Editorial: Cryptocurrency stars can flame out. But they can’t take their customers with them

Out of nowhere, 30-year-old Sam Bankman-Fried became a billionaire mover and shaker in the world of cryptocurrency. Careful to make friends of powerful Democrats and media columnists alike, he threw money around the halls of Congress — and everywhere else he went — while threatening to disrupt Chicago’s financial futures industry.

Known by his initials, “SBF” is a billionaire no more. The house of cards he built over the past several years came crashing down in a matter of days.

His FTX crypto exchange and the entangled Alameda Research hedge fund are now in bankruptcy, amid reports that customer funds are missing. As many as a million of SBF’s customers may have lost whatever they had in their trading accounts, which, unlike traditional bank and brokerage accounts, are not guaranteed by the federal government against a company’s failure.

Media reports are drawing comparisons to the fall of Enron Corp. or the Bernie Madoff Ponzi scheme. Everyone from police in the Bahamas to U.S. Sen. Dick Durbin, D-Ill., is demanding answers from SBF, who sent a series of tweets saying, among other things, he wants to make his customers whole.

Don’t count on it.

It’s too soon to know exactly what happened, and whether criminal conduct was involved. The insolvency expert appointed to shepherd SBF’s businesses through bankruptcy says he’s never seen such a “complete failure” of corporate controls.

“From compromised systems integrity and faulty regulatory oversight abroad to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented,” John Ray III, who helped oversee Enron’s bankruptcy, wrote in a court filing.

A “substantial portion” of the billions held at FTX may be missing or stolen, he wrote.

After a bank-run-style failure like this, no reasonable person should place their confidence in cryptocurrency trading operations. SBF had become the face of crypto, an innovator who supposedly had the money and brains to professionalize an upstart financial industry, which even before this latest fiasco was having a terrible year.

Good riddance, some might say. In August, we asked in these pages if the industry’s hard times meant the crypto craze was over. Our response is the same today as then: Let’s hope not.

We believe stronger rules and greater participation from mainstream financial firms will help this promising marketplace achieve its potential, minus the shady conduct that is giving it a bad name.

Cryptocurrencies are digital files that can be used as money and traded via blockchain, a digital ledger that permanently records transactions. The technology behind crypto is proven. It has the potential to reduce costs, speed up transactions and, yes, improve the security of financial operations around the world. So far, however, crypto markets have been used mainly for speculation.

Aided by lawyers, lobbyists and megabuck political donations, crypto operators created an image of being different from other financial players, and therefore not subject to existing regulation. But while SBF was wearing shorts everywhere and peering out from behind a mop of curly hair, he was angling to remake crucial parts of American finance.

He had in mind, for instance, a different kind of financial derivatives exchange from those pioneered in Chicago. At heart, he wanted to do away with checks and balances established over generations, and he received some support when he proposed the idea.

Chicago’s CME Group fought back, along with its rival InterContinental Exchange Inc., and it’s a good thing they did. Others evidently have been resisting SBF’s siren call as well. The “rules-are-for-everybody-else” attitude may have discouraged large mainstream firms from taking big risks as counterparties or direct investors in SBF’s operation.

As of today, there is no evidence that crypto’s latest failure is leading to a systemic financial crisis, as occurred when Bear Stearns, Lehman Brothers and AIG collapsed during the 2007-08 meltdown. It can take time for knock-on effects to reveal themselves, but with any luck the collapse of FTX will mainly be confined to those directly involved with FTX. Let’s hope that’s where the contagion ends.

For now, the crucial responsibility of regulating crypto in the U.S. remains a jump ball among different agencies. Speaking at the Futures Industry Association conference in Chicago this week, Commodity Futures Trading Commission Chairman Rostin Behnam said he’s hopeful this latest collapse will push Congress into action. Legislation has been stalled for months.

No doubt, clarity is needed about which federal regulator should take on crypto. Beyond that, we’re not even sure new rules are needed. If existing rules governing exchanges and public offerings had been applied and enforced in this case, customer funds would likely have been protected, as they are in other parts of the U.S. financial mainstream.

Whether it’s the CFTC, the Securities and Exchange Commission or some other regulator isn’t as important as resolving who’s on point and giving their staffs the opportunity to close the knowledge gap with crypto entrepreneurs — who seem to come up with new gambits by the day.

To the extent that it is resisting oversight, the crypto industry is hurting itself.

Crypto platforms operating in the U.S. should be welcoming the scrutiny needed to make their industry safe for the public to invest. That’s the path to future growth, and the wise course to follow for whoever’s left in this troubled business after the dust clears from the latest crypto bloodbath.

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