Why is the SEC still allowing crypto to run wild? 

The prosecutions of Sam Bankman Fried (FTX) and Changpeng Zhao (Binance) stand in stark contrast to the SEC’s approvals last week of the issuance of Bitcoin Spot ETFs. As the government is sending crypto kingpins to jail, it is also sprinkling cryptocurrencies with a veneer of government approval.  

Securities and Exchange Commission Chaiman Gary Gensler says he was caught between the limits of his agency’s authority and a U.S. Court of Appeals decision that ordered the agency to better explain itself when rejecting applications. Gensler warns that the Spot ETF approvals do not signal the commission’s willingness to approve or clarify the issues surrounding other crypto assets.  

Honk if you think that is how the markets interpret the SEC’s approvals. 

The SEC missed an opportunity to protect the public interest, opting instead to take a narrow view of its role and settle for anointing itself king of the crypto regulators. In fairness to the SEC and federal banking regulators, the problem is that elected representatives in Congress have seemingly been incapable of motivating themselves over the last 15 years to come to grips with the fact that cryptocurrencies, as part investment and part currency, don’t fit into any conventional regulatory structure. So unelected regulators have had to try and do Congress’s job for it. 

In going beyond its 2021 approval of Bitcoin Futures ETFs, the SEC has now made it easier for non-institutional investors to dabble in the crypto market. First-day trading in these new instruments sucked a whopping $4.5 billion from other parts of the market. SEC Commissioner Caroline Crenshaw warned in her thoughtful dissent to the approvals that there is something seriously amiss with underlying crypto products, citing an analysis that found that 51 percent of reported daily bitcoin trading volume at 157 exchanges were likely bogus. She argues that there is ample evidence that SEC oversight is not reasonably designed to prevent fraud or manipulative acts and protect the public interest.  

Embedded in her dissent are our concerns with constructing new financial markets on a foundation of seriously flawed homemade cryptocurrencies that slip between the boundaries of conventional regulation. 

The SEC does not regulate the quality of products or delivery systems. Unlike bank and payments systems regulation, where the quality of what is done and sold is tightly controlled, under SEC disclosure rules, you can sell shares in a grand jury’s ham sandwich as long as the risks inherent in the purchase — i.e., its worthlessness — are accurately described. That is where the unique features of cryptocurrencies take advantage of the current system of oversight, by acting like securities but also purporting to be currencies that enable new payment systems. 

Congress has failed to recognize the financial challenges created by these instruments and has done nothing to protect consumers or build in systemic precautions. As a result, the value of 23,000 cryptocurrencies, the derivative securities built from them, the leverage created in their purchase, and the capital invested in new ETFs are approaching the size of the U.S. mortgage market. The crypto industry is rapidly becoming capable of impacting traditional financial markets and creating a new brand of financial instability right before our eyes that the rest will have to pay for. 

But threats to the financial stability of the U.S. economy are not the only risk that Congress should be concerned with. Even if the hype about crypto’s democratization of money, security, efficiencies and inclusiveness are true, cryptocurrencies represent a gift to terrorists, hostile nations, criminals and cyber creeps by turbocharging the financial damage that can be done through global money laundering, cyber espionage, repressive surveillance, terrorism, human trafficking, weapons sales, child sexual abuse, online theft and network shutdowns. While tens of billions of dollars are spent every year trying to keep felons — and worse — out of global banking and financial systems, they are essentially being offered access through the unregulated world of crypto.  

We are all for giving investors the opportunity to lose money on speculative fliers. But we get concerned when investment products that double as digital currencies can be invented, moderated, sold, and exchanged by who-knows-who and permitted to become so large that they impact traditional financial systems. 

As Commissioner Crenshaw suggested, the Spot Bitcoin ETF applications provided the SEC with a gold-plated opportunity to expose the underlying flaws in the crypto business and the systemic issues that are being created. The SEC could have deferred its decision until Congress acted. At the other end of the spectrum, it could have begun to regulate the quality of the underlying crypto business despite the legal challenges to its authority that invariably would have followed. It did neither, deciding instead merely to allow the market to decide and see where the chips may fall.  

We are not so removed from the subprime lending disaster to have forgotten how those chips fell when a defective mortgage foundation collapsed the house of securities built on top of it. 

Thomas P. Vartanian, a former federal bank regulator, is currently executive director of the Financial Technology & Cybersecurity Center and the author of “The Unhackable Internet.” 

William M. Isaac, former chairman of the FDIC & Fifth Third Bancorp, is chairman of Secura/Isaac Group, a consultancy to financial institutions globally. The views expressed are his alone and do not necessarily reflect the views of any firm with which he is or has been associated.