The year 2022 will be remembered in financial circles as the meltdown year of cryptocurrency. It may also be the signal of a new recession; historically, downturns often begin with a spectacular commercial bust.
As I write, Sam Bankman-Fried, 30, the mop-headed guru of crypto, and second-largest donor to Democrats after George Soros, has been arrested and charged with defrauding investors. Bankman-Fried’s crypto trading company, FTX, which rocketed into a $32 billion business in three years, is now shut down.
The receiver, John J. Ray III, is familiar with corporate wreckage, having been the bankruptcy receiver at Enron. Upon looking over the dog’s breakfast left by Bankman-Fried, Ray said FTX had been run by “a very small group of grossly inexperienced and unsophisticated individuals,” who nonetheless walked away from a debt of something like $8 billion.
At the moment, media attention is on Sam, who, until a blink ago, was a wealthy and well-connected tycoon of cryptocurrency. But what is cryptocurrency? People are talking about it not knowing what it is.
Says the Federal Trade Commission: “Cryptocurrency is a type of digital currency that generally exists only electronically.” Kaspersky, the cybersecurity company, calls it “a digital payment system that doesn’t rely on banks to verify transactions.” “Instead of being printed,” explains the brokerage house TD Ameritrade, cryptocurrency is “computed through a vast network of independent computers…” Says the cybersecurity company Trend Micro: “A cryptocurrency is an encrypted data string that denotes a unit of currency.”
Nowhere do these accounts say that this “currency” is backed by anything. But then, neither are U.S. dollars, really. They used to be; for a long time, paper dollars promised to “pay the bearer on demand” in gold or silver coin. By the time when the gold promise was removed, in 1933, dollars were woven into every economic transaction in America: contracts, incomes, savings, the works. The system ran on dollars, whether they were backed by gold or not, and still does. Today, most of our dollars are not even paper, but numbers on a screen. You might call them “digital assets,” but they are dollars still, declared by law to be “legal tender for all debts, public and private.”
“Legal tender” is currency that must be accepted in payment of debts. Crypto is not legal tender in the United States. It is private currency. The original crypto, Bitcoin, was described by its inventor in 2008 as “an electronic payment system based on cryptographic proof instead of trust.” It uses a computer code called blockchain, which Forbes describes as “an open, distributed ledger that records transactions in code.” Forbes adds, “In practice, it’s a little like a checkbook that’s distributed across countless computers around the world” — whatever that means.
Crypto came with a story of liberation, the vision of an anarcho-libertarian world in which currency would no longer be a government monopoly. And if that were so, there could be more than one of them. Bitcoin was followed by Ethereum, Tether, Dogecoin, Polkadot, Dai, Litecoin, Solana, TRON, Chainlink, Algorand, ApeCoin, Elrond, on and on. Anyone could cook up a cryptocurrency, and many did. What was it, after all? Encrypted data strings. Ones and zeroes.
Are these really currencies? A currency is a medium for measuring and storing value so that people can buy and sell without resorting to barter. The value of a currency needs to be stable, at least over the short to medium term. That the U.S. dollar has lost 8 percent of its value in the past year is the largest such decline in decades, and has alarmed people. The big cryptocurrencies have lost two-thirds of their values in the past year. Bitcoin, the No. 1 cryptocurrency, has plunged from more than $60,000 to about $17,000. And at the outset, it was worth nothing.
In a report on cryptocurrencies in 2018, the Bank of England concluded that cryptocurrencies “are too volatile to be a good store of value, they are not widely-accepted as means of exchange, and they are not used as a unit of account.” Not a currency, then.
Cryptocurrencies are used for speculation. If a thing can go up in value fast, and people can buy it and sell it quickly, they will speculate in it. Four centuries ago, the Dutch speculated in tulip bulbs. In the 21st century, we speculate in digital things.
In itself, that may be OK. As I write, the public is paying $183 per share of Boeing stock, which for most buyers is numbers on a screen. Few shareholders have actual Boeing stock certificates. Still, Boeing stock is tied to reality in a way crypto is not: It is one 596-millionth share of ownership of America’s largest aircraft manufacturer.
Speaking at a TechCrunch talk in June 2022, the man who for decades was the Seattle area’s richest guy, Microsoft co-founder Bill Gates, disclaimed any interest in crypto. “I’m used to asset classes … like a farm where they have output, or like a company where they make products,” Gates said. Crypto, he said, seemed to be “100 percent based on the greater fool theory.”
The people who created crypto weren’t fools. The developer of blockchain and inventor of Bitcoin was a man who called himself Satoshi Nakamoto. (He has never come forward). He was said to be a genius. Sam Bankman-Fried is no dummy, either, even if FTX receiver Ray includes him in his list of “grossly inexperienced and unsophisticated individuals.” Dummies don’t create billion-dollar corporations.
Bankman-Fried comes from an educated family. His father, Joseph Bankman, is professor of tax law at Stanford University and author of such monographs as “Substitutes for Insider Trading” and “The Structure of Silicon Valley Start-Ups.” Bankman-Fried’s mother is Professor Emeritus at Stanford Law School and author of The Progressive Assault on Laissez-Faire: Robert Hale and the First Law and Economics Movement (Harvard, 1998).
Prosecutors are bound to label young Sam a criminal, aided in his malfeasances by his illustrious parents. Prosecutors know how to make people look bad. Maybe Sam was that, but more likely he went overboard in his pursuit of fortune, the moral shine of “Effective Altruism,” and his hope of changing the world.
If there was “an utter failure of corporate controls at every level” of FTX, maybe the reason was that Sam’s mind was somewhere else.