The Breakdown - Regulators Only Have Themselves to Blame for Crypto Not Being Better Regulated

Episode Date: February 16, 2023

On Tuesday, the Senate Banking Committee held a hearing on the “Crypto Crash.” NLW discusses the opening statements of the ranking committee member and chairman, as well as the regulatory proposals put forward by witnesses. He also discusses the ruling by a U.S. judge that FTX will not have an independent examiner appointed.  Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW - Join the most important conversation in crypto and Web3 at Consensus 2023, happening April 26-28 in Austin, Texas. Come and immerse yourself in all that Web3, crypto, blockchain and the metaverse have to offer. Use code BREAKDOWN to get 15% off your pass. Visit consensus.coindesk.com. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Foothill Blvd” by Sam Barsh. Image credit: aleksei-veprev/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.  

And then, of course, there's the SEC who clearly did focus on this last year, but who spent all of that year making cute videos announcing that they had robbed some quarters from the bottom of Kim Kardashian's purse, rather than engaging substantively with any position other than everything that exists in the world is a security. The point is that regulation over the last couple of years didn't not happen because people were yelling at regulators to not regulate. It's because regulators didn't regulate. Full stop. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world.

The breakdown is produced and distributed by CoinDesk. What's going on, guys? It is Wednesday, February 15th, and today we are talking about yesterday's Senate crypto hearing, FTX, not getting an independent examiner, and so much more. Before we get into that, however, one quick note. There are two ways to listen to the breakdown. You can hear us on the Coin Desk Podcast Network, which comes out every afternoon and features other great Coin Desk shows, or you can listen on the Breakdown-only feed, which comes out a few hours later in the evening. Wherever you listen, I would so appreciate it if you would take the time to leave a five-star rating or a review.

It makes a huge difference, and I appreciate them all. All right, guys, as you can guess from this intro, lots and lots going on today, and I want to start with some late breaking news. One of the big questions in the FTX case has been whether or not there would be an independent examiner appointed. An independent examiner is someone who's brought in in the case of a bankruptcy to get the full facts of the case from a completely neutral party. You'll remember I recently did a show about the independent examiner's findings in the Celsius case, and there were some pretty big revelations in that report.

In the case of FTX, the U.S. trustee from the Department of Justice has been requesting an examiner. Their argument is pretty simply that the goals of uncovering the full truth about what happened at FTX might not always be aligned with the goals of the new management who are trying to recover as much money as possible. for creditors. The U.S. trustee was recently joined by something like 17 or 18 states who filed papers supporting appointment of an independent examiner as well. On the flip side are the new management of FtX led by John J. Ray the 3rd, as well as the official creditors committee. Their argument is also simple that an independent examiner would come with significant costs and duplicate efforts. Ray testified that the independent examiner reports in some other cases where he was in charge of restructuring

costs $90 million to $100 million, and this one could be even more expensive. He also said that when push came to shove, he never really actually used them. However, adding further complications to all of this have been claims of conflicts of interest with Sullivan and Cromwell, who are now the lead lawyers at FTCS. In January 4, senators sent a letter to the judge in the FTCS case, calling for an independent examiner because of some of those concerns. So, to put it mildly, it's been messy. While in a hearing earlier today, a U.S. judge sided with FtX and the creditors,

saying that there wasn't any need to appoint an independent examiner who would, quote, conduct yet another costly investigation that would slow the progress of these cases. James Murphy at Meta Lawman on Twitter writes, Breaking News on FTX Bankruptcy. The FtX judge has denied the U.S. trustees' motion to appoint an independent examiner. If this ruling is allowed to stand, there will be no credible investigation of the third parties who may have enabled one of the largest frauds in U.S. history. He added, this is great news for Sullivan and Cromwell.

I would expect an immediate appeal to the district court judge. I believe such an appeal would likely overturn this ruling. Given all that, I'm sure we haven't heard the last of it. However, speaking of FTX and the fallout thereof, let's talk about yesterday's Senate hearing. To give you a preview of what I think or my base position coming into this, here's what I tweeted yesterday. Congressional hearings as an institution are deserving of so much scorn and cynicism.

They have nothing to do with learning and everything to do with grandstanding and giving politicians five minutes to farm quotes to bring back to their constituencies, utter waste of time. End quote. Yet utter waste of time or not, they still happened, and yesterday the Senate Banking Committee held the first congressional hearing on the crypto industry of the year, entitled Crypto Crash, why financial system safeguards are needed for digital assets. The hearing ended up being less about the specifics of last year's industry-wide catastrophes and had much more to do with discussing how industry regulation should be formulated. Chairman Sherrod Brown's opening could not have been starker in setting the tone. Among the quote

gems from this opener were, the crypto industry promised Americans untold riches and the chance to make history. Of course, they didn't tell us about the high fees, the risk of loss, and the outright theft that plagued the crypto industry. While crypto-contagent didn't infect the broader financial system, we saw glimpses of the damage it could have done if crypto migrated into the banking system. The handful of banks with close ties to the crypto industry have needed liquidity lifelines after they suffered large withdrawals. The crypto nightmare isn't over yet. We're still learning the full extent of the fallout of the FTX collapse. Turns out fortune doesn't favor the brave. It favors wealthy insiders. It's time now to consider how to protect consumers from unregulated digital assets

and ultimately whom we want our financial system to serve. Now, one interesting aside here, obviously this is intense language, which is pretty expected from Brown. But in what? him, it actually seemed like his heart just wasn't really in it. Apparently, he had just come from a national security briefing on these Chinese balloons slash UFOs slash whatever, and the whole presentation felt kind of rushed and of secondary importance. But just so we don't spend too much time psychoanalyzing him, let's move on to ranking Republican member Tim Scott, who used his time at the beginning of the hearing to, quote, address the elephant in the room of SEC Chairman Gary Gensler's absence from the hearing. Scott said, if Chairman Gensler is going

to take enforcement action, Congress needs to hear from him very soon. The chairman has had lots of times to do the rounds on the morning talk shows. And if he has time for that, he should be here testifying with us this morning, and I hope we see him very soon. Now, the rest of Tim Scott's opening dealt with the concept of enabling growth of new industries and fostering responsible innovation within the U.S. economy. If we foreclose financial innovation, he said, we limit future generations from growth and opportunity. Scott also ran through the list of last year's crypto-bankruptcies and laid the blame partly on the lack of attentive supervision by regulators. To date, he said, the SEC has failed to take any meaningful preemptive action

to ensure this type of catastrophic failure does not happen again. If they have the tools they need, were they just to sleep at the wheel? If they don't, why aren't they here to tell us what they need? Scott also drew attention to the need for increased financial education across society. Now, the witnesses of this hearing were notably different to previous crypto hearings. Rather than a mix of lobbyists, industry figures, and skeptical academics, the panel instead featured a trio of highly credentialed law school fellows and professors with experience in financial regulation. Lee Reiner's, the policy director at Duke Financial Economics Center,

opened his testimony with a swipe at Bitcoin in the crypto industry as a whole. 14 years, thousands of cryptocurrencies and trillions of investor losses later, he said, crypto scarcely resembles the purely peer-to-peer version of electronic cash first envisioned by Satoshi. After 14 years in countless claims that crypto represents the future of money, finance, or something, we have yet to see crypto's killer use case. Reiner advocated strongly for crypto to be brought under the jurisdiction of the SEC, providing a detailed roadmap in his written testimony on how to structure what he envisions as a suitable regulatory framework.

He pointed out that the SEC has a track record of enforcement actions against crypto firms and a mandate for investor protection. His proposal went as far as suggesting that all cryptocurrencies, including Bitcoin, should be carved out from other commodities to ensure that the SEC can act as the sole regulator over crypto exchanges. Overall, Reiner's main point was that investor protection in the industry needs to be improved. He floated the idea of requiring exchanges that hold customer assets to be insured by the Securities Investor Protection Corporation, providing insurance for customers up to $500,000

in the event of bankruptcy. Next up, we had Georgetown University Law Professor Linda Jang, who also acts as the chief global regulatory officer at the Crypto Council for Innovation. She had a much more crypto-positive outlook, making the point that the U.S. needs to be careful to foster crypto innovation to reap the potential benefits of a more efficient financial services industry. She focused on the current shortfalls of the existing regulatory framework, which consists of a patchwork of state regulations that failed to provide firms with the certainty that federal legislation could provide. Vanderbilt Law School professor Yesha Yadav

focused on the urgency of the moment, arguing that the current situation where retail investors are seeking compensation via bankruptcy court rather than through well-established regulations is frankly untenable. She put it to the Senate that regulatory agencies are better positioned to ensure the retail investors are dealt with fairly when things go wrong in the crypto industry. Her proposal was focused on speed, suggesting that a self-regulatory organization be formed where crypto exchanges write the rules and monitor the markets in a similar way that commodities exchanges have operated for more than a century. Under Yadav's framework, regulators would oversee the operations of the self-regulatory organization.

During questioning, Yadav pointed out that the U.S. is losing its chance to define the standards for the crypto industry globally. In the case of digital asset regulation, she writes, the U.S. currently has nothing to export. Now, in terms of other topics, both defy and stablecoin regulations were considered individually. Rainers backed the suggestion that defy platforms that operate consumer-facing front-end should register as broker-dealers. This was a suggestion which was criticized as unworkable by industry figures last year when SPF brought it up. He also argued that the SEC could, quote, begin by requiring independent code audits and IT security tests of defy protocols. On stablecoins, Reiner's favored the idea of requiring issuers to hold reserves and

cash and U.S. Treasuries, as well as an oversight framework akin to money market funds or perhaps even banks. Now, overall, like I intimated in that tweet, there were many senators who used the opportunity to just grandstand and deliver soundbites. I would say that ranking member Tim Scott was one of the few bright spots. He was well informed and seemed to have a firm grasp on both the technology and the importance of U.S. competitiveness in the industry. His pro-innovation stance came through clearly, stating at one point, quote, right now the U.S. has the strongest and most enviable capital markets in the world. The reason for this is very simple. The sun never sets on American innovation. Join CoinDesk's Consensus 2023, the most important conversation in crypto and web3,

happening April 26 through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web3, and the Metaverse. Immerse yourself in all that blockchain technology has to offer creators, builders, founders, brand leaders, entrepreneurs, and more. Use code breakdown to get 15% off your paths. Visit consensus.coindex.com or check the link in the show notes. Now, trying to sum up a few themes, overall, as antagonistic as some of this was, it still kind of represents progress. First of all, there was no real plausible discussion of something like a ban.

It seems instead like even the anti-crypto legislators now seem to understand that this tech is here to stay, and they need to be engaged with it on that basis, if nothing else. Second, if you look at the proposals and positions of the witnesses, even the anti-crypto ones, it's pretty clear that there's a lot of compromise space and common sense rules of the road being discussed that the industry could absolutely get behind. The issue is, in fact, political will, and the context in which these discussions happen. So far, Congress hasn't taken on real legislation, at least not when it comes to debate. Instead, what we get is bills that never even get discussed,

or bullshit like the infrastructure bill, which had a random last-minute provision, shoved in. On that front, there is a little bit of an interesting tension right now. Democrats want investor protections, they want to safeguard the banking system from contagion, and they want to do it now, but they don't really have reasonable compromises or proposals to do so. Republicans, meanwhile, are being pushed a little more aggressively because in the absence of things getting done on a congressional level, Tsar Gary is just going fully vigilante on the industry. And of course, this is the great irony of this type of hearing. Perhaps the key theme was that the industry blew up due to lack of regulatory oversight.

But the people expressing that opinion are the people who didn't get their shit together to provide oversight and regulation in the first place. Now, Matt Levine from Bloomberg published a piece basically providing a defense of this, where he said, yeah, well, that's to be expected. When number was going up, no one wanted them to do anything, but now they have to clean up. Specifically, he wrote, When crypto is popular and exciting and going up, if you are a regulator who says, no, we must stop this, you look like a killjoy.

investors want to put their money into stuff that is going up, and then they are mad at you for stopping them. Politicians like the stuff that is going up and hold hearings about how you're stifling innovation. Crypto founders are rich and popular and criticize you on Twitter and get a lot of likes and retweets. Your own regulatory employees who have an eye on their next private sector jobs want to be leaders in crypto innovation rather than just banning everything. When crypto is going down, and so many projects are evaporating in fraud and bankruptcy, you can kind of say, I told you so. There's just a lot more appetite to regulate, or I guess to shut everything down. Your stifling innovation, the indicted founder of a bankrupt crypto firm can say, but nobody cares. I guess this is a little bad in the sense that it would be better for regulators to impose

sensible regulations on the way up, before people lose all their money, rather than being too lax on the way up and overreacting after the crash. But it seems hard to avoid. Also, the advantage of regulating after the crash is that you have a better sense of what the risks are. Crypto is decentralized and transparent and avoids the risks of traditional fractional reserve banking, so it doesn't need to be regulated like traditional finance. I suppose people could say that in 2021, but now we know better. Matt Levine is great with words, but on this one, I don't know, man. I just don't buy it. Look, if the point was that no one was willing to have regulatory conversations for the last three years, it's just flat out wrong.

Stable coins have been on the agenda since Libra was announced in 2019. The larger industry has been a focus of Congress since summer 2020 in the infrastructure bill fight, where crypto was in fact the force that delayed the passage of that bill. There were debates back and forth endlessly last year about a stable coin bill, but ultimately it didn't get done. A bipartisan group of senators put together the Lummus Gillibrand Responsible Financial Innovation Act, which actually tried to address the real challenges, even thorny issues like securities designations and how assets that have both security and commodity-like properties can exist inside the regulatory framework that exists. And then, of course, there's the SEC who clearly

did focus on this last year, but who spent all of that year making cute videos announcing that they had robbed some quarters from the bottom of Kim Kardashian's purse, rather than engaging substantively with any position other than everything that exists in the world is a security. The point is that regulation over the last couple of years didn't not happen because people were yelling at regulators to not regulate. It's because regulators didn't regulate. Full stop. Warren G. would be ashamed. And by the way, it's not just me saying this. Former SEC chairman Harvey Pitt made an appearance on Yahoo Finance on Tuesday. to discuss his alarm at recent enforcement actions.

He said, I think what's required is a comprehensive set of rules of the road. It's no use in telling people you have to follow the law if you don't know what the law is. Most people will try and follow the law, but they need to know what it is. And so doing this on a piecemeal basis, case by case with enforcement actions,

doesn't really get us to where we need to be, which is a comprehensive regulatory scheme. Dan McArdle wrote, former SEC chair reiterating what crypto industry has been saying for years. The law is unclear. Gensers' SEC is refusing to clarify. regulation by enforcement is bad, depressing that the political and or career motivations of the guy in the chair can make such a big difference. However, at the end of the day, even if it's just

the short term, and even if the SEC's actions are suspect, they can still have real market impact right now. There was news last night that Binance had paused USDC withdrawals on the ethchane due to a temporary shortage before turning them back on a few hours later, and Circle responded to rumors that they had been served the Wells notice, dismissing them directly. Later on Tuesday evening, Coinbase, which has a partnership with Circle around USDC, also tweeted a long threat explaining their position on reason StableCoin enforcement. They claimed that Stablecoins are not securities and made a clear call for a more thoughtful approach to Stablecoin regulation. Getting this right, they wrote, means real dialogue between regulators and the industry, followed by clear rules for

the industry and lanes for the various regulators themselves. This is how we ensure the promise of greater financial accessibility, efficiency, and innovation that safe technology like Stablecoins can provide in the U.S. Not through threats of litigation without explanation or a basis. and existing law. You know what would have been really helpful with these questions? A stable coin bill. Anyway, my point is simple. If you are a regulator or a politician who oversees regulators and you believe that rules of the road are needed for crypto and there are not rules of the road for crypto, you can blame all you want, lobbyists or the unpopularity of the position, but there was one party, one category of people who had the ability to write and then pass rules of the road for

crypto. It was you. And if they didn't happen, it's your fault. Until tomorrow, guys, be safe and take care of each other. Peace.