Scenes from the Senate's 'Crypto Crash' Hearing

The Senate Banking Committee's Valentine's Day hearing on the 2022 crypto crash showed very little love for the digital assets industry.

Which isn't really all that unexpected given the crash that saw Bitcoin lose some 75% of its value as a crypto winter exacerbated by a trio of major collapses that wiped $2 trillion off of the $3 trillion market capitalization at the height of the crypto boom in November 2021.

The hearing — named Crypto Crash: Why Financial System Safeguards are Needed for Digital Assets — saw proponents of tough regulation taking something of a victory lap while those in favor of a looser regulatory regime more subdued in their defense of a pro-innovation regime.

One non-crypto group that did come in for criticism from them was regulators, and specifically SEC chairman Gary Gensler, who was accused of being "asleep at the wheel," by Sen. Tim Scott, Republican of South Carolina.

Super Bowl Blues

Senate Banking Committee Chairman Sherrod Brown, an Ohio Democrat, started off the hearing by saying:

"What a difference a year makes. Go back to last year's Super Bowl. The cryptocurrency industry spent a whopping $54 million on eight ads promising Americans untold riches and the chance to make history … These ads left a few things out. They didn't mention the fraud. They didn't mention the scams … the outright theft. The ads didn't point out that you can lose big and cryptos huge price swings, they didn't tell you about the high fees pocketed by the crypto companies and they sure didn't explain that crypto markets lacked basic investor protections and oversight."

Noting that there were no crypto Super Bowl ads a day earlier, Sen. Brown turned to the tagline of FTX's 2022 ad:

"Turns out fortune doesn't favor the brave. It favors wealthy insiders."

Blame the Regulators

Sen. Scott started out by saying he wanted to address the elephant in the room.

"If [SEC] Chairman [Gary] Gensler is going to take enforcement action, Congress needs to hear from him very soon. The chairman had lots of time to do the rounds on the morning talk shows. If he has time for that. He should be here testifying with us this morning … If we foreclose financial innovation, we limit future generations from growth and opportunity. That said, financial innovation must be done in a safe and sound manner. In recent statements, the regulators, the SEC specifically have noted that it is the responsibility of crypto firms to comply with existing regulations. But it is also the responsibility of regulators to enforce existing regulations and to conduct appropriate effective supervision. The American people deserve to know why no action was taken prior to FTX's collapse and how millions of dollars of Americans' hard earned money just vanished into nothing."

Innovation's Value

Lee Reiners, policy director of the Duke Financial Economics Center, is the instructor in courses in cryptocurrency law and financial regulation, as well as a veteran of the federal reserve Bank of New York.

"Satoshi Nakamoto introduced the first cryptocurrency Bitcoin to the world in a nine-page white paper posted on Halloween 2008, and the first Bitcoin transaction occurred in January 2009. Fourteen years and thousands of cryptocurrencies and trillions of investor losses later, crypto scarcely resembles the purely peer-to-peer version of electronic cash first envisioned by Satoshi … The data is clear. Most people invested in crypto simply because they thought they could sell it to someone else at a higher price in the future. Sadly, these people were wrong. A self-serving line spawned by crypto boosters is that policymakers must embrace innovation, or else the crypto industry will migrate to other jurisdictions with a more favorable regulatory climate. But this implies that innovation is an unmitigated good… Instagram for kids is technically innovative. But does anyone think it's a good idea?"

Reiners' solution? Put crypto firmly in the hands of the SEC, carving it out of the CFTC's hands altogether.

"The SEC simply has more expertise, more resources, and more appetite for enforcement in the crypto realm than the CFTC does. Most importantly, unlike the CFTC, the SEC has a statutory mandate to protect investors."

DIY

Professor Yesha Yadav of Vanderbilt University Law School proposed "the creation of a self regulatory regime where cryptocurrency exchanges are tasked with oversight of the market as a whole."

Noting the existence of this type of body in the traditional securities industry, Yadav said the proposal had three goals:

"Firstly, it seeks to bring cryptocurrency exchanges within a framework for federal oversight… Second of all, it would seek to make cryptocurrency exchanges accountable… Third of all, it would make sure that cryptocurrency exchanges are in fact paying to look after their market. This means using [exchanges'] resources, using their expertise, using their knowledge, using their proximity to the technology to make their marketplace, as well as themselves, much more honest, much more stable and much more driven towards protecting customers. To be very, very clear with you, this is not in any way a substitute for public regulation. Rather, it's designed to be a complement."

Say What?

Several of the witnesses said that while the SEC's main tool is disclosure, the wide adoption of crypto by average people means that's not enough. Professor Yadav said:

"This is a technology that has been popularized and has been used by increasingly younger people, folks in minority communities. It's extremely important not just to focus on disclosure, but also literacy, making sure that these disclosures work ... making sure that disclosures are usable. Otherwise, just having a thick bundle of information is no good whatsoever if it's not something that is able to communicate these risks and opportunities effectively."

Comparing it to having blockchain engineers explain why crypto transactions are so transparent, Professor Linda Jeng, chief global regulatory officer of the Crypto Council for Innovation and a visiting scholar on financial technology at Georgetown said white paper disclosures should be required to clearly explain how a cryptocurrency is designed:

"What the risks are, who holds the private keys, the governance, the voting rights, and then, more importantly, where are the funds held?"