Thanks Sam! How FTX Led to World’s Worst Crypto Policy

With Washington, D.C., policymaking, it’s worth remembering that governments, like all human organizations, are made up of, well, humans – complicated creatures whose emotions often undermine their capacity for rational decision making.

Last week, I warned of a dangerous politicization trend in U.S. crypto policy following a barrage of regulatory enforcement actions taken against this industry. I remain concerned about that trend but my view is now slightly more nuanced thanks to the insights of two people with very good D.C. connections. They explained how emotions – specifically anger and embarrassment – played a huge role in driving those policy actions.

It reminded me of the importance of clear, inviolable rules of governance, whether they’re baked into democratic institutions such as the U.S. Constitution or forged into consensus mechanisms used by open-source software communities, like those attached to blockchain protocols.

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Regulation by retribution

Among a string of “Thanks, Sam” moments these past five months, this one takes the cake. You can argue that the crackdown against Kraken, Coinbase (COIN), Paxos, Binance and others was driven significantly by a desire to punish Sam Bankman-Fried, the erstwhile founder of FTX, whose mind-blowingly rapid collapse in November sent shockwaves through the crypto industry.

This is how one of my sources described the mindset of Biden administration officials and of lawmakers from both political parties: “You can’t come into their house, slosh that kind of money around, leave politicians with egg on their faces and not expect to pay a huge price.” He was referring to the fact that before the FTX meltdown politicians – mostly Democrats but also some Republicans – had been beneficiaries of more than $74 million in political donations from FTX and had forged connections with Bankman-Fried, who had wooed progressives with his “effective altruism” commitments. (A CoinDesk investigation found that one-third of Congress took money from SBF or his associates.)

Virtually no one in this industry would try to diminish Bankman-Fried’s extensive wrongdoings and most now want tighter regulation. (In fact, the biggest frustration is that SBF’s actions have set back the chance of a clear regulatory framework, leaving agencies like the Securities and Exchange Commission to continue being a law unto themselves.) What’s so galling is the capricious and utterly disproportionate reaction generated by that malfeasance.

Forget regulation by enforcement; it seems we’ve entered a newly nutty standard of regulation-by-retribution.

Set aside that millions of investors, employees and developers with a stake in the crypto industry are now paying for the sins of a few fraudsters whose behavior they never knew of, let alone condoned. The biggest issue is that because there are very few physical or geographical reasons why blockchain developers would favor one country over another, the U.S. is about to lose all capacity to shape this inherently borderless technology’s direction. No other developed economy is taking as hostile a stance toward this industry.

There’s the growing view that digital asset and blockchain innovation – now, in the age of artificial intelligence, more important than ever – will depart the U.S. for friendlier shores. And there’s the especially counterproductive concept that if the U.S. wanted to keep the tech away from bad guys in rogue states, it is making that more, not less, likely.

The good news is that this vengeful moment is destined to subside – as most emotion-driven overreactions eventually do. Tempers will surely give way to a more grownup approach to policy. Still, the damage already done to the United States’ prospects to attract crypto investment, entrepreneurship and innovation could be profound. U.S. industry leaders of all stripes have been warning of an exodus of crypto businesses.

You see, whether this a “war against crypto” or just a deliberate bruising, crypto business people are seeing the slew of criminal and civil charges as a message that, in the absence of clear legislative guidance defining what activity is or isn’t within bounds, it’s now too risky to keep operating in the U.S.

That message was brought home in two ways. The regulatory actions seemed way too well-sequenced to be coincidental. Then the White House released a scathing report on the industry at the very same moment, one that reversed the open-minded executive order it produced a year ago. It didn’t help, either, that Senator Elizabeth Warren (D-Mass.), a figurehead of the Democratic Party’s progressive wing, launched a political campaign that celebrated a Politico headline stating that she’s forming an “anti-crypto army.”

Who’s governing the governors?

“D.C. is 'Veep.' It’s not 'House of Cards'.”

So said my "Money Reimagined" co-host, Sheila Warren, who is also CEO of the Crypto Council for Innovation and my second source for this story (the other will remain anonymous), during this week’s podcast recording.

On the one hand, it’s comforting to know that we’re not really at the mercy of some cynical uber-conspiracy orchestrated by the likes of Frank Underwood, the political villain played by Kevin Spacey in "House of Cards."

But on the other hand, it’s sad to know that human fallibility leaves our governing institutions prone to absurd moments like these, as if we’re permanently subject to the self-absorbed decision-making of people like Vice President Selina Meyer, Julia Louis-Dreyfus’ comically flawed lead character in "Veep."

These human failures, both evil and farcical, led French philosopher Montesquieu to conceive of the “separation of powers” doctrine, a principle of governance designed to protect society’s interests from the mistakes or corruption of its leaders. Those ideas were then enshrined in the U.S. Constitution and helped shape the Westminster System, with its three, independent branches of government.

They also inform the blockchain idea – initially identified in the Bitcoin white paper – that we need a system for managing money, assets and information that’s not beholden to “trusted third party” middlemen. Having to trust intermediaries and representatives will always leave us vulnerable to the problem that they are run by humans, not math.

I’m no radical advocate of replacing the nation-state with some kind of digital “network state,” but it’s interesting to think how these new technologies offer people the option to exit into alternative, decentralized economic systems and how, indirectly, this could put pressure on our politicians to lift their game.

It’s worrying that the “war on crypto” puts the U.S. and its model of market democracy at greater risk than ever of losing economic and technological leadership. But we can at least take heart that the technology itself might impose a self-correcting force on the political system to avoid the worst outcomes.