FROM: Lee ReinersTO: Bob, Shane
One can only hope that it is the end and we all move on to more productive things. Imagine how much better the world would be if all the money and human capital that has flooded into cryptocurrency over the past decade had instead gone into addressing climate change or curing cancer? But the allure of quick and easy riches is hard to resist for many people.
As much as I wish it were so, I do not believe this is the “end” of crypto. The sector is continuously reinventing itself or, less charitably, spinning new b/s to justify its existence. In the wake of the FTX collapse, you’ve already seen new narrative lines emerge. One of the most prominent is: “FTX represents a failure of centralized crypto, but the underlying technology is sound and here to stay.” In other words, the problem is not the product, it’s the seller, and this message has been dutifully parroted by crypto’s backers in DC, including Senator Pat Toomey. Adherents of this view argue that the sector needs to return to its roots, as first envisioned by Satoshi Nakamoto, and embrace decentralization. Thus, I see the industry increasingly embracing DeFi, or decentralized finance. DeFi represents traditional financial services offered on the blockchain without the need for any third-party intermediaries, all made possible by smart contracts. DeFi is particularly problematic from a regulatory standpoint, as regulation traditionally applies to legal entities. Who is responsible for compliance when the service is provided by open-source software?
DeFi, and crypto more generally, are destined for the ash heap of history because they provide no genuine economic utility. But I do not believe it will be a swift death. At this point, crypto has taken on religious elements and there will always be a core group of true believers, no matter what happens. But as time passes and people realize crypto’s killer use case will never come, most people will move on to other things and twenty years from now, we’ll share a drink and remark: “remember when crypto was a thing, those were wild times.” Until then, good people must actively resist the crypto-con so that innocent people are not taken advantage of, national security is not undermined, and financial stability is maintained. It won’t be easy, but it is necessary.
FROM: Bob
TO: Lee, Shane
“At this point, crypto has taken on religious elements and there will always be a core group of true believers, no matter what happens.” Lee, I’m sure that’s true. I wish those people well, but, I am more concerned about the broader retail investor and how those people have been harmed — people who might have been pursuaded by Tom Brady or LeBron James to risk their life savings on crypto; or pension funds that might have “diversified” into crypto. Unwinding those investments seems sure to cause a lot of pain. Is there some kind of soft landing to offer them? Might lawsuits filed against crypto hype men and women have a chance to help with that? Or could they at least act as a deterrent to the next generation of paid endorsers who might be tempted to hawk financial nonsense?
FROM: Shane
TO: Bob, Lee
Bob, you are right to be concerned about everyday retail investors. It has been difficult to watch the celebrity marketing blitz in this industry over these last couple of years with the sinking feeling that the day would come when many average folks would lose their shirts (or, quite literally, their life savings).
Will the likes of LeBron James and Tom Brady think twice in the future before placing their reputations on a product like this? I like to think so (and surely Taylor Swift is relieved that she passed on the opportunity).
As I was writing this response, my former office, the Southern District of New York, unsealed criminal charges against Sam Bankman-Fried (SBF). The SEC and CFTC have joined with enforcement actions. Celebrities and others who have carelessly pushed a product on which they have done little due diligence are surely taking note. If the warning bells weren’t loud enough before the FTX collapse, they can be heard now.
I’ll return to the SBF case in a moment, but just another quick word on the endorsers. Even as early as this summer, we saw the hype parade slow down, in part due to the crash in the crypto markets. But actions by regulators have also helped.
With all due respect to fans of Kim Kardashian, enforcement actions can serve as important deterrents. Although investor lawsuits can be an uphill climb (in part because of the difficulty of linking one’s loss to specific endorsements), the SEC did reach a $1.2 million settlement with Kardashian for failure to make proper disclosures when touting a crypto asset on her Instagram feed. Regardless of your net worth, that’s real money and few celebrities want to find themselves entangled in regulatory actions or, even worse, getting a knock on the door by criminal investigators. There are easier ways to make a buck, and none of this can be good for one’s brand.
Like Lee, I don’t think crypto is going away anytime soon, at least absent some other major developments (always a possibility in this space).
As bad as the SBF/FTX debacle was, it was no Lehman Brothers, in part because the scale and global financial impact are different by orders of magnitude. Most of the victims were institutional investors, and their losses, however painful, did not send shockwaves through the larger financial system. That matters for purposes of the level of accountability that the public will demand.
I vividly recall my time as a prosecutor when, in the wake of the 2008 financial crisis, the public was looking for individuals to blame – and they desperately wanted those individuals named on an indictment. But much of that outrage was driven by the fact that nearly everyone was affected. The individuals who allegedly were scammed by SBF and his endorsers will surely seek justice, and even the broader public will enjoy seeing wrongdoers answer for their crimes, but those demands will look different than they did after the subprime mortgage crisis.
At the end of the day, this moment may end up being less about the death knell of an industry than a pivot in the way it operates, as Lee suggests. It is also a very recognizable moment: fraud is an old story, and we have seen it told many times over. If the criminal charges against SBF are proven, he will join the ranks of Bernie Madoff, Elizabeth Holmes, and others who have used hype, charm, and deception to swindle innocent investors. In the meantime, the industry will seek to distance itself from FTX and continue to look for ways to reinvent itself.
Where the industry will end up – and what it will look like in the future – is anyone’s guess. But one thing is clear. We are seeing a necessary and long-awaited course correction.
FROM: Lee
TO: Bob, Shane
From the SEC’s civil complaint:
https://www.sec.gov/litigation/complaints/2022/comp-pr2022-219.pdf
- From its inception, FTX had poor controls and fundamentally deficient risk
management procedures. Assets and liabilities of all forms were generally treated as
interchangeable, and there were insufficient distinctions between the assignment of debts and
credits to Alameda, FTX, and executives, including Bankman-Fried, Wang, and Singh. This
reality was a sharp contrast to the image of FTX that Bankman-Fried consistently portrayed to
the public and to investors—a mature company that managed funds and risk in a conservative,
rigorous manner. - FTX invested significant resources to develop and promote its brand as a
trustworthy company. For example, in materials provided to one investor in or around June
2022, FTX cultivated and promoted its reputation:
FTX has an industry-leading brand, endorsed by some of the most trustworthy public figures, including Tom Brady, MLB, Gisele Bundchen, Steph Curry, and the Miami Heat, and backed by an industry-leading set of investors. FTX has the cleanest brand in crypto.
FROM: Bob
TO: Shane, Lee
Personally, I think it’s high time that people who lend their fame to a product have *some* kind of accountability…
FROM: Lee
TO: Bob, Shane
Agreed.
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