The arrest of Sam Bankman-Fried will not stop a crypto-driven recession

The recent arrest of Sam Bankman-Fried at the behest of the Southern District of New York is a sign that the crypto bubble’s impact on the “real” economy may be less destructive than the housing bubble of 2008 or the dot-com bubble some have said years before.

Alongside criminal investigations (and sanctions if necessary), the priority should be to regulate and restore confidence before it is too late. This should include, if not be led by, the Federal Reserve, which is ultimately the guarantor of the fiat system. Inaction is not an option as more and more Americans’ savings — and even retirement accounts — are exposed to crypto.

When crypto sneezes, our entire economy catches cold. Investment banks scramble to get money back after FTX collapse. I think we’re in the early stages of what happened in the ’90s with the dot-com bubble and the 2008 housing crash — a speculative bubble that regulators have ignored for too long. It’s now being tackled by prosecutors, but prosecutors can only act after things are blown up — not before.

Regulation is always a delicate balance. But if regulators had acted so early in the dot-com and real estate bubbles of the past few years, market crashes might have been mitigated or even averted. The parallels are uncanny. In 2021, Bitcoin’s price skyrocketed by more than 700 percent in just 12 months and then quickly lost three quarters of its value.

The dot-com bubble was similar. Between 1995 and its March 2000 peak, the Nasdaq Composite stock market index rose 400 percent, only to fall 78 percent from its peak by October 2002.

The way crypto is today, the dot-com bubble of the 90s was every investor’s dream. And real value was created – this era spawned incredible companies that still exist today, like Amazon and Google. But for every valuable, sustainable company, there were many more tech companies that emerged from thin air with no value proposition. That didn’t stop them from attracting huge investments, often based on nothing more than a pitch deck and a domain name. This lasted until the early 2000s – when the bubble burst.

Markets plummeted 78 percent, causing many tech companies to file for bankruptcy and disappear. When the dust settled, more than $5 trillion was lost. It wasn’t until the damage was done that regulators acted with tighter IPO processes.

Regulators also acted too late during the 2008 housing crisis, which was fueled by cheap credit and lax lending standards. When that bubble burst, banks withheld trillions of dollars in worthless investments. This likely caused the recession to be deeper than it otherwise would have been as financial markets were sidelined by a wide-ranging endemic problem. Many ordinary Americans lost their jobs, savings, and homes in the process.

Gilded souvenir cryptocurrency
Gilded souvenir cryptocurrency Tether (USDT), Bitcoin and Ethereum coins arranged next to a screen showing a trading chart.
JUSTIN TALLIS/AFP via Getty Images

Regulators must learn the lessons of history, or be doomed to repeat them. An almost completely unregulated crypto market, formulated (perhaps intentionally) in language that lawmakers barely understand, is more dangerous than any of the previous bubbles due to its ease of access to the masses compared to the previous bubbles.

The economy was already vulnerable. Over a decade of virtually zero interest rates has been exacerbated by the pandemic. The result has been increased lending, higher inflation, and most importantly, many locked-up, bored individuals with newfound disposable income thanks to the COVID-19 relief payments.

Many of them have been seduced by rags to riches stories and the potential for leverage to generate outsized returns. The possibility of outsized losses has not been as much of a focus for crypto influencers, who effectively operate as unregulated financial advisors. As in 2000 and 2008, there was a generation of inexperienced investors who had yet to go through an economic cycle. You’ve only seen charts going up and to the right. Unlike those cases, this time all they had to do was download an app, link a bank account, click a button, and they were done. Technology is an amplifier of both good and bad.

Arrests, where justified, are an important step to limit the threat of the crypto bubble, which even now has only partially burst. But the priority must be protecting the economy and the public and restoring confidence before any real damage is done.

Other governments are quick to recognize this and take action. The UK has just announced that it is finalizing plans to regulate the crypto sector. This includes overseeing how companies operate and advertise their products to the public. This is in the interests of investors, but also of the (legitimate) crypto industry. The UK Prime Minister has previously stated that “‘effective regulation’ would make the UK a global hub for cryptoasset technology.”

As the largest economy in the world, the United States has a special leadership responsibility. Just as the US dollar is the “gold standard” of the traditional financial system and the Federal Reserve is its regulator, the US and the Fed should lead the way in the new crypto economy.

We acted too late in 2000. We acted too late in 2008. In 2023 we can break the pattern. If there had been any guard rails, we would not have needed arrests now.

Joe Hipsky, co-founder and chief strategy officer of iraLogix.

The views expressed in this article are the author’s own. The arrest of Sam Bankman-Fried will not stop a crypto-driven recession

Rick Schindler

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