Thanks to FTX, legislators can reassess financial rules, boost innovation and thwart bad actors | Guest Opinion

On Jan. 17, Miami Mayor Francis Suarez spoke at an event hosted by The Wilson Center which is the Federal government sponsored think tank. At that event entitled, “The New American Economy” the mayor offered this observation, “You have to update our laws. Our laws have a tendency to be very reactionary, right? Something happens and then we react as opposed to being proactive.”

FTX is a story of misplaced trust and missing money. Investors deposited funds with the cryptocurrency exchange company, and nobody is quite sure what happened to them. The history of financial innovation and regulation is littered with stories like that of FTX, where trusted bad actors or reckless risk takers caused monumental loss.

The cryptocurrency industry is in crisis, with market capitalization down almost 70%. Without prudent regulation, the FTX scandal could lead regulators to enact legislation that might eliminate the promise of a technology, blockchain, which has applications well beyond gambling on the next meme-token.

The crypto crisis of ’22 is an opportunity for policymakers to look at the evolution of financial regulation more generally and come up with the best approach to creating cryptocurrency policy. In doing so, Congress can reconsider the current financial regulatory landscape more broadly, while developing the correct approach to this new technology.

U.S. financial regulation is rooted in crisis and reaction to bad actors. The Securities Exchange Acts of 1933 and 1934 came in the wake of the crash of 1929. The Commodities Exchange Act of 1936 was enacted in response to manipulations and fraudulent trade practices in the futures markets. The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed during the Great Recession.

Reactionary regulatory policy has evolved into a patchwork of laws and agencies overseeing multiple, and sometimes overlapping, financial instruments and people. At the same time, lessons learned from prior crises can offer valuable insights to policymakers as they explore the current crypto crisis.

We can apply these lessons because cryptocurrency is simply a financial instrument. Exchanges like FTX allow investors to purchase and sell cryptocurrency, as well as engage in complicated transactions in digital asset linked derivatives.

But cryptocurrency is not a traditional financial instrument: It is built on blockchain technology, which is a distributed and decentralized data-storage system that can be used to store any type of information (similar to the centralized system of cloud computing). Blockchain can provide financial tools for people without access to banks and other financial institutions; a medical database for the healthcare industry; or a transparent tracking system for logistics and titles. Its advocates describe a future where social media and the web itself have moved onto blockchain infrastructure, allowing individuals to own their own data and control their own digital identities.

These are powerful cases of use that are developing beyond cryptocurrency, but blockchain’s success is still closely tied to that of cryptocurrency, an important financing tool and community currency for innovation in the industry. This relationship makes it essential that policymakers create a regulatory scheme around cryptocurrency that encourages responsible innovation.

Policymakers need to weigh innovation against regulation in the crypto space. During the financial crisis of 2008, Congress recognized that opaque and limitless leverage in the over-the-counter derivatives marketplace encouraged bad actors, unsound practices and systemic risk.

At the same time, policymakers recognized the valuable contribution that financial innovation like derivatives make to functioning capital markets. As a result, Congress crafted Dodd-Frank to address specific issues like transparency, leverage and systemic risk, allowing for continuing financial innovation.

Everyone from Wall Street to Main Street has an interest in innovation. However, unfettered markets can have dangerous consequences. The 2008 crisis demonstrates that the invisible hand of regulation, from time to time, needs to prevent bad actors or reckless activities. Trust sometimes requires third-party verification.

In the case of FTX, even the most seasoned investors lost money by putting too much value on trust alone. Many of Washington’s powerful bought into FTX owner Sam Blankman-Fried as he donated tens of millions of dollars to political campaigns. FTX bought advertising that made his company as American as apple pie. When FTX sponsored Major League Baseball, umpires (the ultimate arbiters of truth) were required to prominently display the FTX logo on their uniforms.

Bankman-Fried’s influence on the future of cryptocurrency regulation will be profound, but not in the way he envisioned. The FTX crisis gives legislators an opportunity to reassess financial regulation across the board to determine the most efficient means of enhancing innovation.

The promise of blockchain innovation may be the catalyst for a new perspective on age-old questions of how to prudently prevent bad people from doing bad things. FTX may be a signal that it is time for a comprehensive reset of domestic financial regulatory policy. In that way, the crypto crisis of 2022 is an important moment in regulatory history — and an important reminder that the more things change, the more they stay the same.

Alan Rechtschaffen is chair of the Digital Assets Forum and a Wilson Center trustee. Kellee Wicker is director of the Wilson Center’s Science and Technology Innovation Program.