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SBC Crypto Crash Hearing

Senate Committee on Banking, Housing, and Urban Affairs

Crypto Crash: Why the FTX Bubble Burst and the Harm to Consumers

Wednesday, December 14, 2022

Topline

  • Senators on both sides of the aisle and witnesses agreed there must be regulation of digital assets, but deviated when it came to what kind of/how much regulation.
  • Senators expressed the importance of allowing new innovation of digital currency while also having a framework that protects investors.

Witnesses

Opening Statements

Chairman Sherrod Brown (D-Ohio)

In his opening statement, Brown expressed appreciation for all of the law enforcement agencies who are holding Sam Bankman-Fried (SBF) accountable because he owes the American people an explanation. He said consumers, not the industry, must be put first and that he looks forward to working with Secretary Yellen on a whole of government approach.

Ranking Member Pat Toomey (R-Pa.)

In his opening statement, Toomey said the Department of Justice and other agencies should pursue this expeditiously and blamed the indifference by Congress and the Securities Exchange Commission (SEC) towards crypto for contributing to this. He emphasized that code committed no crime and that there is nothing intrinsically good or evil about software. Toomey urged the Committee to separate bad actors from lawful and innovative activity.

Testimony

Professor Hilary J. Allen, American University Washington College of Law

In her testimony, Allen said the FTX incident is not isolated but symptomatic of many broader problems in the crypto industry. She said assets are made out of thin air, creating leverage and volatility, and that even if DeFi is technologically decentralized, it is economically centralized. Allen concluded by saying the U.S. has little to lose from limiting growth of the industry because the technology is not good and is just a tool.

Mr. Kevin O’Leary, Investor

In his testimony, O’Leary said he believes crypto, blockchain technology, and digital payment systems will be the twelfth sector of the S&P within a decade. He continued that he was a paid spokesperson for FTX and feels obligated to pursue the facts of the collapse on behalf of all stakeholders. He notes that critics do not like crypto because it is disruptive, but that is necessary for innovation and advancement. O’Leary believes a well-regulated stablecoin backed by the dollar can become the global default payment system.

Ms. Jennifer J. Schulp, Director of Financial Regulation Studies, Center for Monetary and Financial Alternatives, Cato Institute

In her testimony, Schulp said the issues with FTX do not appear intrinsically tied to cryptocurrency or blockchain and that there are important distinctions between centralized exchanges and decentralized projects. She described FTX as a traditional middleman and that unclear regulation in the U.S. remains an issue that drives regulation and operations offshore. Schulp said centralized exchanges should register with the Commodity Futures Trading Commission (CFTC) for digital commodities and the SEC for digital securities.

Mr. Ben McKenzie Schenkkan, Actor and Author

In his testimony Schenkkan said the carnage from FTX is more widespread than that of the Madoff scandal and that the consumers of FTX were lied to. He also said cryptocurrencies are not currencies or serve the purpose of money, and that the industry represents the largest Ponzi scheme in history.

Question & Answer

Stablecoins

Brown asked Schenkkan to describe the parallels between stablecoins and gambling. His response was that both are a zero-sum game and that most investors lose money.

Toomey said that stablecoins exhibit some promise due to their programmability and smart contracts, so they can be programed in case of some exogenous occurrence. He asked Schulp to comment on that observation and his stablecoin legislation. Schulp said stablecoins have promise because of the programable aspect and that Toomey’s legislation addresses the issue of reserves, one of the most obvious risks of stablecoins.

Regulating Digital Assets

Brown asked all the witnesses if this carelessness exists in other firms in the crypto market, and they all said yes. He also asked if it is possible to determine how much leverage is in the market. Allen said researchers struggle to find data in the space and that there are many backdoors. She also said the accounting around crypto is dodgy as well. Brown asked if Allen thinks crypto firms could actually comply with regulation, and she said she believes what they mean by regulatory clarity is bespoke legislation.

Toomey asked if it was hard to establish bitcoin as a common enterprise with respect to the HOWEY Test. Schulp said it does not satisfy the HOWEY Test and that security laws were written to deal with information asymmetry when a body makes decisions.

Sen. Jack Reed (D-R.I.) mentioned the Private Markets Transparency and Accountability Act (S.4857) he introduced in September and asked Allen if it would have been helpful to illuminate what was going on with FTX. Allen said it would have been and that we should also be weary of The Financial Accounting Standards Board (FASB) moves to implement fair value accounting for crypto because it can undermine audits.

Sen. Bob Menendez (D-N.J.) asked why traditional financial regulation should not apply to the crypto industry and if FTX customers would have been better off if FTX complied with existing regulation. Allen said we should apply regulation, and O’Leary said customers would have absolutely been better off but that FTX was never compelled to comply with existing regulation. Menendez also noted his concern for crypto becoming integrated with the financial system and asked how we can stop the spread of crypto disinformation. Schenkkan said accurate words need to be used because cryptocurrency is not a currency.

Sen. Jon Tester (D-Mont.) said he wants to make sure taxpayers are not left holding the bag and asked if the prize for crypto is to be regulated because regulation will give crypto credibility. O’Leary noted LedgerX was one of over a hundred companies in the FTX portfolio, and they did not go bankrupt because they were regulated by the CFTC.

Sen. Bill Hagerty (R-Tenn.) was interested in working with global counterparts on regulation and promoting competitiveness. Schulp said we should have an ongoing dialogue with other regulators but should also create regulatory clarity to bring firms onshore. O’Leary said foreign jurisdictions are beating us by laying down regulations.

Sen. Cynthia Lummis (R-Wyo.) said those in the crypto industry need to get serious about risk management and compliance and that the Committee needs to be focused on putting regulation in place. She asked Schulp how the technology can make the industry safer. Schulp said payment systems would be faster and cheaper, and because there is no intermediary, there are also no risks that would normally be associated with one. Lummis closed out by saying she and Sen. Kirsten Gillibrand (D-N.Y.) would be reintroducing their crypto bill next year.

Elizabeth Warren(D-Mass.) mentioned the bill she and Sen. Roger Marshall (R-Kan.) introduced today, the Digital Asset Anti-Money Laundering Act to combat money laundering.

Sen. Chris Van Hollen (D-Md.) asked Allen what crypto is backed by at the end of the day. Allen said nothing and that it is just a story. Sen. Catherine Cortez Masto (D-Nev.) asked if any of the witnesses disagree with banning or isolating crypto from the banking sector. O’Leary said that would short every U.S. bank stock if that happened because the sector would then be the least innovative and least competitive. Schulp said congress needs to draw clear lines as to what is and is not a security.

Sen. Tina Smith (D-Mont.) asked if the crypto market has segregation. Allen said no. Smith also voiced her displeasure with how energy intensive and inefficient mining becomes overtime. Sen. Kyrsten Sinema (I-Ariz.) said Congress has the responsibility to make sure participants have the information they need to understand risks and opportunities, to grow the economy and protect the integrity of the markets, and to provide a regulatory framework that promotes innovation in the U.S. Sinema asked what disclosure requirements should be in place. Allen said she was not sure how consumers can be protected by disclosures because there is nothing behind crypto.

Innovation/Technology

Toomey said tokens are the incentive to maintain the blockchain and asked O’Leary to address the notion that it is a zero-sum game. O’Leary said the zero-sum assertion is preposterous and that the success of the blockchain’s ability to track assets will be the shining outcome. He said the brightest students are working on blockchain.

Sen. Mark Warner (D-Va.) said he is all in on technology innovation but that he also sees a lot of illegal activity and bad actors. Warren also expressed her concern with illicit activity. Sinema said she is optimistic and believes in the potential of the technology.

For more information on this hearing, please click here.

For an archive of past SIFMA hearing coverage, please click here.