Following the recent collapse of FTX, it’s time to repurpose an old Reagan-era phrase: “Trust, but verify.” First used in the context of Cold War nuclear arms diplomacy, the phrase now applies to today’s cryptocurrency markets, which have exposed small investors to disproportionately high risk.
The federal government is at a crossroads, facing two possibilities: They can either continue on the current path and keep the door open to more instability or regulate crypto, potentially lending legitimacy to a novel financial product–but also putting it through a stress test that will require it to demonstrate that its much-touted merits can stand up to scrutiny.
I’ve spent decades studying the sociology of trust as it relates to credit, regulatory arbitrage, and financial markets–and I would argue that regulation is most likely to serve as a stabilizing force, while protecting small investors from the extreme losses that many suffered after FTX’s downfall. If crypto is here to stay, it’s time for regulators to step off the sidelines.
A perfect storm has been brewing over the past few years in crypto markets. Retail investors rushed in, perhaps motivated by the fear of missing out or inspired by the prospect of spectacular gains. Promoters eased their way by creating user-friendly apps so that people could trade from their home computers and smartphones. Investing began to seem like a game.
Many of these new entrants into the market didn’t fully understand what they were getting into and the risks they were running. They may have trusted prominent market figures like FTX’s now-disgraced founder Sam Bankman-Fried, well-placed celebrity endorsements like Larry David’s Super Bowl ad for FTX, or the “smart money” put into crypto by venture capital firms, hedge funds, and private equity.
We’ve since seen that even the smart money wasn’t so smart. Cryptocurrency markets have gone through multiple booms and busts as they gradually moved from the anarchic fringe of the tech industry toward the center of financial markets.
The SEC’s job has been made easier
Many federal politicians have been swayed by industry lobbying efforts, so until now there has been little effort to set standards or establish protections for small investors. Regulators have also been hesitant about what to do, not sure if these exotic and unstable assets involved financial securities, derivatives, money, or something entirely different. They were reluctant to meddle with transactions that seemed to be on the cutting edge of wealth generation.
As cryptocurrency markets face their own “Lehman Brothers moment,” one must consider whether the sudden losses could be contagious, or even threaten to destabilize the broader financial system. The bigger crypto markets become, and the more …….
