tokens had no real value to start with.
Usually, a financial asset is tied to something in the physical world. You decide what a toaster manufacturer’s stock is worth based on its perceived ability to produce and sell toasters. You decide what a crypto token with a Shiba Inu’s face on it or an image of a cartoon ape is worth based on, well, what you figure everyone else thinks it is worth. FTX reportedly paid Tom Brady $55 million for appearing in a Super Bowl ad promoting crypto’s world-changing potential. No wonder: Faith in crypto was literally priceless.
Cryptocurrency’s value depends on people believing in cryptocurrency value. When they believe, the number goes up. When they stop, it plummets.
Crypto is a near-useless commodity that not only enables people to gamble their savings but also helps criminals launder money and evade detection. Even in its best-case scenarios, crypto serves no glaring need. Bitcoin has become a store of value to the point that many refer to it as digital gold; that means it might help people living in countries whose sovereign currency is so devalued or so volatile as to be irrelevant. But its stability depends on belief in its intrinsic value among those holding it. Meanwhile, stablecoins — crypto tokens tied to more traditional currencies — aren’t actually stable. For those that are, a digital dollar would serve the same purpose, with more protections.
Advocates treat crypto’s lack of a trusted intermediary as a virtue. The answer to the lack of oversight that allowed SBF to defraud so many people of so much money, unnoticed, would appear to be to put cops on the beat and laws on the books — finding an analogue in the traditional financial system for every crypto entity, and imposing matching oversight. But subject these entities to the same requirements as their fuddy-duddy off-blockchain counterparts, and you’ve also gutted much of their raison d’être. That’s all the more reason to do it.