Thanks Sam! How FTX led to the world’s worst crypto policy

When looking at Washington policymaking, it’s worth remembering that governments, like all human organizations, are made up of, well, people—complicated creatures whose emotions often undermine their ability to make rational decisions.

Last week, I warned of a dangerous politicization trend in US crypto policy following a barrage of regulatory enforcement actions against this industry. I’m still worried about that trend, but my view is now a bit more nuanced thanks to the insight of two people with very good DC connections. They explained how emotions—particularly anger and embarrassment—played a major role in driving these political actions.

It reminded me of the importance of clear, inviolable rules of governance, whether baked into democratic institutions like the US Constitution, or forged into consensus mechanisms used by open source software communities, like those associated with blockchain protocols.

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Among a number of “Thanks Sam” moments over the past five months, this one takes the cake. You could argue that the crackdown on Kraken, Coinbase, Paxos, Binance and others was largely driven by a desire to punish Sam Bankman-Fried, the former founder of FTX, whose astonishingly rapid collapse in November sent shockwaves through the crypto industry.

This is how one of my sources described the thinking of Biden administration officials, and of lawmakers from both political parties: “You can’t come into their house, fling 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 recipients of more than $74 million in political donations from FTX and had established ties to Bankman-Fried , which had wooed progressives with its “effective altruism” pledges.(A CoinDesk survey found that one-third of Congress took money from SBF or its associates.)

Virtually no one in this industry would attempt to reduce Bankman-Fried’s extensive wrongdoing and most now want tighter regulation. (Indeed, the biggest frustration is that the SBF’s actions have set back the chance for clear regulation, allowing agencies like the Securities and Exchange Commission to continue to be a law unto themselves.) What’s so irritating is the capricious and completely disproportionate response generated of that mistreatment.

Put aside that millions of investors, employees and developers with stakes in the crypto industry are now paying for the sins of a few fraudsters whose behavior they never knew about, let alone condoned. The biggest problem is that because there are very few physical or geographic reasons why blockchain developers would favor one country over another, the US is losing all capacity to shape the direction of this inherently borderless technology. No other developed economy takes such a hostile stance towards this industry.

There is a growing view that digital assets and blockchain innovation – now, in the age of artificial intelligence, more important than ever – will leave the US for friendlier shores. And it’s the particularly counterproductive concept that if the US wanted to keep technology away from rogue states, that makes it more, not less, likely.

The good news is that this vengeful moment is destined to subside – as most emotion-driven overreactions eventually do. Temperament will surely give way to a more mature approach to politics. Still, the damage already done to America’s prospects for attracting crypto investment, entrepreneurship, and innovation could be profound. US industry leaders of all stripes have warned of an exodus of crypto businesses.

You see, whether this is a “war on crypto” or just a deliberate bludgeon, crypto business people see the spate of criminal and civil charges as a message that in the absence of clear legislative guidelines defining what activity is and is not in bounds, it is now too risky to continue operating in the US

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

“DC is Veep. It’s not House of Cards.”

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

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 scoundrel 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 decisions of people like Vice President Selina Meyer, Julia Louis-Dreyfus’ comically flawed Veep protagonist.

These human failings, both evil and farcical, led the French philosopher Montesquieu to conceive of the doctrine of “separation of powers,” a principle of governance designed to protect the interests of society against the errors or corruption of its leaders. These ideas were then enshrined in the US Constitution and helped shape the Westminster system, with its three, independent branches of government.

They also inform the blockchain idea – originally identified in the Bitcoin Whitepaper – that we need a system to manage money, assets and information that is not tied to “trusted third-party” intermediaries. Having to rely on intermediaries and representatives will always leave us vulnerable to the problem that they are governed by people, not mathematics.

I am not a radical advocate of replacing the nation-state with some kind of digital “network state”, but it is interesting to think about how these new technologies allow people to enter alternative, decentralized economic systems and how this can indirectly put pressure on our politicians to raise their game.

Worryingly, the “war on crypto” puts the US 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 technology itself can impose a self-correcting force on the political system to avoid the worst outcomes.