When will crypto learn from the mistakes of the banks?

Some crypto industry operators will point to the failures of Silicon Valley Bank, Silvergate Capital and Signature Bank as further evidence that traditional financial institutions (TradFi) are inefficient and untrustworthy.

In fact, you may have already heard from the bitcoiner in your life about avoiding financial horrors by storing their crypto in cold wallets. That sentiment fuels the narrative that banks have nothing to offer the crypto industry in terms of infrastructure, risk assessment mechanisms and regulatory compliance.

Eric Sumner is the Chief Content Officer at ReBlonde, a technology PR firm specializing in blockchain and Web3. Based in Tel Aviv, he is a former editor of The Jerusalem Post.

The idea that SVB and the like somehow incriminate the entire banking industry and prove that crypto works better couldn’t be further from the truth. Crypto cold storage is hardly an alternative to banking.

The reality is that SVB appears to have made some bad bets on the treasury, having failed to predict the inflation-induced interest rates we are now seeing when they bought government bonds. It led to a massive bank run which will have ripple effects throughout the entire technology, but it does not currently indicate a fault on SVB’s part. This is in stark contrast to FTX, for example, simply redistributing the investors’ funds without disclosure and losing all their money. The same goes for Celsius Network and countless other crypto companies.

Crypto’s mission as an industry is to offer an alternative financial landscape that corrects for the banks’ mistakes. Yet, ironically, too many founders are replicating TradFi’s mistakes in a blockchain setting because they refuse to learn the lessons banks have already learned from their own past mistakes.

There are some clear reasons for that. Most notably, most crypto leaders come from a technology, rather than finance, background, and have not spent much of their youth studying financial history to date. So captivated by the beauty of blockchain as a technology, such founders forget that banks are actually quite good at what they do. Banks are efficient at doing things like leveraging assets and assessing risk. The banks are also open about lending your money when they do.

Instead of recreating entire financial ecosystems from scratch, crypto projects should build on the things banks are already doing well. From there, they can find the problems and focus on solving them.

Some entrepreneurs also miss that regulation can work quite well. One of the main themes of the Obama-era financial reforms of the Dodd-Frank Act was an attempt to limit banks’ ability to take risks using public money. Although there is still debate about the overall effect of Wall Street reform, industry leaders largely agree that capital requirements and stress tests are effective, according to a Grant Thornton survey.

The introduction of certain blockchain features and products introduces crypto-specific regulatory issues, such as how to classify different types of digital assets and how to solve the problem of cold wallets. But the conceptual approach to regulating crypto already exists in laws like Dodd-Frank. Just as there is no need to reinvent TradFi practices that already work, there is no need to start regulatory ideas from scratch.

Part of the challenge, however, is that much of the regulatory framework for cryptography was created with input from FTX’s former CEO, Sam Bankman-Fried. As such, it will be difficult for regulators to determine which parts are genuine and which are designed to give FTX a competitive advantage.

The truth is that while SVB has taken over the news cycle, we are still feeling the aftershocks of FTX and there are still questions that need to be answered. When Fireblocks, for example, a company that enables self-storage of digital assets, accepted $400 million in user funds from FTX and sister company Alameda Research, what was really going on there? It appears that Bankman-Fried initiated the transfer even though he was no longer CEO of FTX.

There are rules in place to prevent such transactions, but crypto companies don’t always comply.

In its early days, crypto was often compared to the Wild West. These days it looks more like an overgrown lawn in that it has experienced tremendous growth without regulation matching, so it’s hard to follow the action. This is precisely why it is important to recognize that regulation is the only way to clean up the industry.

The US Securities and Exchange Commission announced last month that it is considering a proposal to crack down on qualified crypto custodians to prevent foul play. Chairman Gary Gensler even used Bernie Madoff and the 2008 financial crisis to justify the crackdown.

The next generation of crypto leaders should welcome the proposal and take a genuine approach to the regulatory process. Supporting legitimate regulatory measures does not mean bribing politicians behind closed doors to write the industry a blank check to do what it wants. It’s not real regulation, and certainly not the kind of approach that shaped Dodd-Frank and the like.

The naïve sentiment that prevailed in crypto circles in the early days of the industry, that individuals can perform the same financial actions they would in a bank only minus the middleman and minus the regulation, has simply been proven wrong. Businesses exist to earn maximum profit. The fact that a company happens to use blockchain doesn’t change that, and it won’t prevent shady practices if there are no legal consequences.

Crypto has branded itself as the alternative to TradFi, and yet it seems that far too many platforms are building TradFi forays into dollar stores that don’t follow the rules. If entrepreneurs can begin to grasp that, then maybe crypto can start seriously talking about challenging the big banks.