In the wake of the collapse of FTX, the world's second largest crypto exchange, and the loss of more than $2 trillion in supposed value among the largest cryptocurrencies this year, the Senate Banking Committee today held a hearing on "The Crypto Crash: Why the FTX Bubble Burst and the Harm to Consumers." The wide-ranging hearing examined the state of the crypto industry.
The Committee heard from a panel of witnesses across the crypto spectrum, including two academic experts -- American University law professor Hilary J. Allen and the Cato Institute's Jennifer Schulp -- and two television personalities: Shark Tank host Kevin O'Leary, who served as a paid spokesman for FTX and actor Ben McKenzie Schenkkan who studied economics at the University of Virginia and has been an outspoken critic of the crypto industry.
U.S. Senator Jack Reed (D-RI), a senior member of the Banking Committee, pointed out that FTX used cryptocurrency to cook its books and mislead customers, investors, lenders, and regulators.
During the hearing, Reed asked Professor Allen: "When we talk about crypto tokens, in fact, it's reported that FTX held about $900 million in liquid assets and $9 billion in liabilities when it failed. And the vast majority of FTX's assets were illiquid cryptocurrencies created and promoted by FTX and Alameda. The company held them at wildly optimistic valuations that turned out to bear little resemblance to reality. Can you explain how aggressive valuation practices contributed to the failure of FTX and put customers at risk, Professor?"
Professor Allen replied: "Many crypto assets are created out of thin air and there's no real basis for their valuation. There's simply no way to perform a sanity check on the valuations that are provided as those assets trade entirely on sentiment. And so, when assets trade entirely on sentiment, meaning what other people think they're worth, that creates a space where significant amount of leverage can be created, and fraud can easily go undetected."
Reed concluded his hearing remarks by observing that: "The one thing that seems to be consistent is that the need to regulate not just this industry, but private entities that are controlling a huge amount of funds that are investing in ways that are not obvious to the public, or even to their own shareholders or equity owners. And we have to move. I would suggest as a starting place to legislation I proposed," referring to the Private Markets Transparency and Accountability Act (the S. 4857), which Senator Reed introduced to require the largest private companies in the Nation, including FTX and other crypto trading platforms, to register their shares with the Securities and Exchange Commission (SEC).
After the hearing, Reed stated:
"There is inherent risk in any bet or investment, especially one as volatile and lightly regulated as cryptocurrency. The rules of the road that apply to traditional intermediaries in the financial markets also should apply to crypto trading platforms.
"We simply need more transparency into the biggest crypto companies. They are not required to disclose audited financial statements or comply with even basic corporate governance requirements. The public, customers, investors, and the government are kept in the dark about what's going on at the most important companies in these markets.
"When customers hand over their money to crypto trading platforms, they need confidence that company executives won't steal it to line their pockets. FTX's splashy Super Bowl ads certainly didn't highlight the risks for customers to entrust their money with FTX. The company attracted new money with celebrity endorsements, and now that money is gone.
"We already have a well-developed rulebook for trading financial instruments like cryptocurrency. Our regulators need to vigorously enforce these rules to protect investors. To the extent regulators need additional authority to address major risks and vulnerabilities in the crypto markets, I stand ready to work with the Administration and my colleagues on the Banking Committee."