When Will Crypto Learn From the Mistakes of Banks?

It’s time to bring the lessons of TradFi to crypto’s shadow banks, unregulated custodians and offshore exchanges before another FTX or Silvergate failure.

AccessTimeIconMar 15, 2023 at 3:26 p.m. UTC
Updated Sep 28, 2023 at 2:23 p.m. UTC
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Some crypto industry operatives will point to the failures of Silicon Valley Bank, Silvergate Capital and Signature Bank as further evidence that traditional financial (TradFi) institutions are ineffective and untrustworthy.

In fact, you may have already heard from the bitcoiner in your life about avoiding financial scares by storing their crypto in cold wallets. That sentiment feeds the narrative that banks have nothing to offer the crypto industry in terms of infrastructure, risk-assessment mechanisms and regulatory compliance.

Eric Sumner is the content chief at ReBlonde, a tech PR firm specializing in blockchain and Web3. Based in Tel Aviv, he’s a former editor for The Jerusalem Post.

The idea that SVB and the like somehow incriminate the entire banking industry and prove crypto works better couldn’t be further from the truth. Crypto cold storage is hardly an alternative to banking.

The reality is SVB seems to have made some bad Treasury bets, having failed to predict the inflation-induced interest rates we’re seeing now when it bought government bonds. That led to a massive bank run that will have ripple effects throughout tech, but it doesn’t as of now indicate wrongdoing on SVB’s part. That stands in stark contrast to FTX, for example, having straight up reallocated investors’ funds without disclosure and losing all their money. The same goes for Celsius Network and countless other crypto companies.

Crypto’s mission as an industry is to offer an alternative financial landscape that corrects for the mistakes of banks. Yet, ironically, too many founders replicate TradFi’s flaws in a blockchain setting because they refuse to learn the lessons banks have already learned from their own past mistakes.

There are a few clear reasons for that. Most notably, most crypto leaders come from a tech, rather than finance, background, and haven't put much of their youth into studying the history of finance to date. So enthralled by the beauty of blockchain as a technology, such founders forget that banks are actually quite good at what they do. Banks are effective at doing things like leveraging assets and assessing risk. Banks are also transparent about the fact that they lend out your money when they do.

Instead of recreating entire financial ecosystems from scratch, crypto projects should build on the things banks already do well. From there, they can pinpoint the problems and focus on solving those.

Top-down regulation works better than bottom-up trust

Some founders also miss the fact that regulation can work quite well. One of the main themes of the Obama-era financial reforms of the Dodd-Frank Act was an attempt to restrict the ability of banks to take risks using public money. While there is still debate over the overall efficacy of the Wall Street reform, industry leaders broadly agree capital requirements and stress tests are effective, according to a Grant Thornton survey.

The introduction of certain blockchain features and products introduces crypto-specific regulatory questions, such as how to classify different kinds of digital assets and how to address the issue of cold wallets. But the conceptual approach to regulating crypto already exists in laws like Dodd-Frank. Just as there is no need to reinvent TradFi practices that already work, there’s no need to start regulatory ideation from scratch.

Part of the challenge, however, is that much of the crypto regulatory framework in the works was crafted with the input of FTX’s former CEO, Sam Bankman-Fried. As such, it will be hard for regulators to determine which parts are genuine and which were designed to give FTX a competitive edge.

The truth is while SVB has taken over the news cycle, we’re still feeling the aftershocks of FTX and there are still questions that need to be answered. There are rules in place to prevent blatant fraud, but crypto companies do not always comply.

In its early days crypto was often compared to the Wild West. These days it looks more like an overgrown lawn in that it has experienced immense growth without the regulation to match, so it’s hard to follow the plot. That’s precisely why it’s important to recognize regulation is the only way to clean up the industry.

The U.S. Securities and Exchange Commission announced last month it’s considering a proposal to crack down on qualified crypto custodians to prevent foul play. Chair Gary Gensler even used Bernie Madoff and the 2008 financial crisis to justify the crackdown.

The next generation of crypto leaders should welcome that proposal and take a genuine approach to the regulation process. Supporting legitimate regulatory measures doesn’t mean bribing politicians behind closed doors to write the industry a blank check to do whatever it wants. That’s not real regulation, and certainly not the kind of approach that shaped Dodd-Frank and the like.

The naive sentiment that prevailed in crypto circles during the industry’s early days, that individuals can perform the same financial actions they would in a bank only minus the intermediary and minus the regulation, has simply been proven wrong. Businesses exist to earn maximum profit. The fact that a company happens to use blockchain doesn’t change that, and it won’t prevent shady practices if there aren’t any legal consequences.

Crypto has branded itself as the alternative to TradFi, and yet too many platforms seem to be building dollar-store TradFi knockoffs that don’t play by the rules. If founders can start by addressing that, then maybe crypto can start seriously talking about challenging the big banks.

CORRECTION (MARCH 21, 2023 21:30 UTC): An earlier version of this article implied Sam Bankman-Fried illegally transferred assets to Fireblocks. FTX reportedly initiated the transfer at the request of the Bahamian government.

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Eric Sumner

Eric Sumner is the content chief at ReBlonde and former editor for The Jerusalem Post.


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