Don’t let FTX’s fall discredit blockchain

Congress’s frustration with the cryptocurrency industry was on full display last week when the House Financial Services Committee held a hearing to investigate the collapse of FTX. Lawmakers on both sides of the aisle are fed up with fraud and abuse among crypto companies, making it all but certain that Congress will take action to regulate the industry next year.

But in the rush to hold FTX founder Sam Bankman-Fried accountable, Congress should be careful to craft legislation that separates bad actors and fraud from the promise of continued innovation in blockchain technologies.

Bankman-Fried, once an industry darling, is now accused of defrauding millions of investors out of billions of dollars. Last month, information emerged indicating that FTX and Alameda Capital — a venture capital firm also founded by Bankman-Fried — commingled client funds, leading to a run on the stock market and eventual bankruptcy. In the wake of the collapse, court documents and other watchdogs allege that he misused clients’ deposits to make investments, including buying real estate and trading options. Only a fraction of FTX’s assets are secured by the new management, and millions of creditors are likely to experience a total loss.

Legislators are understandably outraged and demanding answers about Sam Bankman-Fried, who is now the poster child for hubris and fraud within the crypto industry. Rep. Maxine Waters (D-Calif.) was one of the first to act, asking Bankman-Fried to testify before the House Financial Services Committee, which she chairs. Bankman-Fried agreed to testify until he was arrested by Bahamian authorities at the request of federal law enforcement.

Fortunately, Bankman-Fried is not the only person capable of providing Congress with insight into the collapse. FTX’s new CEO, John J. Ray III, appeared before the committee, and his testimony was as eye-opening as it was damning.

With over 40 years of corporate restructuring experience, including presiding over the Enron bankruptcy, Ray has seen his fair share of corporate misconduct. “But never in my career have I seen such a complete failure of corporate controls at every level of an organization,” he told the committee.

Many members of the committee used this opportunity to criticize the crypto industry and blockchain technologies as a whole. Rep. Jesús Garcia (D-Ill.) opined: “FTX is not an anomaly; the collapse is not the case of a corrupt guy stealing money. It’s about an entire industry that refuses to follow existing regulation, that believes it is above the law.” Rep. Juan Vargas (D-Calif.) went further: “I really don’t see the point of blockchain and cryptocurrencies … other than if you’re a terrorist or someone who wants to hide money.”

Reports that the Justice Department is also weighing the possibility of filing charges against Binance — another major crypto exchange — and its CEO, Changpeng Zhao, for money laundering violations and criminal sanctions only worsen the industry’s image on Capitol Hill.

With a slew of legislation already making its way through the halls of Congress, the FTX collapse and possible fall of Binance make it more likely that lawmakers will take action to regulate cryptocurrencies and other blockchain-based technologies next year. Unfortunately, the understandable outrage at FTX also increases the likelihood that Congress will miss the forest for the trees.

The collapse of FTX was clearly caused by corporate malfeasance, hardly a crime unique to crypto. It is fitting that Ray is leading the restructuring of FTX since its collapse has been compared to that of Enron. The difference here is that, in Ray’s own words, the Enron fraud was “highly orchestrated financial machinations by very sophisticated people,” while the FTX fraud was “old-fashioned embezzlement” and “not sophisticated at all.”

Corporate crimes of this type can and should be handled through targeted regulation. Establishing new transparency requirements for centralized exchanges and clarifying enforcement authority over cryptocurrencies and stablecoins will go a long way toward preventing the next FTX. However, Congress must also separate bad actors and fraud within the crypto industry from the underlying technology.

Both the White House and Congress have independently recognized that blockchain technologies hold enormous potential for positive innovation. Ironically, the openness of public accounts makes it easier for Ray and his team to trace many of Bankman-Fried’s activities. In the hearing, several members praised, among other things, blockchain-based technologies for their ability to increase the efficiency of transactions, facilitate legitimate cross-border payments and establish new organizational governance structures.

There have already been cases of poorly drafted regulations that have created more confusion than clarity for the many stakeholders who build, operate and facilitate the use of blockchain technologies. Any new legislation should clearly define which sectors of the crypto industry are being regulated and avoid sweeping generalizations. Now that lawmakers are moving toward regulating crypto, they should avoid unnecessarily impeding the innovation that so many of them seem to recognize.

Luke Hogg is policy manager at Lincoln Network.