FTX bankruptcy points to more difficult times for crypto

The crypto industry is in trouble — just look at the drama surrounding the collapse of the FTX crypto exchange, which is looking worse every day.

Add to that the huge drop in value of cryptocurrencies like bitcoin and the crash of stablecoin TerraUSD earlier this year. And now regulators and investors are wondering about the next shoe to drop.

Marketplace’s Kimberly Adams spoke with Hilary Allen, a law professor at American University’s Washington College of Law, about what’s next for the crypto sector. And Allen is not exactly optimistic about crypto’s future.

The following is an edited transcript of their conversation.

Hilary Allen: This is an asset class that really trades a lot on sentiment and [fear of missing out], etc. And for that kind of asset class to be successful, there really needs to be a lot of money sloshing around, looking for a home. In the current macroeconomic environment with interest rates high, there simply isn’t that much money floating around. And so I think the crypto industry is really in for a lean time, unless they can find new sources of investment, capital, liquidity, etc. And so that’s why I think the battle has turned in Washington for the industry trying to encourage regulation that is lighter touch than what is available for traditional financial markets, because a lot of the crypto business models wouldn’t survive under traditional financial regulation.

Kimberly Adams: One of the big reasons why regular people, not savvy market traders, not venture capitalists, invested in crypto was because many of them didn’t really have access to our traditional financial systems to build their own wealth, or maybe couldn’t afford the biggest wealth builder, like owning a home or something, and really saw crypto as an alternative. Is there a safe way for people to take advantage of crypto as an investment vehicle?

Allen: Yeah, I think the answer to that is no, it will only be valuable if you can find someone to buy it from you. And unfortunately, what I think has happened is this rhetoric about this being an asset class that is available to people who’ve been traditionally locked out of the system, has been weaponized to encourage people to be in many respects, the ones who end up holding the bag on this currency. So I agree very much with the statement that our financial system has not done right by a lot of people. Unfortunately, crypto is not an answer to that. Crypto is in many ways the same kind of people perpetuating problems, the same problems that exists to some degree in the traditional financial system, but without any of the investor or consumer protections that would protect people in the traditional financial system.

Adams: So many people did jump on the crypto bandwagon during the pandemic, when a lot of people were sitting on much more cash than they were used to, with interest rates that would pay almost nothing if you put it in the bank, and crypto for a lot of people seemed like a viable option. What’s the financial condition of those types of consumers now?

Allen: Well, a lot of them have lost everything, unfortunately. So what we saw I think was, you know, as you say, a combination of there being a lot of cash available, but also with interest rates being so low, what we call classic reaching-for-yield behavior, trying to find a return. And that’s one of the dangers of, you know, extended low interest rate environments, it makes people reach for risky investments. Whereas right now, with interest rates going up, people can get a much less risky return by putting their money in a certificate of deposit or buying government bonds, etc. So I think that’s part of the reason why crypto has lost some of its appeal.

Adams: So what kinds of regulations do you think we should have around crypto, given what we’ve seen?

Allen: So there are consumer and investor protection regulations out there, and they should be applied to crypto, but they have not been applied to crypto to the extent that they should have for a number of reasons. One is resource limitations at the regulators. The SEC, in particular, the Securities and Exchange Commission that has an investor protection mandate, they have done some good enforcement work in the crypto space, but they need to do a lot more. Providing them with more funding to enforce the existing laws, I think would protect people significantly. You know, returning to FTX, one of the big problems was that there’s this strong affiliation between the exchange and the hedge fund Alameda. And in fact, the consumer assets that were stored on the exchange were actually lent to Alameda to fill a hole in its balance sheet, and that’s where the problem came from. So traditional exchange regulation for securities exchange would not allow that kind of a relationship.

Adams: There are a lot of crypto advocates out there who are really trying to emphasize and arguing that these are isolated incidents, that there is still a good purpose for cryptocurrency and decentralized finance in our economy. Is there anything there that you feel like you can latch on to to say that this is where we can actually see this doing good?

Allen: Not really. I mean, I spent a long time sort of along the road of evaluating all the possibilities of this sort of technology and space. And the more I learned about it, the more skeptical I became. Blockchain technology is, in many ways, slow, inefficient, cumbersome compared to your traditional centralized database. The only claim to fame it has really is that it is decentralized — in other words, that there is no centralized authority controlling over it. But if you really get into the details and look at it, in fact, there are centralized intermediaries everywhere. So I really don’t see much to save from this system, though the one thing I will say that crypto does very well is identify problems in our existing financial system. The diagnosis is correct, but it doesn’t have the solution. Unfortunately, the solution is hard work. It’s hard political slog in making financial services more available to more people on terms that are safe and equitable.

Adams: In the meantime, what lesson should regular people take moving forward when they’re considering investing in a new currency or token?

Allen: Well, I think that the starting point is you should never invest anything that you’re not willing to lose. You should see it as a gamble. I think, especially as I mentioned earlier, with interest rates rising, you should see if there are safer, much less exciting, but much more reliable products available that can offer you a yield and that might be a better place to place your money.