Since my last post, the crypto market has imploded, almost precisely as most financial journalists and myself predicted last year. The stablecoins at the core of the entire space were all a house of cards built on lies and were never fully backed, and thus became systemic once the market direction inverted. This future was all incredibly predictable, and the same phenomenon has occurred in dozens of other market manias throughout history. There’s nothing new under the sun; this has all happened before and will happen again. But now we have to turn out eyes to the post-mortem and look at the carnage that was unfortunately incredibly preventable. We must ask some fundamental questions about why this disaster occurred.
An average crypto investor is just a normal person, the salt of the earth people who don’t know anything about technology, finance, or the history of market manias. They didn’t know how to analyze risk on investment and were honestly chasing what they thought was easy money, all while our public institutions ultimately failed to do their jobs. And worse, it wasn’t due to bureaucratic incompetence but an explicit choice to let the public fall into harm’s way.
Two officials bear the bulk of public scrutiny for their actions, or more explicitly, their choice of inaction. These are Jay Clayton, chairman of the SEC under President Trump, and Gary Gensler, chairman of the SEC under President Biden. Both men have done enormous harm to the public by legitimatizing and allowing crypto investment schemes to run wild through markets with no regulatory oversight, which is their job.
There is a common misconception that American law does not know how to deal with crypto assets, which is entirely false. Crypto assets are investment contracts, and they clearly meet the Howey Test for securities and fall under the remit of the SEC. And yet the SEC is explicitly choosing not to regulate these investments for seemingly no reason. This selective enforcement is a choice being made behind closed doors, thus undermining both the democratic process and the rule of law. If unelected bureaucrats can selectively choose which laws from Congress they personally want to enforce, then this undermines both the rule of law and our democracy itself.
Gensler and Clayton had had plenty of clear choices put before them where they consistently made the wrong decision, so much so that it’s impossible to assume good faith anymore. On April 1, 2021, Coinbase Global, Inc filed its S-1 for an initial public offering. While not the only exchange, it is the first one that put itself up for public scrutiny by the SEC and was a critical moment that the agency had to act. For global crypto exchanges, their entire business model is to act as a fully vertically integrated broker-exchange-market-maker for unregistered securities. The whole model business of market making for crypto is entirely based on securities fraud, which the entire purpose of the SEC as an agency is to prevent. And yet, in the most blatant affront to its fundamental mission, the SEC just casually decided to let the company go public with no scrutiny whatsoever. This is a clear and explicit choice by chairman Clayton to ignore the mandate of the agency he chaired. There is no more straightforward example of legitimatizing and turning a blind eye to enforcement. It’s as if the police stumbled in on a bank robbery and then just decided that armed robbery is “OK today.”
Not surprisingly, Clayton immediately joined a crypto firm after his tenure was over. There is no better example of regulatory capture and the revolving door than this.
After Clayton, President Biden appointed Chairman Gensler to head the agency. Gensler had an understanding of technology, as he gave lectures at MIT about blockchain technology. In hindsight, these lectures are intellectually flawed, but they represent a 2017-era understanding that was not exceptionally uncommon. There was indeed a great deal of optimism around the financial sector uses cases of the technology for post-trade clearing, settlement, processing, trade finance, and supply chain applications. However, in the years after, every single attempt to apply the technology to these applications has completely failed. Crypto and blockchain are now universally considered failed projects.
During his tenure, Gensler paid ample lip service to the securities framework and said many empty words about how crypto assets fall under it. And yet Gensler has done nothing to uphold the laws the agency is mandated to enforce regarding crypto. Chairman Gensler is all talk and no trousers. And this strange situation leads to increasing legal schizophrenia where in our society, the private sector can effectively ignore the laws as written because the cop on the beat decided to go out for donuts instead. And after a year of his tenure and no action and a market meltdown on his watch, we have to regard his action as an abdication of the agency’s role as an explicit choice. Congress doesn’t need to write any new rules, SEC v. W. J. Howey Co still applies, and yet we have a chairman who clearly is undermining a hundred years of precedent for whatever his unclear personal interests are. What is clear is that President Biden chose poorly for this role, and history will likely not be kind after the final existential collapse of the crypto market and with the public asking the simple question: Where were the regulators?