Cornell University Professor Eswar Prasad and Solldus Labs VP of Regulatory Affairs Kathy Kraninger join Yahoo Finance Live to discuss the FTX collapse, how decentralized exchanges actually are, crypto regulation, and the outlook for the crypto sector.

Video Transcript

AKIKO FUJITA: A lot to break down here, but let's bring in our panel for the hour. We've got Kathy Kraninger, former director of the Consumer Financial Protection Bureau. We've also got Eswar Prasad, Tolani senior professor of trade policy and professor of economics at Cornell University.

Eswar, I want to start with you here because I know you've been watching this space very closely. We've heard so many people say that this isn't really about crypto at the end of the day. It is about the company, FTX, how they operated. Give me your reaction first to the charges that we have seen come down so far.

ESWAR PRASAD: It is about crypto in one very important way because if you think about crypto as an asset class, the basic requirements of an asset class are that you'll be able to keep those funds someplace safe, and that is custody of those accounts in a safe place, and to be able to trade those assets. That's what the FTX was supposed to do. It was supposed to custody accounts and also allow for easy trading.

Now, it turns out that the very basic elements of this asset-- of this asset class cannot be easily sustained because FTX was supposed to be the safest part of the operation. What we're learning now is that a lot of crypto, while it is meant to be decentralized, is, in fact, heavily centralized through these exchanges, which are hardly decentralized by any measure. And while the notion of decentralization was supposed to remove the single points of fragility or vulnerability, what we are finding out is that this centralization actually leads to a lot of vulnerability.

So the notion that crypto is a sector that can essentially escape the basic precepts of economics, finance, and corporate governance, that has certainly been put to the rest by the travails that FTX is undertaking. And also the fact that investors and consumers were willing to go in with their eyes blind and essentially got taken in by the razzle dazzle of the new technology and did not do their due diligence is certainly very worrying for the prospects of this entire industry.

RACHELLE AKUFFO: And, Kathy, Eswar raises an important point there, not centralized in the sense that it's banks. But when you have it centralized around a particular exchange or a particular personality like an SBF, what does that actually do then to, really, the credibility of the industry, and especially as you have these parallel investigations going on with the SDNY, the SEC, and then, of course, the Commodities Futures Training Commission as well.

KATHY KRANINGER: There is no doubt this is a huge blow to the credibility of this industry, someone who purported to be a true leader, who had a vision for a regulated industry, and who was a responsible player. And now obviously the wool is being pulled off of everyone's eyes here, and it looks like a classic case of fraud and greed and certainly has all of the soap-opera qualities of a story that just is unbelievable, frankly.

And I will echo the absolute need for due diligence. I mean, the investors, it's clear, did not do some of this, but you also get to the malfeasance versus negligence. That was the story that we've heard a bit in the media versus what you see in the indictments and in the SEC and CFTC allegations as well. So all of that is definitely going to be playing out here in the future, and people will be looking closely at it.

But I would say, yes, trading in crypto today is largely centralized. It's a matter of scale and other aspects of this. But you must have, as a company-- I mean, when you're purporting to put out and custody assets for clients and putting out a product to the public, you have to disclose information. You have to have internal controls and risk-management procedures. The things that you assert need to be true.

And so this really-- I'll use Chair Gensler's words. It's clearly a house of cards that fell about itself and harmed a lot of people.

AKIKO FUJITA: Kathy, it's been interesting to see all the finger pointing in the aftermath of this. You heard lawmakers in this House hearing that's going-- happening right now point the finger at the SEC, saying there wasn't enough enforcement. We heard from Chair Gensler last week on our air on Yahoo Finance saying that this isn't necessarily about new regulation, that there can be enforcement mechanisms with the rules on the books right now. And then you've got the CFTC saying we don't have enough right now of a mandate here to go after some of these companies. How do you see it?

KATHY KRANINGER: So I will say the FTX situation is distinguishable from many of the questions about how this ecosystem and this industry should be regulated. As I said, that will play out. That will play out in courts and the criminal proceedings as well as, unfortunately, the bankruptcy filings and otherwise. So we're going to see the risk management, corporate controls, governance was not there that should be there and distinguishing that.

But the question of what are the regulatory frameworks that should be in place for this ecosystem? Congress needs to act. There are some infrastructure dimensions like around stablecoins and how they are backed and reserved and making sure that is overseen. Some questions about, again, spot-market oversight and really bringing in a regulator that can do that oversight like the CFTC. So those are things that Congress will put into place.

But it is important to note to the public, that's why you're seeing criminal allegations here. There was fraud. That is illegal.

RACHELLE AKUFFO: Eswar, it does seem to be a case of playing catch up. When is sort of regulation by enforcement going to stop being the norm? Because we keep hearing there's regulations on the books, but yet these things keep slipping through.

ESWAR PRASAD: Yeah, I think there is still--

[INTERPOSING VOICES]

KATHY KRANINGER: You're absolutely right. I'd say that the regulatory dimensions are important. Oh please, go ahead.

ESWAR PRASAD: Sorry. There is a real quandary here about whether existing regulatory frameworks are going to be sufficient to regulate what seems to be a new-- or is purported to be a new asset class or if a fundamentally different framework is needed.

And I think we are moving towards some sort of resolution, but there are basic definitional issues that still need to be sorted out. So, for instance, is a stablecoin really a security or a commodity or is it a narrow bank or is it a money-market mutual fund?

These are really important, but basically I think we are dealing with more fundamental issues related to corporate governance, related to, you know, as your other guest mentioned, sheer fraud. So I think in this case we have a combination of greed, hubris, and sheer incompetence, and the question is how we can protect investors and financial markets more broadly from this sort of obvious malfeasance.

It's going to require a combination of, I think, existing regulation being enforced in a much more effective way in this new sector but also some new elements of regulation that require oversight in areas which seem to be decentralized, which seem to be very transparent, but where, in fact, there is much less transparency than you might believe.

I think there is certainly movement in Washington, but given how large the sector has become, how there might be potential spillovers to the traditional financial system, it's certainly going to be important for Congress, as your other guest pointed out, to move quickly rather than leaving it to the regulatory agencies one by one to try to figure out what to do within the existing regulatory parameters.

AKIKO FUJITA: Kathy, you agree?

KATHY KRANINGER: I do. I think Congress needs to act. And to your point about regulation by enforcement, it absolutely goes after bad actors, but it does not provide clear requirements to those who are seeking to be responsible market participants to offer services and the opportunities of this new technology.

So having a regulatory framework that's clear, having the industry working closely together and putting these measures into place around oversight are really important and valuable for the future.

RACHELLE AKUFFO: I know these will be conversations we'll continue to have.

A big thank you for joining us. Kathy Kraninger there, former director of the Consumer Financial Protection Bureau, and Eswar Prasad, Tolani senior professor of trade policy and professor of economics at Cornell University. Thank you both for joining up.