Friday, November 11, 2022

No Actual People Were Harmed In The Making Of This Market

FTX Token

The modus operandi of the crypto-bros in responding to criticism and calls for regulation is to talk about "innovation" and gaslighting about hypothetical future benefits, to deflect attention from the actual current costs of their favorite technology (see also autonomous vehicles). Below the fold I point out an egregious example of the genre.

What we see as I write this is that the anti-regulation forces (Binance) have destroyed the pro-minimal-regulation forces (FTX):

After days trying to shore up his teetering crypto empire, Bankman-Fried sought Chapter 11 bankruptcy for more than 130 entities in the FTX Group, including Alameda.

Bankman-Fried resigned as chief executive officer of the FTX Group as part of the filings, and John J. Ray III was appointed to replace him, according to a statement. Ray, a turnaround and restructuring expert, has previously served senior roles in bankruptcies including Enron.
This leaves the "investors" in FTX facing an indefinite but long wait to get any money back, if they ever do, because as Adam Levitin takes 77 pages to point out, the legal status of their "investments" in bankruptcy is obscure. What we also see is that apparently Binance suffers from exactly the same problem that it used to take down FTX:
Binance holds $74.7 billion worth of tokens of which around 40% are in its own stablecoin and native coin, according data shared by Nansen.
Of the $74.6 billion termed as networth, about $23 billion was in its own stablecoin BUSD and $6.4 billion in its Binance Coin, according to Nansen.

The exchange has also allocated 10.5% of its holdings in Bitcoin and 9.8% in Ether, Nansen data shows.
But the crypto-bros argue that these disasters are simply the price to be paid for the huge benefits of "financial innovation". Today's example of the genre comes from Aaron Brown in FTX Collapse Is a Feature, Not a Bug, of Financial Innovation:
The problems at FTX have already led to calls for more regulation of crypto, but there are three big problems with that idea. First is that these same disasters happen frequently in the regulated financial world. Particularly large examples lead to more regulations, but that never seems to stop people from finding new ways to make old mistakes. Second is that in all material respects relevant to these problems, FTX was already subject to regulations. FTX was not a bunch of anonymous offshore hackers nor was it run by regulation-dodging libertarians. Its three pieces were regulated, audited entities that — at least until someone proves different — complied with regulations.

The third and biggest problem is that FTX had good ideas — vetted by many smart people — about how to avoid financial disasters via technology rather than regulation. This was the main impetus for the introduction of Bitcoin after the 2008 financial crisis. We can’t dismiss those ideas because FTX failed. It’s not as if “more regulation” has any track record of success. Failure means we need more experimentation with more new ideas until we find a mix that works.

No new regulations will help FTX’s customers and creditors. They might stop someone from starting a copycat FTX, but no one is likely to do that now, nor would anyone trust it. What new regulations would do is block one of the most exciting areas of crypto innovation, which is a new type of financial exchange. Most of the promising ones are simple, pure exchanges without attached entities and that hold no customer funds. Automated market makers, frequent batch auctions, zero-knowledge orders, portfolio trading and other innovations attempt to use cryptographic security to take away the ability of people to cheat rather than just telling them not to do it and occasionally fining or jailing a few of them afterwards. These are padlocks rather than “Do Not Enter” signs. And if they prove successful, the new exchange mechanism can re-engineer trading in traditional assets as well as crypto assets.

No doubt there will be failures and scandals associated with these innovations, just as no doubt there will be failures and scandals associated with regulated financial institutions. But the innovations have the potential to fix problems and eventually eliminate them, while no one can believe that some future round of regulation will be the one to finally solve the ancient problems of finance.
So, Aaron Brown, how are these "good ideas — vetted by many smart people" working out in the actual present as opposed to the hypothetical future? Are they really managing to "avoid financial disasters via technology rather than regulation"? He even admits that, so far, they haven't. They have actually caused financial disasters. But not to worry, we'll just try something else. Eventually we'll find something that works.

What he cavalierly dismisses is that the costs of "financial disasters" aren't paid by the SBFs of this world, who escape with only a paltry few hundred million dollars, or even the Aaron Browns, but in the wrecked lives of ordinary people. He needs to read Molly White's heartbreaking collection of Excerpts from letters to the judge in the Voyager Digital bankruptcy case or the Consumer Financial Protection Bureau's 46-page Complaint Bulletin: An analysis of consumer complaints related to crypto-assets:
The majority of the more than 8,300 complaints related to crypto-assets submitted to the CFPB from October 2018 to September 2022 have been submitted in the last two years with the greatest number of complaints coming from consumers in California. In these complaints, the most common issue selected was fraud and scams (40%), followed by transaction issues (with 25% about the issue of “Other transaction problem,” 16% about “Money was not available when promised,” and 12% about “Other service problem”). In addition, analyses suggest that complaints related to crypto-assets may increase when the price of Bitcoin and other cryptoassets increase.
Actually reading the report is something that should, but likely wouldn't, upset Aaron Brown's world view. The CFPB reports that:
  • The top issue across all crypto-asset complaints was “Fraud or scam.” This issue appears to be getting worse, as fraud and scams make up more than half of “virtual currency” complaints received thus far in 2022. Some consumers stated that they have lost hundreds of thousands of dollars due to unauthorized account access. The prevalence of fraud and scam complaints raises the question of whether crypto-asset platforms are effectively identifying and stopping fraudulent transactions.
  • Consumers report many different scam types, including romance scams, “pig butchering,” and scammers posing as influencers or customer service. Crypto-assets are often targeted in romance scams, where scammers play on a victim’s emotions to extract money. According to the FTC, of all romance scam payment types, crypto-asset romance scams accounted for the highest median individual reported losses at $10,000. Some of these scammers employ a technique law enforcement refers to as “pig butchering,” where fraudsters pose as financial successes and spend time gaining the victim’s confidence and trust, coaching victims through setting up crypto-asset accounts. Some scammers try to use social media posts by crypto-asset influencers and celebrities to trick victims. Finally, lack of customer service options for many cryptoasset platforms and wallets creates opportunities for social media scams where attackers pretend to be customer service representatives to gain access to customers’ wallets and steal crypto-assets.
  • Crypto-assets are a common target for hacking. Consumers reported “SIM-swap” hacks, where an attacker intercepts SMS messages to exploit two-factor authentication, and phishing attacks, social engineering, or both. Companies oftenresponded to these complaints by stating that consumers are responsible for the security of their accounts. Crypto platforms are a frequent target of hacks by malicious actors, including certain nation-state actors. Hackers affiliated with one nation state have stolen over $2 billion in crypto-assets total, including more than $1 billion from Jan 2022 – July 2022 alone, and their hacks have included several prominent crypto platforms, including a “play to earn” crypto-asset game.
  • There are signs that older consumers are also impacted by crypto-asset frauds and scams. Older consumers report a higher rate of crypto-asset related frauds and scams compared to complaints overall: 44% versus 40%.
  • Complaints suggest that servicemembers are facing issues with crypto-asset scams. Servicemembers have submitted complaints about “SIM-swap” hacks, identity theft, and romance scams. Servicemembers have also submitted complaints about transaction problems and poor customer service at crypto-asset platforms.
  • Complaints about frauds or scams continue to rise, making up more than half of all total crypto-asset complaints received by the CFPB thus far in 2022. Crypto-asset complaints and fraud reports have also been increasing at other federal agencies: The SEC has received over 23,000 tips, complaints, and referrals regarding crypto-assets since fiscal year 2019, with a particularly sharp increase in the last two years, while crypto-asset losses reported to the FTC in 2021 were nearly sixty times more than in 2018
An increase of "nearly sixty times" in losses in three years is just the price ordinary people need to pay for the awesome benefits that accrue to the Aaron Brown of the world from "financial innovation".

The point of financial regulations is not to "avoid financial disasters". It is to prevent the inevitable financial disasters affecting ordinary people, by ensuring that their costs fall on the perpetrators.


David. said...

Patrick Boyle's FTX Bankruptcy Explained! is well worth watching.

David. said...

Dennis Kelleher's Setting the Record Straight on Crypto, FTX and Sam Bankman-Fried, Jamie Dimon, and Financial Regulators is excellent antidote to Aaron Brown, and well worth reading. It is especially good on the role of regulators:

"As detailed below, the SEC and banking regulators also clearly understood the fraud of crypto, although the CFTC decided to become a crypto cheerleader in an attempt to expand its jurisdiction (even at the expense of gutting the SEC’s ability to properly regulate the capital markets."

David. said...

More gaslighting about the hypothetical future from Jill Gunter in Crypto’s bad incentives are dying:

"Since the early days of the crypto industry, the incentives have just been about making money. These incentives have, unfortunately, held the industry back from focusing on creating actual, real utility."

The problem with Gunter's optimism is that decentralized systems cannot function without speculation in a cryptocurrency because they need to be costly in order to defend against Sybil attacks. The idea of non-speculative utility is a fantasy.

David. said...

One of the best pieces inspired by the collapse of FTX comes from Dean Baker. In Sam Bankman-Fried’s Truly Effective Philanthropy: Teaching he uses SBF to argue that:

"We should all recognize that Sam Bankman-Fried is much smarter than the rest of us. After all, outwardly he looks to be one of the biggest frauds of all time. By the age of 30 he amassed a fortune that dwarfs that of your average billionaire. He did it by running a crypto Ponzi-scheme. While claiming to be using his wealth to support philanthropies that were carefully selected to maximize human welfare, he was actually living a high life-style with his friends.

Now that the Ponzi has collapsed, the investors who trusted him look to be out of luck. And, of course there is no money for the philanthropies that he supported, many of which will are now struggling because they won’t get contributions they had been counting on.

That all looks pretty reprehensible, but maybe that’s the point. See, Sam Bankman-Fried was so committed to his philosophy of effective philanthropy that he was prepared to make himself appear to be the epitome of a despicable human being, and spend many years in prison, all to teach us that finance is a wasteful cesspool that needs to be reined in for the good of humanity. And, the place to start is his particular corner of the cesspool: crypto."

The key to his argument is:

"The broad finance, insurance, and real estate sector has more than doubled as a share of GDP over the last half-century, increasing from 5.5 percent of GDP in 1971 to 12.0 percent in 2021.[1] The additional 6.5 percent of GDP being devoted to finance in 2021 is equivalent to more than $1.4 trillion being absorbed by the sector. That comes to more than $11,800 a year for an average family"