The vertiginous fall of Sam Bankman-Fried—the disgraced founder of the cryptocurrency exchange FTX who was recently convicted of fraud and money laundering in New York—has cast a harsh light on a largely unregulated market. For all the supposed wonders of the blockchain technology underpinning cryptocurrencies, the headline-grabbing events of the past few years indicate an industry in turmoil.
In addition to the criminal activity that led to the spectacular collapse of FTX in 2022 and Bankman-Fried’s guilty verdict in early November, US regulators have sued Binance—the world’s largest crypto exchange—for allegedly operating a “web of deception.” An industry-wide reckoning looms. Will crypto always be a magnet for fraud and misconduct, or can it eventually transform and democratize finance?
A paradox has become increasingly evident. After the 2008 global financial crisis, Satoshi Nakamoto, the pseudonymous creator of Bitcoin, introduced the notion of a purely peer-to-peer electronic cash system, a period marked by a significant erosion of trust in governments and central banks. Nakamoto expressed that the fundamental issue with conventional currency is all the trust that’s required to make it work shortly after the introduction of Bitcoin in 2009. Today, the system that was supposed to eliminate the need for trust between people and traditional financial institutions is experiencing a crisis of faith.
Cryptocurrencies like Bitcoin and Ethereum operate based on computer code and decentralized networks that are not controlled or managed by any central authority. Remarkably, such decentralization works. Transactions can be securely completed without relying on a credit card company, bank, credit card company, or any other institution. This feature is expected to reduce the vulnerability of financial systems to fraud and manipulation.
Unfortunately, grifters and unscrupulous companies have exploited customers and investors enamored with the new technology and, in the process, obscured crypto’s most compelling innovation: blockchain-enabled tools that can improve transparency and strengthen the trustworthiness of the financial sector. Maintained on computers worldwide and publicly accessible by anyone with an internet connection, blockchains are digital ledgers that carry an immutable record of all transactions in a system. Their reliance on algorithms, rather than human interaction, creates a robust money trail that traditional financial infrastructure needs to improve.
So, how did we end up with a crypto industry that often contradicts its founding ethos? One answer is that any innovation inevitably attracts speculative mania and chicanery, especially in its early development stages. In the 19th century, banks deceived examiners by padding gold reserves with nails. More recently, the dot-com era gave us the likes of Enron, while a biotech boom brought us Elizabeth Holmes and Theranos.
Another problem is that the new industry’s consumer-facing platforms have grafted old business methods onto a technology explicitly designed to do away with them. While FTX was an ‘exchange’—a gateway to blockchain-powered cryptocurrencies—it did not fundamentally use decentralized technologies. Most crypto holders today store their assets in exchanges that require high trust and carry many of the risks of traditional financial institutions.
Behind the scenes, the crypto industry has started using technology to shift the balance toward innovation. One example is the development of proof of reserves, a mathematically based method that enables institutions to verify their crypto assets. Such tools could help prevent debacles like FTX, where the lack of transparency allowed Bankman-Fried to conceal financial fraud.
Notably, proof of reserves and similar tools work best for cryptocurrencies, not ordinary financial assets—including the US dollar. These technical advances have, therefore, prompted traditional financial institutions—the very ones Bitcoin sought to replace—to embrace crypto. For example, JPMorgan intends to transfer trillions of dollars of value onto the blockchain. Simultaneously, monetary authorities are investigating Central Bank Digital Currencies (CBDCs), a development that utilizes blockchain technology to issue digital versions of their respective fiat currencies.
The crypto industry faces several daunting challenges: the large environmental footprint of Bitcoin mining, its use for illicit transactions, privacy shortcomings, and more. But, as proof of reserves suggests, the crypto community is innovating powerful new ways to harness blockchain technology’s inherent transparency and trustworthiness to create a more secure and flexible financial ecosystem.
As these innovations proceed, governments worldwide are exploring ways to safeguard consumers from the crypto industry’s excesses. They would do well to look past the headlines that often scream scandal and seek a balanced approach that enables this remarkable technology to thrive.
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