Progressive Regulators Are Salivating over the Sam Bankman-Fried Scandal

T here is a significant political dimension to the federal legal actions taken this week by the Justice Department, the Securities and Exchange Commission, and the Commodity Futures Trading Commission against alleged mega-swindler Sam Bankman-Fried, founder of the now-imploded FTX cryptocurrency exchange. We need to keep our eye on the ball.

Like Democrats everywhere, Biden administration officials see crypto as the “Wild West” of finance, as the SEC’s aggressive honcho Gary Gensler has limned it. There isn’t enough government oversight, they say. For progressives, the rule of the road is “If you see something, regulate something.”

Naturally, then, they are hot to get their nanny-state tentacles around crypto. To do so legally, though, is not so straightforward — not that such an inconvenience has stopped progressives from trying before. The statutory architecture for policing securities is nearly 90 years old, and there remains controversy over whether comparatively novel cryptocurrencies constitute securities under its coverage, as Gensler insists they do.

The Commodity Exchange Act is New Deal–era legislation, in which Congress sought to regulate more complex financial arrangements (e.g., futures and options). Although the CTFC was not created until 1974, that’s still 35 years before Bitcoin, the first cryptocurrency of note, appeared on the scene. In “because we say so” style, the CFTC maintains that cryptocurrencies are regulable as commodities. Yet the law is sufficiently unclear that the Senate has been considering bipartisan legislation, the Digital Commodities Consumer Protection Act, co-sponsored by senators Debbie Stabenow (D., Mich.) and John Boozman (R., Ark.), that, if enacted, would bring two major cryptocurrencies, Bitcoin and Ether, under the ambit of CFTC oversight.

Ergo, for all their bluster, prosecutors and administrative agencies know they are not on the surest of legal footing as they contradictorily urge both that crypto is already under their thumb and that urgent action is required to put it under their thumb. Historically, this is not unusual: Much of today’s securities law is a result of regulations that push the limits of the SEC’s statutory authority, which prosecutors, mainly in the Southern District of New York (with Wall Street in the backyard), proceed to press further still by their creative prosecution theories.

Of course, where the administrative state sees regulatory gaps as opportunities for mischief and, therefore, bureaucratic scrutiny, many Americans see, instead, havens of liberty and innovation that Washington should leave alone. Progressive “reforms” often make matters worse.

With this as the state of play, you can see why progressives eye crypto so warily. It is not just that the novel digital currencies evade the full run of extensive disclosure-and-monitoring protocols that the feds impose on American financial markets in equities and debt. It is that crypto’s raison d’être is to shield monetary instruments and their exchange from the control and oversight of governments.

The crypto sector employs blockchain technology to issue digital currency (represented by “tokens”), believing it will ultimately prove more creditworthy than fiat currencies, such as the U.S. dollar, the world’s reserve currency. Untethered to any external standard of value, fiat currencies are seen as arbitrary, subject to the reckless fiscal policies of governments and the whims of central bankers (e.g., you’d need close to $7 today to buy what $1 bought a half century ago). Crypto, meanwhile, does not merely elude government regulation, it defies it.

This is worth keeping in mind as we watch the FTX scandal unfold. There are deep divisions in Congress regarding crypto. There are understandable public suspicions about the prospect of more financial regulation by a government that cannot regulate itself: surging past $30 trillion in debt, spending way beyond its means despite record-high tax revenues, and now attempting to corral the worst bout of inflation in 40 years that is caused, at least in part, by these irresponsible policies coupled with Fed mismanagement. (For a comprehensive explanation of our straits, you can’t do better than David Bahnsen.)

Under these circumstances, it is highly unlikely that Democrats could get a “Sarbanes–Oxley for crypto” bill enacted by a divided Congress. The Biden administration is thus doing what it does in various policy matters: relying on legal-enforcement action by the Justice Department and administrative agencies — here, the SEC and CFTC — to fill what it regards as the regulatory void. In the meantime, the administration and Democrats have been biding their time, waiting for some financial catastrophe that can be stoked into a groundswell of support for thoroughgoing crypto regulation.

In Bankman-Fried’s alleged FTX scam, they obviously perceive such an opportunity — a multibillion-dollar implosion, easily portrayed as one of those crises that should never be permitted to go to waste.

But here’s the thing: The schemes described in the Justice Department’s indictment and the SEC’s civil complaint against Sam Bankman-Fried reflect run-of-the-mill fraud — “old-fashioned embezzlement,” was the apt description offered by John Ray III, the new CEO brought in to clean up the FTX mess. Sure, the dollar amounts are prodigious, but it’s not like we’ve never seen even bigger numbers before — remember Enron, WorldCom, Bernie Madoff, and so on.

The FTX scandal arises out of the crypto sector, but it does not stem from the opaque nature of cryptocurrency. If what the government is alleging proves true, then you hardly need a Ph.D. in blockchain to grasp it: SBF tricked investors into trusting him with their funds, and then diverted them to his own use through his hedge fund, Alameda. To carry off the scheme, he used a series of internal accounting tricks to conceal what he was doing and how deeply in hock Alameda was to FTX customer funds. Finally, the clock struck midnight, as it inevitably does with Ponzi-type schemes. People grew suspicious, demanded their money back, and Bankman-Fried couldn’t pay them.

Crypto happened to be the context, but a scheme such as this could have arisen in any asset class. Investors could instead have been gulled into parting with their dollars, stock, fine art: You name it. Consequently, the FTX scandal should not be a clarion call for a suffocating degree of cryptocurrency regulation.

Fundamentally, FTX in many ways represents the antithesis of crypto. The business was a cryptocurrency exchange, which is to say: a middleman, brokering transactions between prospective customers and lenders, buyers and sellers. Yet a major feature of crypto is the absence of a middleman. Thanks to blockchain, willing parties can transact in confidence without intermediaries to vouch or facilitate. By contrast, to use the FTX exchange, customers surrendered custody of their digital assets: That’s what gave SBF the opportunity to steal them, as he is alleged to have done. To the contrary, the guideline for crypto aficionados is: Not your keys, not your coins. Parties to a transaction should not have to deposit with an intermediary the computer code that constitutes keys to their assets: The blockchain provides security.

Note that within just four weeks of the FTX collapse, the Justice Department, the SEC, and the CFTC have been able to bring daunting charges and civil claims that are more than adequate to ensure that SBF is aggressively prosecuted and, if found guilty, sentenced to a lengthy prison term in addition to punishing fines and forfeiture provisions. This strongly suggests that existing law is sufficient to address the kind of mainstream fraud that SBF is alleged to have committed. In fact, reports indicate that he was heedless of ordinary business compliance and bookkeeping protocols. Ignorance and recklessness are not issues unique to crypto. They are what you expect in standard financial-fraud cases.

There are good reasons for Congress to examine crypto, but it ought to do so in a deliberate, careful manner. What we have with FTX is a financial scandal, like those that have occurred before and will inevitably occur again. What we don’t have is a crisis requiring rash action that could do more harm than good, no matter how well-intentioned our progressive regulators may be.