    [Senate Hearing 117-757]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 117-757

        CRYPTO CRASH: WHY THE FTX BUBBLE BURST AND THE HARM TO CONSUMERS

    =======================================================================

                                    HEARING

                                   before the

                                  COMMITTEE ON
                       BANKING,HOUSING,AND URBAN AFFAIRS
                              UNITED STATES SENATE

                        ONE HUNDRED SEVENTEENTH CONGRESS

                                 SECOND SESSION

                                       ON

        EXAMINING THE FAILURE OF THE NON-U.S. AND U.S. BASED FTX CRYPTO
      EXCHANGES AND THE FALLOUT AFFECTING OTHER CRYPTO AND FINANCIAL FIRMS

                                   __________

                               DECEMBER 14, 2022

                                   __________

      Printed for the use of the Committee on Banking, Housing, and Urban
                                    Affairs

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                    Available at: https: //www.govinfo.gov /

                                 _________

                     U.S. GOVERNMENT PUBLISHING OFFICE

    53-797 PDF               WASHINGTON : 2023

                COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                         SHERROD BROWN, Ohio, Chairman

    JACK REED, Rhode Island              PATRICK J. TOOMEY, Pennsylvania
    ROBERT MENENDEZ, New Jersey          RICHARD C. SHELBY, Alabama
    JON TESTER, Montana                  MIKE CRAPO, Idaho
    MARK R. WARNER, Virginia             TIM SCOTT, South Carolina
    ELIZABETH WARREN, Massachusetts      MIKE ROUNDS, South Dakota
    CHRIS VAN HOLLEN, Maryland           THOM TILLIS, North Carolina
    CATHERINE CORTEZ MASTO, Nevada       JOHN KENNEDY, Louisiana
    TINA SMITH, Minnesota                BILL HAGERTY, Tennessee
    KYRSTEN SINEMA, Arizona              CYNTHIA LUMMIS, Wyoming
    JON OSSOFF, Georgia                  JERRY MORAN, Kansas
    RAPHAEL WARNOCK, Georgia             KEVIN CRAMER, North Dakota
                                         STEVE DAINES, Montana

                         Laura Swanson, Staff Director
                     Brad Grantz, Republican Staff Director
                           Elisha Tuku, Chief Counsel
                     Dan Sullivan, Republican Chief Counsel
                          Cameron Ricker, Chief Clerk
                          Shelvin Simmons, IT Director
                            Pat Lally, Hearing Clerk

                                      (ii)

                                C O N T E N T S

                                  ----------

                          WEDNESDAY, DECEMBER 14, 2022

                                                                       Page

    Opening statement of Chairman Brown..............................     1
            Prepared statement.......................................    40

    Opening statements, comments, or prepared statements of:
        Senator Toomey...............................................     4
            Prepared statement.......................................    41

                                   WITNESSES

    Hilary J. Allen, Professor, American University Washington
      College of Law.................................................     6
        Prepared statement...........................................    44
        Responses to written questions of:
            Chairman Brown...........................................    80
            Senator Tester...........................................    81
            Senator Warnock..........................................    84
    Kevin O'Leary, Investor..........................................     8
        Prepared statement...........................................    64
        Responses to written questions of:
            Senator Tester...........................................    86
            Senator Cortez Masto.....................................    89
            Senator Warnock..........................................    90
    Jennifer J. Schulp, Director of Financial Regulation Studies,
      Center for Monetary and Financial Alternatives, Cato Institute.    10
        Prepared statement...........................................    66
        Responses to written questions of:
            Senator Tester...........................................    93
            Senator Warnock..........................................    95
    Ben McKenzie Schenkkan, Actor and Author.........................    11
        Prepared statement...........................................    76
        Responses to written questions of:
            Chairman Brown...........................................    96
            Senator Tester...........................................    96
            Senator Warnock..........................................    98

                  Additional Material Supplied for the Record

    Letter submitted by National Association of Federally-Insured
      Credit Unions..................................................   100
    Letter submitted by AFR, et al...................................   101
    Letter submitted by North American Securities Administrators
      Association....................................................   105
    Letter submitted by Alliance for Innovative Regulation...........   110

                                     (iii)

        CRYPTO CRASH: WHY THE FTX BUBBLE BURST AND THE HARM TO CONSUMERS

                                  ----------

                          WEDNESDAY, DECEMBER 14, 2022

                                            U.S. Senate
                Committee on Banking, Housing and Urban Affairs
                                                        Washington, DC.
        The Committee met at 10 a.m., in room G50, Dirksen Senate
    Office Building, Hon. Sherrod Brown, Chairman of the Committee,
    presiding.

               OPENING STATEMENT OF SENATOR SHERROD BROWN

        Chairman Brown. The Senate Banking, Housing, and Urban
    Affairs will come to order. Thank you to the witnesses for
    joining us today.
        Today's hearing, we believe, is in a hybrid format. That
    was the intent. We are having some problems, some technical
    problems that may be Senate-wide, and Cameron is a genius at
    this stuff and doing everything he can to fix it. So we are
    letting Committee Members who sometimes want to ask questions
    remote, that they probably need to show up in person. So that
    is our issue; certainly not the witnesses'.
        I want to express my gratitude to the Department of
    Justice, the SEC, the CFTC, and the Bahamian authorities for
    taking the critical step to hold Sam Bankman-Fried accountable
    for his misdeeds. I would also like to thank Ranking Member
    Toomey and his staff--thank you--for working with me and my
    staff to try to secure Mr. Bankman-Fried's testimony. I trust
    that he will soon be brought to justice. It is clear he owes
    the American people an explanation.
        Meanwhile, our job is to keep learning more about the
    collapses of FTX and other crypto firms--and I emphasize ``and
    other crypto firms''--and work with regulators to put
    consumers, not the crypto industry, first.
        This is not just about crypto. This is about protecting the
    consumers and the regulated financial sector from bad actors
    who think rules simply do not apply to them.
        Two-and-a-half years ago, I explained why I thought
    Facebook's Libra currency was dangerous. At the time, Facebook
    was moving full steam ahead, as most of you know, to create its
    own ``currency''--put that in quotation marks--to impose on its
    billions of users. Congress, regulators, and policymakers saw
    Facebook Libra for what it was: a shiny new tool Facebook could
    use to reach into Americans' pockets and profit from, no matter
    the risk to consumers or our economy.
        Members of this Committee, and others in Congress,
    responded. Republicans and Democrats alike made it clear that
    Facebook could not be trusted, and our financial system was not
    to be played with.
        The risk of a company creating its own currency to compete
    with the U.S. dollar was obvious. Ultimately, Facebook shut
    down its crypto project, but this Committee's work to protect
    consumers of course continues. Even though Facebook shelved its
    crypto plans, in the last 2\1/2\ years, the stablecoin market
    has grown 20 times, to become a tool for rampant speculation.
        The number of crypto tokens has exploded, even as the total
    value of all crypto assets fell by two-thirds in the last year.
        I have noted in the past the similarities that
    cryptocurrencies share with risky mortgage bonds and over-the-
    counter derivatives during the lead up to the financial crisis.
    In all these cases, they told us how great innovation is and
    how derivatives make markets efficient. Wall Street made it
    easy for everyone to get a mortgage so bankers could create
    more mortgage bonds and increase profits. Making money in
    crypto seemed easy, too easy. Every crypto token could double
    or triple in value in a matter of hours or days.
        It did not matter if it was created with vague details or
    as a joke. Money still poured in. But no one is laughing now.
        The weekend before our stablecoin hearing last February, we
    saw crypto companies spending big money on Super Bowl ads to
    attract more customers and pump up crypto tokens. I appreciated
    the comments of one of you in this panel on public radio today
    about that.
        Crypto, like Facebook's Libra before it, was the shiny tool
    that was supposed to capture our imagination and revolutionize
    our lives. Wealthy celebrity spokespeople told Americans, if
    you are not buying crypto, you are missing out.
        Crypto platforms created dozens of investment products,
    products that look and sound like bank deposits, and that used
    words like ``lend'' and ``earn,'' or tokens that resemble
    securities and have a ``yield'' or governance rights. Yet these
    products had none of the safeguards of bank deposits or
    securities.
        Crypto firms, and their backers, argued that billions of
    dollars invested in lending programs, or earning yield, should
    be exempt from basic oversight and regulatory protections.
        That is not how regulation works. The things that look and
    behave like securities, commodities, or banking products need
    to be regulated and supervised by the responsible agencies who
    protect the public and serve consumers.
        Crypto does not get a free pass because it is shiny and
    bright, or because venture capitalists think it might change
    the world, or its TV ads campaigns were witty and featured
    famous people, especially when so many consumers are at risk of
    losing their hard-earned money.
        And that is before we even consider how crypto has ushered
    in a whole new dimension of fraud and threats to national
    security--people are talking about that more and more because
    it is a central issue in this--that support dangerous Nation
    States, embolden criminals, and finance terrorists.
        North Korea uses crypto stolen in hacks to finance its
    ballistic missile programs. Think of that. Human traffickers
    and drug cartels and gunrunners launder their proceeds using
    crypto assets--think of that--and some of these laundered funds
    end up bankrolling terrorists bent on undermining our Nation
    and our society. Think of that.
        The ability of rogue States, cyber criminals, and
    terrorists to use crypto for their own malign purposes is a
    feature of the technology, and that is the point.
        Crypto also has made it easier for fraudsters and scammers
    to steal consumers' money. Hacks and complex crypto
    transactions made it easy to steal billions of dollars of
    investors' money. That is what we saw with FTX. That is what
    will continue as long as we allow crypto firms to write their
    own rules.
        The myth of Sam Bankman-Fried and his crypto trading
    success was supposed to impress us. We are still learning how
    he shuffled money between FTX and his trading firm, Alameda
    Research, a name calculated to sound as generic as possible to
    avoid raising eyebrows while sending money across the world.
        FTX and Alameda Research took advantage of the crypto
    industry's appetite for speculation. They were able to borrow
    and lend from other platforms and invest in other crypto firms,
    inflating the crypto ecosystem and growing their own profits.
        Even this summer as crypto values crashed and platforms
    began to fail, FTX and Alameda found ways to benefit. In one
    case, FTX made a $250 million loan to a platform using its
    proprietary token, and Alameda borrowed client deposits worth
    more than twice that from the platform.
        All the while, venture capitalists and other big
    investors--shame on them--fell for it. They were caught up in
    the speculative frenzy, missed the red flags at FTX, and
    showered Mr. Bankman-Fried with more and more money, and now it
    is all most likely gone.
        It is no surprise that in 2018, Alameda solicited investors
    by guaranteeing 15 percent returns with, quote, ``no
    downside.'' That is more than the guaranteed 11 percent that
    Bernie Madoff offered. With Madoff and with Sam Bankman-Fried,
    investors did not ask questions for fear of missing out. It is
    a good reminder that most guaranteed investments are, in fact,
    too good to be true.
        In this story, Sam Bankman-Fried was also the shiny object.
    Now he is the villain, possibly worse. But this story is bigger
    than one person or even one firm, and that is the point of this
    hearing. This is not just about misconduct at FTX, but about
    how to protect consumers and the financial system from
    unregulated crypto products.
        For many investors, it might be too late. I have heard from
    far too many Ohioans who have money stuck at FTX.US, that they
    tried to get out before it filed for bankruptcy. But despite
    Mr. Bankman-Fried's assertions that the U.S. side of FTX should
    be fine, the court proceedings are likely to drag on and on.
        If we are going to learn from FTX's meltdown, we must look
    closely at the risks from conflicts at crypto platforms that
    combine multiple functions. It means thinking about the kinds
    of disclosure that consumers and investors really need to
    understand how a token or crypto platform works. We can look to
    existing banking and securities laws for time-tested approaches
    to oversee and examine entities that want Americans to trust
    them with their money.
        To protect consumers and the financial system we need a
    comprehensive framework that looks at crypto products for what
    they are, not looking at these products the way crypto
    executives want them to be, or want to tell us they should be.
        I look forward to working with Treasury Secretary Yellen.
    We have been working with her to step and lead this
    governmentwide regulatory approach--and the other financial
    regulators to ensure there is an all-of-Government approach,
    just as we have done in the past. Anything less simply will not
    work.
        Senator Toomey.

                 STATEMENT OF SENATOR PATRICK J. TOOMEY

        Senator Toomey. Thank you, Mr. Chairman, and I want to
    thank our witnesses for joining us this morning.
        We are here to discuss the fallout after the collapse of
    FTX. Some Americans very likely suffered significant losses
    from the bankruptcy of FTX and Sam Bankman-Fried's misconduct.
        On Monday, we saw the arrest of Mr. Bankman-Fried. This
    came as a surprise to no one, with the possible exception of
    Mr. Bankman-Fried. We owe it to each customer to get to the
    bottom of the FTX implosion, and any violations of the law
    should be aggressively prosecuted. The Department of Justice
    and other enforcement agencies should expeditiously investigate
    the unseemly relationship between a company that was
    effectively a hedge fund, and an exchange entrusted with
    customer funds.
        While all the facts have not yet come to light, we have
    clearly witnessed wrongdoing that is almost certainly illegal.
    There was unauthorized lending of customer assets to an
    affiliated entity, and there were apparently fraudulent
    promises to investors and customers about FTX's operations.
    These are outrageous and completely unacceptable. The SEC also
    believes FTX committed fraud against equity investors. They are
    going to pursue that, as they should.
        But I want to underscore a bigger issue here, and that is
    the wrongful behavior that occurred here is not specific to the
    underlying asset. What appears to have happened here is a
    complete breakdown in the handling of those assets. In our
    discussion of FTX today, I hope we are able to separate the
    likely illegal actions from perfectly lawful and innovative
    cryptocurrencies.
        Now it is important to define this space. Cryptocurrencies
    are analogized to tokens, but they are actually software. The
    software protocols that are foundational to the crypto
    ecosystem are like operating systems, and then applications are
    run on top of these operating systems. Currently there are many
    competing operating systems and many apps running on them.
    There is nothing intrinsically good or evil about software; it
    is about what people do with it.
        With this analogy in mind, what we should all understand
    here is one simple thing: the code committed no crime. FTX and
    cryptocurrencies are not the same thing. FTX was opaque,
    centralized, and dishonest. Cryptocurrencies usually are open-
    source, decentralized, and transparent.
        To those who think that this episode justifies banning
    crypto, and I have actually heard that suggested, I would ask
    you to think about several other historical parallels.
        The 2008 financial crisis involved obvious misuse of
    products related to mortgages. Did we decide to ban mortgages?
    Of course not. A commodity brokerage firm run by former New
    Jersey Senator John Corzine collapsed after customer funds,
    including U.S. dollars, were misappropriated to fill a
    shortfall from the firm's trading losses. Nobody suggested that
    the problem was the U.S. dollar, or that we should ban it. With
    FTX, the problem is not the instruments that were used. The
    problem was the misuse of customer funds, gross mismanagement,
    and likely illegal behavior.
        So let us talk about what comes next. Some of my colleagues
    have suggested somehow pausing cryptocurrencies before we pass
    legislation. This is a profoundly misguided, not to mention
    impossible, idea. Short of enacting draconian, authoritarian
    policies, cryptocurrency cannot be stopped. If we tried, the
    technology would simply migrate offshore; cryptocurrency does
    not need brick and mortar facilities to operate. And typing
    computer code should clearly be seen as a form of protected
    speech.
        Are we going to decide to pause the Constitution to stop
    crypto? This is exactly the kind of mindset that has driven
    this activity to the darker and less regulated parts of the
    world.
        Now, if Congress had passed legislation to create a well-
    defined regulatory regime with sensible guardrails, we would
    have multiple U.S. exchanges competing here under the full
    force of those laws and regulations. In that scenario, it is
    not clear that FTX would have ever existed, at least on the
    scale that it did, not if we had American companies that were
    an alternative and properly regulated. The complete
    indifference to an appropriate regulatory regime by both
    Congress and the SEC has probably contributed to the rise of
    operations like FTX.
        Others have suggested we refrain from addressing
    cryptocurrency at all, because we would not want to legitimize
    its use. Well, I think that is both misguided and
    irresponsible. Congress can and should offer a sensible
    approach for the domestic regulation of these activities. I
    think we should start with stablecoins. This is an activity
    that my colleagues can analogize to existing, traditional
    finance products. There is clear bipartisan agreement that
    stablecoins need consumer protections. There are virtually none
    in place now. I have proposed a framework to do that. Senators
    Lummis and Gillibrand have also proposed a framework.
        Congress also needs to determine the criteria and the
    disclosures by which the issuance of digital assets will be
    regulated. And we should acknowledge the possibility that
    certain token issuances, like Bitcoin, do not need that kind of
    regulation. We should also clearly delineate regulations for
    secondary market trading of these assets, including at
    exchanges like FTX.US. Some of my colleagues have begun this
    important work.
        We can provide sensible consumer protections for which
    there would be very broad agreement, while still allowing for
    the development of applications that are going run on operating
    systems that we cannot even imagine today, just as I do not
    think any of us ever imagined applications like Uber operating
    on iOS today.
        Let me conclude with this. It is absolutely essential to
    investigate any fraud and violations of existing law, and
    prosecute those who are committing those crimes. Congress owes
    it to the American people to do so. But this is fundamentally
    not about the kind of assets that were held by FTX. It is about
    what individuals did with those assets.
        Individuals can also be tremendously empowered by the use
    and access to cryptocurrencies. Cryptocurrencies can protect
    against inflation when Governments irresponsibly manage their
    own currencies. They can provide useful services without the
    need for a company or a middleman. And they can let individuals
    preserve the freedom to transact privately.
        Mr. Bankman-Fried may have well committed multiple crimes.
    The SEC and DOJ will determine that. But let us remember to
    distinguish between human failure and the instrument with which
    the failure occurred. In this case the instrument is software,
    and the code committed no crime. And while Sam Bankman-Fried
    very well may have, it is important we do not convict the code
    of anything but preserving and protecting individual autonomy.
        Thank you.
        Chairman Brown. Thank you, Senator Toomey.
        I will introduce today's witnesses. Starting on my left we
    will hear from Professor Hilary J. Allen from the American
    University Washington College of Law. She has testified
    remotely in this Committee last year, I believe.
        Mr. Kevin O'Leary, an investor, television personality, and
    founder of several companies. Mr. O'Leary, welcome.
        Ms. Jennifer Schulp, the Director of Financial Regulation
    Studies at Cato Center for Monetary and Financial Alternatives.
    Ms. Schulp, welcome.
        And Mr. Ben McKenzie Schenkkan, an actor, writer, director
    who is cowriting a book on cryptocurrency and fraud. Mr.
    Schenkkan, welcome.
        And Professor Allen, please begin.

     STATEMENT OF HILARY J. ALLEN, PROFESSOR, AMERICAN UNIVERSITY
                       WASHINGTON COLLEGE OF LAW

        Ms. Allen. Chairman Brown, Ranking Member Toomey, and
    Members of the Committee, thank you for inviting me to testify
    today. My name is Hilary Allen and I am a professor of law at
    the American University Washington College of Law, and I am the
    author of the book, ``Driverless Finance: Fintech's Impact on
    Financial Stability''.
        I would like to make three points today. The first is that
    FTX's failure was not an isolated incident but is symptomatic
    of many broader problems in the crypto industry. FTX is just
    the latest in a series of major crypto industry failures,
    failures of centralized crypto intermediaries like Celsius, and
    failures of DeFi offerings, like Terra Luna. These failures
    arose, in large part, because of a feature that is unique to
    the crypto industry. Crypto assets can be made up out of thin
    air. When assets can be made up out of thin air that generates
    leverage that makes the whole system more vulnerable to booms
    and busts. When assets can be made up out of thin air, they can
    also be used to obscure financial realities, as was done with
    FTX's FTT tokens, which were used as collateral for the FTX
    customer assets loaned to Alameda.
        How can you have any reliable check on the valuation of an
    asset with no productive capacity behind it? The attestations
    and proof of reserves offered by the crypto industry are poor
    substitutes for rigorous and independent audits. Such an
    environment is highly conducive to fraud. Sam Bankman-Fried may
    have engaged in good old-fashioned embezzlement, as it was put
    yesterday, but the embezzlement was able to reach such a scale
    and go undetected for so long because it was crypto, shrouded
    in opacity, complexity, and mystique.
        To be clear, decentralization will not protect us from
    future crypto frauds because even if DeFi is technologically
    decentralized it is not economically decentralized. If one
    person owns 90 percent of the governance tokens that control
    the software, which is quite common in DeFi, then they could
    cause it to perpetuate shady behavior.
        The second point I want to make is that when we talk about
    regulating crypto we are often not being specific about the
    type of regulation we mean to apply. There are several
    different options. A ban on crypto, for example, would be the
    most straightforward way of protecting both investors and the
    financial system, and because crypto is not really
    decentralized it is possible to enforce such a ban. If
    policymakers do not wish to proceed with a ban then they will
    need to be careful to ensure that any laws that they do adopt
    do not inadvertently make crypto too big to fail.
        Crypto should not be regulated like banking products
    because that would give crypto access to the Government support
    that we afford to banking because of its critical role in
    providing credit and processing payments for the broader
    economy. Banking regulations should, however, continue to keep
    actual banks away from crypto. The harm from FTX's collapse has
    been limited to those who invested in crypto, but allowing
    crypto to integrate with the rest of our financial system could
    cause a broader financial crisis that would hurt those who
    never even invested.
        Investor protection regulation as opposed to banking
    regulation does not come with any deposit insurance or lender
    of last resort. It does not signal that an investment is a good
    investment or that an investment will not lose value. Robust
    enforcement of the securities laws could make significant
    strides in protecting U.S. investors without conveying the
    message that crypto is too big to fail. The SEC has been very
    clear in its public statements that most crypto assets are
    securities, but Sam Bankman-Fried and the rest of the crypto
    industry were not looking for this clarity on the current law.
    They were looking for changes in the law that would accommodate
    the industry. In particular, they wanted to be regulated by the
    CFTC and not the SEC.
        I respectfully submit that Congress should not adopt
    legislation to that end that was endorsed by Sam Bankman-Fried,
    in particular, because the proposed CFTC self-certification
    regime for crypto assets would allow the unlimited supply of
    crypto assets to continue to proliferate. Energetic enforcement
    of the SEC's existing securities registration requirements, on
    the other hand, would make it a lot harder to make crypto
    assets up out of thin air. If Congress wishes to provide more
    clarity and certainty to the crypto industry they could adopt
    legislation that categorically provides that all crypto assets
    are indeed securities.
        The final point I want to make is that we have little to
    lose from limiting the growth of the crypto industry. The
    underlying blockchain technology can never deliver on the
    industry's promises, both because the technology itself is not
    very good and because technology is only a tool. After 15 years
    without a killer app, it is time for policymakers to listen to
    the technologists explain why blockchain technology is
    fundamentally not fit for purpose.
        Even if it were good technology, though, it would not fix
    the underlying political and structural problems that limit
    access to financial services. In many ways, relying on the
    crypto industry to improve access to financial services is like
    adopting a policy to open more casinos in underserved
    communities. And to those who say that crypto investment is a
    matter of personal choice, crypto creates problems even for
    those who choose not to invest in it. It facilitates ransomware
    attacks, sanctions evasion, tax evasion, has significant
    environmental consequences, and as I have already discussed,
    could cause financial crises if allowed to integrate with the
    traditional financial system.
        I would submit that the United States should not want to be
    a world leader in the worst kind of innovation that allows its
    suppliers to profit handsomely but offers little benefit to
    society and, in fact, inflicts a multitude of harms.
        Chairman Brown. Thank you, Professor Allen.
        Mr. O'Leary, welcome.

                  STATEMENT OF KEVIN O'LEARY, INVESTOR

        Mr. O'Leary. Thank you very much. Chairman Brown, Ranking
    Member Toomey, and Members of the Committee, thank you for
    inviting me to testify about crypto and the collapse of FTX.
        I am the Chairman of O'Shares, an ETF indexing firm, and
    also a private equity and venture investor. I support
    entrepreneurs at every stage of their journeys. I have dozens
    of family run businesses in our investment portfolios. My
    extensive social media platform enables me to tell the stories
    of their products and services to help reduce their customer
    acquisition costs. It is a model that has worked well for over
    a decade and helped support so many small American businesses,
    which create over 60 percent of the jobs in the American
    economy.
        In 2017, I was a public critic and skeptic of crypto and
    blockchain technology. As the global regulatory environment
    began to open up in 2018, I began to invest. Now I am a
    shareholder in multiple companies involved in crypto
    technology, including WonderFi/BitBuy, the largest and first
    regulated broker/dealer crypto exchange in Canada, Immutable
    Holdings, a developer of NFT technology, and Circle, the
    company that brought USDC stablecoin to market. I have also
    invested in multiple crypto tokens, infrastructure and Level 1
    and Level 2 blockchains.
        I am of the opinion that crypto, blockchain technology, and
    digital payment systems will be the 12th sector of the S&P
    within a decade.
        Many of these technologies are going to disrupt the
    existing financial services sector with faster, more efficient,
    more productive and more secure ways of investing, paying,
    transferring, and tracking assets.
        As you are aware, Bitcoin, a store of value, is not a coin.
    It is software. Ethereum is software. Blockchain is software.
    In the last 30 years, every American enterprise has driven
    major efficiencies using various versions of enterprise
    software, and crypto is no different. The potential of these
    crypto technologies is astronomical in scale.
        In August of 2021, nearly 3 years after I started
    allocating capital to the crypto sector, I entered into an
    agreement with FTX to be a paid spokesperson. I was paid
    approximately $15 million for these services, plus
    approximately $3 million to cover a portion of the taxes due.
    Of the remaining amount, approximately $1 million was invested
    in FTX equity and approximately $10 million in tokens held in
    FTX wallets. The equity is now most likely worthless and the
    accounts have been stripped of their assets and, interestingly,
    financial records. I have written them off to zero. Because I
    was a paid spokesperson, however, I never invested any capital
    from our partners or LPs in FTX. The capital lost was from an
    operating company that I had 100 percent ownership in.
        I am using my own capital to pursue record recovery of the
    FTX accounts so that I can conduct a forensic audit. The truth
    of this situation will be discovered by following the
    transaction trail after obtaining the records. I have applied
    for membership on the FTX creditors' committee, in connection
    with the bankruptcy proceedings, because I feel obligated to
    pursue the facts on behalf of all stakeholders, and believe my
    perspective of this situation will be helpful to the other
    creditors' committee members.
        The collapse of FTX is nothing new. While this situation is
    painful for shareholders, employees, and account holders, in
    the long run, it does not change this industry's promise. Enron
    came and went and had no impact on the energy markets. Bear
    Stearns' and Lehman Brothers' demise had no impact on the long-
    term potential of American debt and equity markets.
        I am only one of many investors that has experienced this
    loss. However, this changes nothing in terms of the potential
    of crypto. In fact, the recent collapse of crypto companies has
    a silver lining. This nascent industry is culling its herd.
    Going or gone are the inexperienced or incompetent managers,
    weak business models, and rogue, unregulated operators.
    Hopefully, these highly publicized events will put renewed
    focus on implementing domestic regulation that has been stalled
    for years. Other jurisdictions have already implemented such
    policies and are now attracting both investment capital and
    highly skilled talent. In the U.S., we are falling behind and
    losing our leadership position.
        I understand why many leaders in the banking industry are
    openly skeptics, calling for the banning of these new crypto
    software technologies. Disruption is always uncomfortable at
    first, and entrenched businesses abhor new competition. But it
    has been proven time and time again that disruption is
    absolutely necessary in advancing the economy.
        There is the risk of investing in crypto and there is also
    the risk of not investing in it and letting others accrue its
    benefits first, essentially gifting them a competitive
    advantage that could be hard to recapture.
        So where to start? We need clear policy and regulation for
    the crypto industry, its entrepreneurs, its developers, and its
    users. Congress should start by passing bipartisan legislation
    that creates a sensible regulatory framework for digital
    stablecoins backed by the U.S. dollar. Why? A well-regulated
    stablecoin backed by the U.S. dollar and other high-quality,
    liquid assets could become the global default payment system
    over time. The U.S. dollar already denominates the price of oil
    and other commodities. Why not everything else? What could be
    more bipartisan than this?
        Let me close with this. We need to get to the bottom of
    what happened at FTX, but we cannot let its collapse cause us
    to abandon the great promise and potential of crypto.
        Chairman Brown. Thank you, Mr. O'Leary.
        Ms. Schulp, welcome.

        STATEMENT OF JENNIFER J. SCHULP, DIRECTOR OF FINANCIAL
         REGULATION STUDIES, CENTER FOR MONETARY AND FINANCIAL
                     ALTERNATAIVES, CATO INSTITUTE

        Ms. Schulp. Thank you, Chair Brown, Ranking Member Toomey,
    and distinguished Members of the Senate Committee on Banking,
    Housing, and Urban Affairs. My name is Jennifer Schulp and I am
    the Director of Financial Regulation Studies at the Cato
    Institute's Center for Monetary and Financial Alternatives.
    Thank you for the opportunity to participate in today's
    hearing.
        At the outset, I note that because the facts are developing
    it is premature to definitively diagnose the causes of FTX's
    demise. Claims of fraud and contractual breaches should be
    vigorously pursued, and courts should determine what crimes and
    violations took place.
        Importantly, the issues with FTX do not appear to be
    intrinsically tied to cryptocurrencies or other blockchain
    technologies. John Ray, the company's bankruptcy CEO, described
    the situation as ``a complete failure of corporate controls and
    a complete absence of trustworthy financial information.''
    These risk management failures, whether the result of
    intentionally fraudulent practices or the product of gross
    negligence, should reflect on the perpetrators themselves, not
    on the crypto ecosystem.
        Today I suggest three takeaways for policymakers. First,
    there are important distinctions between centralized entities
    and decentralized projects. Policies designed to address risks
    posed by centralized financial intermediaries should not be
    blindly applied to decentralized projects. FTX is, at heart, a
    traditional middleman. As a centralized exchange, and like a
    traditional bank or broker, FTX took possession of people's
    assets and kept the books, however poorly.
        Decentralized finance, or DeFi, seeks to mitigate these
    intermediary risks through technology. While designs vary,
    decentralized exchanges utilize open-source software to provide
    exchange services by, among other things, publicly recording
    transaction data and allowing users to self-custody assets.
    That is not to say that decentralized exchanges solve every
    problem or eliminate every risk, or that DeFi is always
    preferable to centralized finance. Rather, the point is that
    different risks ought to be treated differently.
        Second, unclear regulation remains a problem that can drive
    innovation offshore. A rational regulatory framework should
    distinguish between projects that reproduce the risks of
    traditional finance and those that mitigate those risks through
    disintermediation. For exchanges to provide rules that are
    narrowly targeted to relevant risks, Congress should provide
    for centralized marketplaces to register with the CFTC for
    crypto commodities and the SEC for crypto securities.
    Decentralized exchanges should be permitted to voluntarily
    register, which recognizes their capacity to address
    intermediary risks through technology.
        Addressing marketplace regulation, though, is only part of
    the task. It is also important to clearly define when crypto
    projects trigger securities regulation to determine which
    regulator oversees trading and what customer protections are
    appropriate.
        Federal securities law is appropriately applied to address
    the specific risks of fraud, deception, and manipulation by
    developers, sellers, or promoters who are active managers of a
    crypto project. But where no individual or entity acts like a
    manager, Congress should clarify that securities laws do not
    apply. Congress should also provide a disclosure option for
    decentralizing projects that covers information relevant to
    crypto purchasers.
        Finally, following FTX's bankruptcy there have been the
    usual calls to protect consumers by banning crypto or,
    paradoxically, by declining to regulate crypto, to delegitimize
    it. This type of protection, premised on a value judgment about
    the worth of the crypto ecosystem, takes the choice to engage
    in technological innovation out of the hands of consumers,
    investors, and entrepreneurs and wrongly places it in the
    Government's hands.
        While circumspection around a novel asset class and
    technology is more than fair, blocking access to an instrument
    that approximately 1 in 5 Americans already have chosen to use
    for diverse purposes, from trading to sending remittances, is
    entirely different. That crypto has yet to meet all of the
    goals that it or other have set is not a reason to limit
    access.
        Moreover, the risk that some people will lose money does
    not justify harsh regulation. Risk is a natural component of
    markets, and failure is often necessary for development.
    Americans should be able to participate, for better and for
    worse, in that process.
        Thank you, and I welcome any questions you may have.
        Chairman Brown. Thank you, Ms. Schulp.
        Mr. Schenkkan, welcome.

         STATEMENT OF BEN MCKENZIE SCHENKKAN, ACTOR AND AUTHOR

        Mr. Schenkkan. Thank you, Mr. Chairman. Chairman Brown,
    Ranking Member Toomey, Members of the Committee, thank you for
    inviting me to testify before you today.
        This hearing has been called for two reasons. The first is
    to examine the spectacular collapse of the crypto exchange FTX
    and its sister company, Alameda Research, both owned by Sam
    Bankman-Fried. These companies, valued at more than $32 billion
    earlier this year, are today worth less than nothing. In fact,
    they are $8 billion in the hole.
        The demise of FTX and Alameda represent the most
    spectacular corporate downfall since Bernie Madoff's Ponzi
    scheme imploded in the wake of the Great Financial Crisis. It
    has captured the Nation's attention.
        Like Madoff, FTX and Alameda owe enormous sums to
    supposedly sophisticated investors such as venture capital
    firms and hedge funds, and like Madoff, they also owe a lot of
    money to regular people.
        However, the carnage at FTX is far more widespread. Madoff
    defrauded some 37,000 clients. FTX claims 32 times that amount
    in the U.S. alone. According to FTX, some 1.2 million retail
    traders, aka regular folks, and 5 million worldwide have lose
    access to the money they entrusted to FTX. It is unclear when,
    if ever, they will get any of that money back.
        The harm to those consumers--I would prefer the term
    ``investors''--is the second reason we are here today, and it
    is fitting that I am here, for those people are the focus of my
    attention. I believe they, and the estimated 40 million other
    Americans who have invested in cryptocurrency, have been sold a
    bill of goods. They have been lied to in ways both big and
    small, by a once seemingly mighty crypto industry whose entire
    existence, in fact, depends on misinformation, hype, and yes,
    fraud.
        The first lie is the most obvious. Cryptocurrencies are not
    currencies by any reasonable economic definition. Anyone with
    even an undergraduate degree in economics, such as myself, can
    tell you that money services three functions: medium of
    exchange, unit of account, and store of value. Cryptocurrencies
    cannot do any of the three well, and they have no hope of ever
    doing so, for reasons I am happy to discuss at greater length
    during our session.
        But in the interest of time let us keep it simple for now
    and focus on the present. If cryptocurrencies are not
    currencies, then what are they? Well, what do they do? How are
    they used? Via FTX, Binance, and a host of other exchanges,
    usually domiciled overseas, millions of Americans have used
    real money to purchase some of the over 20,000 cryptos in
    existence today. According to a recent Pew study, they are
    doing so as an investment, a way of making money.
        So what do we have in the eyes of the law? We have an
    investment contract, more precisely, a security, an investment
    of money in a common enterprise, with the expectation of profit
    to be derived from the efforts of others.
        To my mind, the four prongs of the Howey Test are easily
    satisfied by every coin, token, or whatever nonsense words the
    crypto industry attaches to lines of code, stored on ledgers
    called blockchains, in an attempt to convey legitimacy or
    technological sophistication to them.
        But if these cryptos are securities they are bizarre ones.
    They offer no products, no services, no revenue streams. The
    projects they represent accomplish almost nothing in the real
    world that cannot be done better by other means, and add no
    overall value to our economy or any other. They are, at best, a
    vehicle for speculation, an exercise in a zero-sum game of
    chance, much like online poker. At worst, they are an
    instrument of crime.
        Surveying the cryptocurrency mania during the summer of
    last year, I came to a terrifying conclusion: the supposedly
    multitrillion-dollar industry was nothing more than a massive
    speculative bubble, bound to pop. Worse than that, I had myriad
    reasons to believe that the crypto bubble was built on a
    foundation of fraud.
        Investment contracts that are effectively valueless are
    often described as Ponzi schemes, which are regulated under
    American law by the Securities and Exchange Commission. In my
    opinion, the cryptocurrency industry represents the largest
    Ponzi scheme in history. In fact, by the time the dust settles,
    crypto may well represent a fraud at least ten times bigger
    than Madoff. The fact that his roped in tens of millions of
    Americans from all walks of life, as well as hundreds of
    millions of people worldwide should be of concern to us all.
        Thank you for your time. I look forward to your questions.
        Chairman Brown. Thank you, Mr. Schenkkan.
        My first question I would like to ask all four of you, and
    please give as close to a yes or no answer as you can.
        The world is troubled by the extent of the fraud and
    misconduct at FTX. We all agree on that. Too many people have
    lost money they thought was safe. Some have suggested that what
    we see at FTX was unique, a one-off caused by one immoral
    fraudster rather than something more widespread and systemic.
        So starting with you, Professor Allen, does this kind of
    carelessness, misconduct, or worse exist at other crypto firms?
        Ms. Allen. Yes.
        Chairman Brown. Mr. O'Leary?
        Mr. O'Leary. Yes, the unregulated crypto firms.
        Chairman Brown. Ms. Schulp?
        Ms. Schulp. Most likely.
        Chairman Brown. Mr. Schenkkan?
        Mr. Schenkkan. It is endemic.
        Chairman Brown. Thank you.
        Professor Allen, we know that FTX was overleveraged, but
    look beyond, as you did in your testimony, beyond FTX. Given
    that a lot of crypto trading recycles one token into another,
    often with borrowed money, it seems as if the value of crypto
    has detached itself from the actual currency that was
    originally invested.
        Is it possible to determine how much leverage there is in
    the crypto market, and if it is not, why is that a problem?
        Ms. Allen. Well, I do not think it is possible to
    determine. I think researchers have really struggled to find
    data in this space, notwithstanding that people say that the
    blockchain is transparent. In fact, a lot of transactions
    happen off-chain. There are a lot of sort of back doors in
    software. So the data is not available to figure out what
    transactions have happened, and the accounting around the
    individual crypto assets themselves can be very dodgy as well.
    So even before you lose track of them in transactions it is not
    clear what they were worth up front.
        So for all those reasons, it is very hard to get a bead on
    what the leverage is in this space, and that is problematic
    because, as we saw in 2008, when you do not understand how much
    leverage is in the system, you do not understand how fragile it
    is.
        Chairman Brown. Thank you. Mr. Schenkkan, your testimony
    highlights the similarities between crypto and gambling. Based
    on your research, can you describe the parallels between
    gambling and stablecoins as casino chips?
        Mr. Schenkkan. Sure. Economically speaking, these are zero-
    sum games, strictly competitive. For someone to win, someone
    else has to lose. That does not mean the distribution is even.
    We know, at this point, most people who have invested in
    cryptocurrency have lost money. We know that from the
    industry's own research. Grayscale December 2021 report said
    that 55 percent of people who have ever bought Bitcoin bought
    it that year. Given the current price of Bitcoin, those people
    have lost money.
        That does not include the people who have been locked out
    of their accounts. The list is very long and I include it in my
    written testimony.
        So this is gambling. This is speculation, at best, zero
    sum. That is not including the environmental cost that Bitcoin
    incurs.
        There are also members of the industry who come from online
    poker. I would refer you to Stuart Hoegner, general counsel of
    a company, Tether, a stablecoin company. He was former
    compliance officer of Excapsa, which was the holding company of
    Ultimate Bet. Ultimate Bet, from the online poker era, had a
    Secret God Mode, where players could see the other players'
    cards in order to defraud them, in order to win at poker.
        Stuart Hoegner was joined at Excapsa by Daniel Friedberg.
    Daniel Friedberg was the former general counsel of FTX. He is
    now their chief regulatory officer. Alameda, FTX's sister
    company, is Tether's biggest client.
        Chairman Brown. Thank you. Last question, again, if you
    would answer as close to yes or no as you can. I want to talk
    about solutions. FTX, like other crypto firms, perform multiple
    roles in crypto trade. It acted as an exchange and as a broker.
    It provided margin to investors. FTX was essentially on every
    side of every transaction. Combining these functions undermines
    the fundamental regulatory checks and balances that exist to
    protect consumers and to protect our financial system.
        My question, starting again with you, Professor Allen,
    should there be strong rules addressing related party
    transactions and creating firewalls between related entities?
        Ms. Allen. Absolutely, to address conflicts of interest.
        Chairman Brown. Mr. O'Leary?
        Mr. O'Leary. I find the analogy of crypto to be that of
    gambling and speculation interesting. That was exactly what we
    described the New York Stock Exchange 150 years ago. And what
    happened was because of the nature of the risk we regulated it.
    We did it for bonds. We call them securities now. Back then, if
    they were speculations, no different than this nascent
    industry.
        The reason this is happening over and over again, and we
    will be back here again soon, when the next one blows up, is
    the lack of regulation. That is why we regulate stocks and
    bonds. They are speculations too. You speculate the profits of
    the companies underlying those securities. We need to regulate
    this. I mean, this premise that it is some kind of different
    issue, it is not. It is just unregulated, wild west. And it
    will go on and on and on. The definition of madness is
    expecting different outcomes. I mean, it needs regulation. That
    is it.
        Chairman Brown. I take that is a yes, that there should be
    strong rules addressing related party transactions and creating
    firewalls.
        Mr. O'Leary. A long yes.
        Chairman Brown. A long yes. Ms. Schulp?
        Ms. Schulp. I also have a longer answer but I will still
    keep it short. I do think that conflicts of interest are
    something that need to be examined and addressed. Whether that
    results in strong rules banning certain types of transactions
    or whether it is simply that disclosures must be made is a
    different question. So while I agree that there are potential
    issues there, I am not sure I will agree with the outcome that
    you are looking for, Mr. Brown.
        Chairman Brown. Thank you. Mr. Schenkkan?
        Mr. Schenkkan. Yes.
        Chairman Brown. Thank you. Senator Toomey.
        Senator Toomey. Thanks, Mr. Chairman. Let me start with Ms.
    Schulp. Mr. Schenkkan indicated his opinion that, I think he
    said every cryptocurrency, or virtually every one, easily meets
    the Howey Test for the definition of a security. The Howey Test
    includes the investment of money in a common enterprise, with
    the expectation of profit, through the efforts of others.
        So in Bitcoin, we have no corporation that controls it or
    issued it. We have no individual. We have no committee. It
    seems to me purely decentralized. Is it not hard to establish
    that there is a common enterprise when there is no central
    authority that controls and operates it?
        Ms. Schulp. I agree. I do not think for Bitcoin you can
    meet the elements of the Howey Test, in multiple respects.
        Senator Toomey. Right. And would you say, as a general
    matter, a truly decentralized protocol, pretty hard to
    establish a common enterprise?
        Ms. Schulp. I completely agree. The securities laws were
    evolved in no small part in order to deal with questions of
    information asymmetry coming from managerial bodies that are
    doing that.
        Senator Toomey. Right. Where is that asymmetry?
        Look, I think there is a case to be made that there should
    be a regulatory regime on disclosure requirements for an
    issuer, that there should be a regulatory regime for secondary
    market trading. But I think we ought to make it specific to
    this sector because to try to shoehorn it into decades-old
    legislation that deals with different instruments, I think is
    very problematic.
        Mr. O'Leary, it seems to me that tokens are very often the
    tool or mechanism to incentivize people to validate and
    maintain a distributed ledger. Now you can gamble with them.
    You can speculate as to what a given token is going to be
    worth. But it seems to me that underlying blockchain technology
    is potentially extremely powerful, is actually already being
    used in a variety of ways.
        Could you address this notion that the only possible use is
    a zero-sum gambling enterprise?
        Mr. O'Leary. No, I do not agree with that at all. It is
    preposterous to say that. The potential of blockchain
    technology in authenticating physical assets and contracts and,
    and tokens as you suggest, is incredibly powerful. In fact, I
    think what is going to happen, as we peel the onion on FTX over
    the next year or two, is the shining outcome of the success of
    the blockchain to track these assets will become the focus of
    everybody. We will realize every security or token that left
    FTX, left Alameda, got traded between shareholders, all tracked
    irrefutably on the blockchain. The power of this technology is
    very harnessable, very powerful, and, of course, we should lead
    the world in it because so much of it is developed here.
        The hottest hands coming out of MIT right now, where do
    they want to work? A third of the class, they want to work on
    the blockchain. You cannot take that much potential and not
    expect extraordinary outcomes. This is a remarkable technology.
    Yes, it requires regulation. But if you just ask where the hot
    hands are going, the great engineers, this is where they are
    going. We train them here and then we kick them out of the
    country so they do their work somewhere else.
        Senator Toomey. So let me ask you directly. You were an
    investor in FTX, and I know you have spoken frequently with Sam
    Bankman-Fried over an extended period of time. Why do you
    believe FTX failed?
        Mr. O'Leary. I have an opinion. I do not have the records.
    Here it is.
        After my accounts were stripped of all of their assets, and
    all of the accounting and trade information, I could not get
    answers from any of the executives in the firm so I simply
    called Sam Bankman-Fried and said, ``Where is the money, Sam?''
    He said he had been refused access to the servers. He no longer
    knew. I said, ``OK. Let us step back.''
        This is a simple case in my mind of where did the money go.
    And I said, ``Sam, walk me back 24 months. Tell me the use of
    proceeds, of the assets of your company. Where did you spend
    it?''
        And then he told me about a transaction that occurred over
    the last 24 months, the repurchase of his shares from Binance,
    his competitor. I did not know this at the time, but at some
    point CZ or Binance, who runs Binance, purchased 20 percent
    ownership in Sam Bankman-Fried's firm, for seed stock, and
    then, over time--and I asked him, ``What would compel you to
    spend $2 billion,'' which was the number he was giving me at
    that time. Later, in a subsequent conversation, about 24 hours
    later, he told me it could have been as much as $3 billion, to
    buy back the shares from CZ. I asked him, ``What would compel
    you to do that? Why would you not keep your assets on your
    balance sheet, and why would you offer this to just one
    shareholder?'' He said, ``Because every time we went to get
    licensed in different jurisdictions--because you must
    understand the prize of crypto is to get regulated. For all the
    talk we say about Bitcoin and everything else, no institutions
    own this.''
        I work for the sovereign wealth and pension plans. They do
    not touch this stuff because it is unregulated.
        Between these two, let us call them ``frenemies,'' because
    they obviously were potentially the two largest shareholders in
    the firm, they had a disagreement. They had a falling apart.
    Apparently, according to Sam Bankman-Fried, CZ would not comply
    with the regulators' request in these different geographies, in
    these different jurisdictions, to provide the data that would
    clear them for a license. He withheld it, according to Sam
    Bankman-Fried. The only option the management and Sam Bankman-
    Fried had was to buy him out at an extraordinary valuation of
    close to $32 billion, less, apparently, a 15 percent discount.
        That stripped the balance sheet of assets. You asked me why
    it went bankrupt. Go to the last week. All of a sudden, in
    social media, CZ is asking for another $500 million. He wants
    to do a block trade of FTT, or the proprietary token of FTX. He
    wants to convert it back to fiat. Why would you put that out
    there? You know it is going to push down the value of that coin
    dramatically, and that is exactly what happened.
        Every trader knows if you have a large block trade you go
    negotiate a clearing price with other buyers, and you do the
    transaction. In my view, my personal opinion, these two
    behemoths that owned the unregulated market together and grew
    these incredible businesses in terms of growth, were at war
    with each other, and one put the other out of business,
    intentionally.
        Now maybe there is nothing wrong with that. Maybe there is
    nothing wrong with love and war. But finance is a massive,
    unregulated global monopoly now. They put FTX out of business.
    Now lots of other reasons, I am sure, but that is my personal
    opinion. That is what Sam Bankman-Fried told me in terms of
    where the assets went. Why should we care? Single reason: I am
    a shareholder. You tell me the two largest shareholders do a
    transaction together? That is related party transaction. I am
    not sure that is OK. Maybe I want a Madoff claw-back on those
    proceeds. Maybe I want to pursue----
        Chairman Brown. Mr. O'Leary, I am sorry. You are about 3
    minutes over. Do you have a follow-up, Senator Toomey?
        Senator Toomey. I had another topic, so if we do a second
    round I will take it up then. Thank you, Mr. Chairman.
        Chairman Brown. Thank you. Senator Reed, of Rhode Island.
        Senator Reed. Thank you very much, Mr. Chairman, and thank
    you, panel, for your insights.
        The restructuring officer John Ray described in detail the
    absence of audited or reliable financial statements, absolutely
    no internal controls. Professor Allen, I would like to ask you
    a few questions about FTX and how they were able to get away
    with essentially cooking the books. First, was FTX a publicly
    traded company?
        Ms. Allen. No.
        Senator Reed. As a private company, was FTX required by law
    to disclose basic information to the public about its business,
    like audited financial statements?
        Ms. Allen. No.
        Senator Reed. Was FTX required to disclose transactions
    with related parties, like Mr. Bankman-Fried's hedge fund
    called Alameda Research?
        Ms. Allen. No.
        Senator Reed. And also Mr. O'Leary's example, that would
    not be required to be disclosed. Was FTX required to have a
    chief financial officer or disclose whether a financial expert
    was on the board of directors?
        Ms. Allen. No.
        Senator Reed. Was FTX's auditor required to attest to the
    effectiveness of the company's internal and corporate controls?
        Ms. Allen. No.
        Senator Reed. And if FTX had been a publicly traded
    company, would it have been required to make disclosures and
    attestations that we just discussed?
        Ms. Allen. Sorry. I missed the question.
        Senator Reed. If FTX had been a publicly traded company,
    would it have been required to make the disclosures and
    attestations that we have just discussed?
        Ms. Allen. Yes.
        Senator Reed. OK. Thank you very much. And it is not just
    that FTX is a private company. In fact, just about all the
    biggest companies in the crypto industry are also privately
    held. In September, I introduced S. 4857, the Private Markets
    Transparency and Accountability Act, which would require the
    Nation's biggest private companies, including FTX, to disclose
    basic information about their financial condition and comply
    with basic corporate governance requirements. And according to
    a letter from the North American Securities Administrators
    Administration, this legislation, in their words, ``would have
    made it easier for all of us to spot or prevent the alleged
    fraud and other misconduct at FTX earlier.''
        Mr. Chairman, I am going to ask unanimous consent to
    include this letter in the record.
        Chairman Brown. Without objection, so ordered.
        Senator Reed. The whole point is that we have all talked
    about the need for regulation, and I think that is obvious. And
    we have many mechanisms pending here in the Senate and the
    House to do that. We just have to move quickly. I would suggest
    this is a good place to start.
        And final question, Professor Allen, do you think that
    would have helped illuminate what was going on at FTX?
        Ms. Allen. Yes, I think so. I mean, attestations and proof
    of reserves and other forms of accounting disclosures common in
    the crypto industry, they do not include the rigor or the
    independence and the professional skepticism we get from
    auditors. But I would note that we should be wary of FASB's
    moves to implement fair value accounting for crypto assets
    because accepting market valuations from the crypto industry
    could potentially undermine the value of the audit function,
    and that is something to be wary of.
        Senator Reed. Thank you very, very much. When we talk about
    crypto tokens, in fact, it is 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?
        Ms. Allen. Sure. As I outlined in my written testimony,
    many crypto assets are created out of thin air and there is no
    real basis for their valuation. There is 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 are worth, that creates a space where a significant amount
    of leverage can be created and fraud can easily go undetected.
        Senator Reed. Thank you very much. Again, I think the one
    theme 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, the legislation I have proposed.
        Thank you, Mr. Chairman.
        Chairman Brown. Thank you, Senator Reed.
        Senator Menendez, of New Jersey, is recognized.
        Senator Menendez. Thank you, Mr. Chairman. A lot of
    securities regulation essentially comes down to one thing--what
    actions are and are not permissible when one person is handling
    another person's money? And by and large, we, in Congress, the
    securities industry, and the general public have agreed on the
    major principles that should guide that activity. For instance,
    as you point out in your testimony, Professor Allen, brokers
    are not permitted to use customer funds to finance their
    business. They are required to fully disclose conflicts of
    interest. And when dealing with retail investors they are
    required to go further and mitigate certain conflicts. FTX did
    not seem to have done any of this, and if they had it seems
    like a lot of harm would have been prevented.
        So Professor Allen, is there any reason why we should not
    apply the same broad regulatory principles that are now in
    place with the traditional financial sector to digital assets?
        Ms. Allen. I see no reason. The reason we typically hear is
    that crypto is different because it is decentralized, but in
    fact, it is not decentralized. At every level there are people
    controlling things.
        So we heard that Bitcoin was decentralized. Well, you know,
    Bitcoin is controlled by a few core software developers, fewer
    than 10, and they can make changes to the software, and then
    that software is implemented by mining pools, and there is just
    a few of them.
        So in all these spaces there are definitely people, often a
    very few people, pulling the strings, but the fact of the
    matter is that they are unidentified and unregulated, and that
    is not an ideal space to be in.
        Senator Menendez. Yeah. Mr. O'Leary, in your testimony you
    said you hope that the events at FTX would ``put renewed focus
    on implementing domestic regulation.'' Do you agree that FTX
    customers, and perhaps your own investments, would have been
    better off if FTX had complied with the existing regulation we
    have that bars brokers from trading with customer funds?
        Mr. O'Leary. Absolutely. But they were not compelled to do
    that because they were offshore and unregulated. I think the
    model will not work.
        There are examples of how regulated exchanges that are
    attached to broker-dealers have worked. You only have to look
    up to Canada, the OSC order, where Bitbuy wallets are
    controlled by the regulator. They limit the number of tokens.
    They limit the margin. They limit the lending. They do an
    exhaustive test of proof of reserves.
        That is just the rules they implemented that they just
    copied from their own exchanges. We need to do the same thing
    here. It works. It has been proven to work. There are millions
    of Canadians that have accounts that are working under a very
    strict regulatory environment. We can implement the same.
        Senator Menendez. Well, I agree. We already know what
    should and should not be allowed when one person is handling
    another person's money. Whether we are talking about a new
    celebrity-endorsed coin or an index fund, I think we would be
    well served to keep in mind the basic principles that have
    largely saved and served investors and the markets well for
    decades.
        As I was listening to some of your testimony back in my
    office it all seems like you looked at this as more of a
    security than a currency, at the end of the day, and that makes
    it pretty clear for me.
        In the wake of FTX collapse, many crypto firms have
    attempted to reassure the public of their soundness by hiring
    outside auditors to provide proofs of reserve. However, the
    quality of these audits are inconsistent and often time provide
    an incomplete picture of the company's assets and liabilities.
        Professor Allen, can you explain some of the flaws in these
    reports and why they are not as helpful to investors as the
    crypto industry claims?
        Ms. Allen. Well, I mean, there is the fundamental issue
    that where do you even get the valuation number from these
    assets? Do we treat them on a sort of a fair value accounting
    basis? If so, we are essentially accepting whatever the market
    says about these asset prices, and then they are entirely based
    on sentiment.
        You know, in addition, even if we put that aside, the
    actual attestations, et cetera, that we are getting, they do
    not have the skepticism that we expect from professional
    auditors who look at the financial statements to find red
    flags. They are required to look for red flags. In these
    attestations and proof of reserves, it is basically just the
    accountants sort of reporting what they have been told by the
    industry.
        Senator Menendez. Yeah. One of the things I am concerned
    about is the extent that cryptocurrency becomes integrated with
    the financial system and therefore the risks to financial
    system, which up to now has been pretty stable, and that is
    something I am concerned about.
        Let me close on this. Prior to its collapse, FTX was well-
    known for huge spending on celebrity endorsements. Dozens of
    sports stars and actors received millions of dollars to
    generate hype for FTX and assure the public that crypto was a
    safe investment. There have even been reports that FTX was
    pursuing a $100 million sponsorship deal with Taylor Swift
    earlier this year, even as the firm was hemorrhaging money.
        FTX is not the only firm doing this. Endorsements from
    public figures are just one of the factors contributing to
    misinformation about crypto. Mr. Schenkkan, how can we combat
    the spread of crypto disinformation and encourage investor
    education?
        Mr. Schenkkan. Use words that are accurate. The
    cryptocurrencies are not currencies. We need to classify them
    as securities properly. I also think that we should consider
    treating crypto like gambling and having potential limitations
    on advertising and disclosures.
        Senator Menendez. Thank you, Mr. Chairman.
        Chairman Brown. Thank you, Senator Menendez.
        Senator Tester, from Montana, is recognized.
        Senator Tester. Yeah, I want to thank the Chairman and
    Ranking Member for having this hearing and I want to thank the
    folks who testified today for being here to testify. I
    appreciate it.
        I am concerned that we are signaling to people that this is
    a credible and sound investment, but as we have seen lately
    there are clearly bad actors. Crypto has been peddled
    everywhere, from the internet to the Super Bowl as get-rich
    schemes or safe places to put your retirement savings, but
    things look pretty uncertain right now, and that is a best-case
    scenario.
        Ultimately, I want to make sure that taxpayers are not left
    holding the bag. These may be interesting technologies but I
    have yet to see how it can be useful in a real world without
    substantial risks for Americans. I am skeptical, but I am here
    to hear from both you, the proponents and opponents, and that
    is why I am glad you are all here today.
        Professor Allen, when you were in front of this Committee
    about a year ago today, as a matter of fact----
        Ms. Allen. Exactly.
        Senator Tester. ----you discussed similarities with
    synthetic products and you highlighted concerns that unlike
    2007, these products are targeted to institutions and
    individuals. As we have seen larger and larger issues play out
    in this industry over the past year, how is your concern that
    you expressed a year ago played out?
        Ms. Allen. So in some ways I have been heartened by the
    fact that the banking regulators have really kept this stuff
    out of the banking system, and I think that is why we are
    talking about the investors of FTX being harmed rather than
    everybody being harmed. But still, I mean, I think the idea
    that crypto is trying to disrupt banking is inaccurate. Crypto
    and banking would love to merge, and it is the regulators that
    are keeping them apart.
        And so as we look at the banking industry trying to dip
    their toes into this water, I think there are a few causes for
    concern. Bank of New York Mellon has custody in crypto.
    JPMorgan is doing trades on permission-less blockchains. So I
    think we need to firm up the separation between crypto and
    banking in order to protect the broader financial system. But
    as I said, I think banking regulation has held up pretty well
    so far.
        Senator Tester. For you again, Professor Allen, the new
    bankruptcy-appointed FTX CEO has warned that the U.S. entity is
    not solvent. American customer accounts are in doubt. What does
    this mean for the consumers who are utilizing FTX?
        Ms. Allen. Well, in the short term it means that they are
    not going to be able to access their funds because they are
    tied up. In the long term it means that they may not have any
    funds. So that is, I mean, really devastating, and we have to
    think about how much of this we are willing to tolerate in the
    name of innovation.
        I would point out that the Australian stock exchange spent
    years trying to use blockchain technology to restructure it,
    and it has just given up entirely because the technology was
    not fit for purpose. I think we need to think really hard about
    the costs of what is going on.
        Senator Tester. So could you tell me what this could have
    meant for taxpayers if legislators had gone further with
    blessing this industry?
        Ms. Allen. Sure. You know, the size of the subprime
    mortgage market in 2007 was estimated to--and I do not have my
    figures here but I think it was about $1.3 trillion. And, you
    know, we have just talked about a crypto industry, and as I
    said, the valuations are crazy in crypto, but we have talked
    about an industry that has shrunk apparently from $3 trillion
    to under $1 trillion.
        So if that amount of assets or exposure had been brought
    into the existing financial system, intertwined with our
    existing financial system, then the banks would have been in a
    very serious problem. They would not have been able to lend.
    They would not potentially have been able to process payments.
    All the things that we count on for our broader economic growth
    would be jeopardized.
        Senator Tester. Do you think there would have been an
    inherent response that would have required Congress to step in
    and bail out folks, like happened in 2008?
        Ms. Allen. Absolutely. It is simply untenable to let the
    economy tank like that. I mean, it is just the fact of the
    matter. And so that is why I think it is so critical that
    crypto be segregated away from banking. We do not want to make
    it too big to fail. Too big to fail is problematic with any
    asset class. An asset that has no productive capacity, that
    does not serve any capital formation function, that just is
    crazy.
        Senator Tester. Mr. O'Leary, in one of the answers to one
    of the other Senator's questions you said that the prize for
    crypto is to get regulated. Is that because it gives it
    credibility?
        Mr. O'Leary. It can exist for the institutional client. The
    potential of crypto is for it to be indexed with sovereign
    wealth and pension where about 70 percent of the world's wealth
    is actually managed. There is great interest there,
    particularly around Bitcoin and Ethereum and a few other
    platforms. But they have no infrastructure to apply to their
    compliance platforms. When you are managing a $900 billion
    fund, every day you have a massive compliance infrastructure
    that marks to market all your positions. There is no
    infrastructure for crypto.
        I want to make a note here, just around this regulatory
    issue that you are raising, and it is a good one. Of all the
    entities that went to zero, that went to bankruptcy in the FTX
    portfolio, the only one that is not bankrupt, out of the 130-
    plus--and this is probably the best evidence of why we need
    regulation--is LedgerX. Why? It is regulated by the CFTC, 100
    percent regulated. It is not bankrupt. Had the other entities
    been regulated, wherever they were, they would too not be
    bankrupt.
        And so just look at this. This is a use case of why we need
    regulation. There would not be this tragedy and all of this
    drama and all the rest of this stuff and the loss of billions
    of dollars. The lack of regulation has caused some problems
    here, and will continue to, and the evidence is right here. The
    only entity that did not go to zero, in the FTX portfolio, CFTC
    forced the scrutiny, forced the transparency, forced the proof
    of where the assets were held in the reserves, forced the lack
    of comingling with the assets. They forced it. They did it.
    Proof positive that you can regulate this asset class.
        Senator Tester. I want to thank you all for being here
    today. We will have some questions for the record, but I
    appreciate the hearing, Mr. Chairman.
        Chairman Brown. Thank you, Senator Tester.
        Senator Hagerty, of Tennessee, is recognized.
        Senator Hagerty. Thank you, Mr. Chairman, Ranking Member
    Toomey. Thank you for holding this hearing. To all of our
    guests here today I appreciate you being here.
        I would like to touch on something that has been troubling
    me for some time. We know that FTX's collapse, as the second-
    largest exchange, is continuing to have ripple effects
    throughout the entire digital asset industry. If you look back
    to even early November, FTX did not appear to have the
    necessary scale to cause an industry-wide systemic meltdown.
    Binance, on the other hand, is the largest global crypto
    exchange, nearly 7 times larger than FTX by trading volume--at
    least it was in the month leading up to FTX's collapse. And
    Binance's market share, now with the absence of FTX, I think
    means will only grow.
        You think about a similar implosion by Binance. That would
    really prove catastrophic. It would prove catastrophic for the
    cryptocurrency industry and it would prove catastrophic to all
    of the consumers that utilize the industry.
        Yet U.S. regulators are limited in the extent to which they
    can mandate appropriate audits or appropriate disclosure of
    Binance's operations. Unlike the requirements placed on
    companies which are publicly traded here in the United States,
    Binance operates outside of our system.
        Ms. Schulp, I would like to start with you. How can U.S.
    regulators work with their global counterparts to bring
    transparency to Binance's activities and to understand the
    reserves that it holds?
        Ms. Schulp. I think you raise a very important point that
    when we talk about FTX or we talk about Binance so much of what
    we are talking about is happening outside of our shores. And
    the influence that U.S. regulation can have on those exchanges
    and other crypto projects that are not taking place here is
    limited.
        I think it is very important to have an ongoing dialogue
    with international regulators in order to have influence where
    we can. But I think the most important thing for the United
    States to do is to create a rational crypto regulatory
    framework in the United States to try to bring some of that
    home so that we have maximum influence over how those
    businesses are operated.
        Senator Hagerty. I hear you. Mr. O'Leary, you touched on
    this just a moment ago, about the impact of regulation and the
    certainty that it could bring. And from your perspective as an
    investor, Mr. O'Leary, what needs to change here in Washington
    from a regulatory standpoint so that capital actually does
    float to U.S.-based entities and empower U.S.-based entities to
    win on the global stage?
        Mr. O'Leary. Every global platform, the number one prize is
    to be regulated in the U.S. market, the number one financial
    market on earth, period. Now when you talk about other money
    center banks or other financial services industries that want
    to do business in the U.S., they must disclose their worldwide
    operations. They are scrutinized by the rules we already have
    in place.
        A coordinated effort between the Canadian regulator, the
    U.S. regulator, the ADGM in Abu Dhabi, the regulators in
    Singapore, basically laying out the ground rules for any entity
    that wishes to do business in the U.S. or any of those
    jurisdictions solves this problem. If finance is not willing
    to--and you started by talking about them--disclose, and the
    reason that Sam Bankman-Fried claims he spent $3 billion was
    that he could not get the regulators to approve the fact that
    Binance owned 20 percent of their platform. CZ was not
    cooperative with any of those regulators. He was shut out of
    those markets, and he realized the prize was to get regulated
    for institutional capital.
        Just having four or five markets coordinate, as we do
    already in other securities, solves this problem into
    perpetuity. All these regulators talk to each other. I have
    been to Abu Dhabi. I have talked to the ADGM. I seek a license
    there. And I have done the same in Canada. I am an investor and
    licensed there. These are long-term, very sound structural
    concepts, but it needs a coordination, and in one phone call we
    could solve this problem.
        Senator Hagerty. I am going to come back to you, Ms.
    Schulp, for a moment, and I want to stay on this concern that I
    have, particularly about Binance, about the Chinese Communist
    Party's role in support of that. To be clear, Binance is being
    proliferated around the world. It is a State-backed network.
    They are proliferating in emerging markets in a very predatory
    fashion. They are in developed markets. And again, how they
    have an even more open platform, as FTX has been taken down.
        But think about an example like Binance, with ties to the
    CCP, a committed partner to the Belt and Road Initiative, and
    particularly as it expands its market dominance with the
    collapse of FTX, what does that spell, if lawmakers here in
    America follow through with their threats to ban digital
    assets, or leave the current regulatory uncertainty in place?
    What does it mean for the global crypto market in general? What
    does it mean for our Nation's national security and our
    economic security? And most important, what does it spell for
    the dominance of the U.S. dollar as the world's reserve
    currency?
        Ms. Schulp. Well, regardless of whether Binance itself is
    connected with the Chinese Communist Party, which Binance
    denies, but regardless of whether that is the case, by having a
    system in the United States that is unclear, that is
    regulatorily hostile, that could go so far as banning
    cryptocurrency in the United States, we would be losing the
    position of having a possibility to maintain American dominance
    for these technological innovations.
        Senator Hagerty. I am deeply concerned about that.
        Ms. Schulp. We would also be losing many of the great minds
    that want to work on these types of projects, that can make
    strides not just in blockchain and cryptocurrency but in other
    technological functions as well. To the extent that the United
    States is not a place that people look to for economic
    development, that also puts the U.S. dollar at risk.
        Senator Hagerty. Thank you. Thank you, Mr. Chairman.
        Chairman Brown. Thank you, Senator Hagerty.
        Senator Warner, of Virginia, is recognized.
        Senator Warner. Thank you, Mr. Chairman. I appreciate you
    holding this hearing. I want to echo some of the concerns my
    friend from Tennessee just echoed, about Binance. I do think it
    is curious that China has made the decision to basically take
    that kind of risk to bank crypto, because of their, at least,
    risk reward analysis.
        I have got so many questions. I know a lot of this started
    around Bitcoin. And I think, Professor Allen, you may have
    touched on this in your testimony. The clunkiness of the
    technology behind Bitcoin, it could never go to scale, no
    matter what. If you can only do five or six transactions per
    second, that is not a scalable tool and obviously a technology
    at a power and environmental cost that just does not make sense
    to me.
        But I am going to try to get as quick as I can in my 4
    minutes. I am going to start with Professor Allen and Mr.
    McKenzie. I sometimes worry that FTX is just a tip of the
    iceberg. You know, I am sure many of my colleagues have gone
    through all of the bad things Bankman-Fried has done and the
    graft and the Ponzi schemes and so forth. And I know Senator
    Hagerty already made comments about the Reuters story about
    Binance.
        I really worry. I mean, I know the original pitch was this
    is going to be a seamless ability to transact, without currency
    risk, without timing risk. I can send my grandmother in Kenya
    resources on Sunday in way that is kind of error-free.
        Sitting where I do on the Intelligence Committee, as
    Chairman, I have seen virtually no examples of that kind of use
    case. I know, Mr. McKenzie, you have gone down to El Salvador,
    where they tried to make that as the case. It just does not
    seem to be the case. Instead, we are seeing, at least at this
    stage--and Senator [unclear] has been a leader on this. I keep
    trying to have an open mind on the technology innovation, and I
    am all in on technology innovation. But at least so far, you
    know, from where I sit on the Intelligence Committee, I see an
    awful lot of illegal activity. I see drug deals. I see bad
    actors. I see ransomware criminals. And frankly, it is not even
    safe for them. Go back to the Colonial Pipeline issue where our
    Government, when payment was made in crypto, was able to
    recover some of that.
        So I guess I would start again with Professor Allen and Mr.
    McKenzie. Do you think FTX is a one-off or is this the tip of
    the iceberg where we may be seeing a whole series of
    activities? And if you want to go ahead--I know it has been
    raised but I do not think in any detail--Alameda Research and
    some of the potential--I think we are only beginning to see the
    conflicts that were taking place there. But I will start with
    Professor Allen and Mr. McKenzie.
        Ms. Allen. I think we saw the tip of the iceberg a couple
    of months ago, and then this is sort of moving further down the
    iceberg, you know, with the earlier rounds of Terra Luna and
    Celsius.
        You know, the concern is that fraud is definitely being
    perpetuated, but that the whole industry itself is basically an
    asset class built out of nothing. It trades entirely based on
    people's belief that it can be worth something. But as you
    said, the technology has not worked for a payments mechanism.
    It has become a speculative instrument. But ultimately, you
    know, as Mr. McKenzie said, it is a zero-sum game, and if
    people stop believing in it then it all falls apart.
        Mr. O'Leary has talked about that regulation in the United
    States is the prize. That is exactly right. Without that
    regulation as the prize to legitimize crypto, there is nothing
    there, and it could all go to zero. And while that is very bad
    news for the people who have already invested, I think it is
    very good news for the rest of us because it is being kept out
    of the broader financial system, and we will not suffer the
    consequences from its broader failure.
        Senator Warner. Mr. McKenzie.
        Mr. Schenkkan. Thank you, Senator. Yes, I just want to echo
    what Professor Allen was saying. One of the many, many
    seemingly limitless ironies of cryptocurrency is that the
    supposedly decentralized nature of it, it is, in fact, highly
    centralized. I know this. I wrote an article with my colleague,
    Jacob Silverman, for the Washington Post about Binance this
    spring. Binance is incredibly murky, but Binance, as Mr.
    O'Leary, as other Senators have pointed out, Binance is in
    communication with FTX. They were an early investor in FTX.
    There is apparently a private signal chat group entitled
    ``Exchange Coordination'' that CZ is on. Yes, this is publicly
    reported. I believe Mr. Bankman-Fried submitted into the
    congressional record, if I am not, yeah. So they are all
    talking to each other.
        The crypto industry is actually really, really small
    amongst the people that count. And a zero-sum, strictly
    competitive game, there are winners and losers, and in an
    unregulated zero-sum strictly competitive game you are either a
    scammer or a mark. If you do not know which one you are, you
    have a problem.
        Oh, do you want me to answer the remittances question? I am
    sorry, sir.
        Senator Warner. Well, if you want to just touch on Alameda
    as well.
        Mr. Schenkkan. Sure. So Alameda is Tether's biggest client.
    That is according to reporting from Protos last year.
    Supposedly Alameda purchase, I believe, $36.7 billion worth of
    Tethers. Given FTX's insolvency, I think one question might be
    where did the money come from.
        Senator Warner. I know I am running out of time, but Mr.
    O'Leary, I have great respect for you as an entrepreneur. I
    spent a long time as an entrepreneur. I am trying to sort this
    through as well. I get your point, but I guess what I would
    raise for the Chairman and the Ranking Member is, you know, I
    am still trying to wrestle with this in my mind whether we need
    a crypto set of rules or whether we frankly--what are we, 14
    years after Dodd-Frank?--ought to take a bigger step backwards
    and realize we have got this bright, shiny problem over here
    around crypto, but the amount of financial activity--if you
    look at the fact that over 50 percent or the mortgage
    origination now is outside the regulated banking sector.
        I have been a big advocate for fintech for a long time, but
    there are a whole series of lending entities out there, again,
    that have no regulatory protections around them at all. And
    nothing would be worse than doing a relatively good job--and we
    maybe overdid it in certain parts on Dodd-Frank--but put a
    structure our regulated industry, and suddenly see this huge
    escape of financial activity going outside any kind of
    regulatory envelope at all.
        I am all for innovation, but Lord knows, if crypto was
    suddenly followed by a whole series of fintech entities that
    were coming back saying, ``Hey, I need my money back as well. I
    did not get my lending that was taking place on this
    platform,'' we could have a problem. Thank you, Mr. Chairman.
        Chairman Brown. Thank you, Senator Warner.
        Senator Lummis, of Wyoming, is recognized.
        Senator Lummis. Thank you, Mr. Chairman. I also want to
    thank Senator Toomey for his wonderful leadership on this
    Committee, just in the event this is our last hearing. Thank
    you for your service.
        Chairman Brown. We have a hearing tomorrow.
        Senator Lummis. We are conflating topics today. Digital
    assets are not on trial. Fraud and organizations are on trial.
    So let us separate digital assets from corrupt organizations.
        FTX, as I have been saying for the last few weeks, is good
    old-fashioned fraud, and what they did is separate from digital
    assets. Now we have all heard that FTX lent its executives
    hundreds of millions of dollars in comingled customer funds for
    personal use, and customers who tried to wire money to FTX were
    instead given Alameda's routing number. That is fraud. That is
    fraud whether it is conducted in U.S. dollars or euros or
    digital assets. That is fraud.
        Additionally, even though FTX was a multibillion-dollar
    enterprise, it had a shocking lack of corporate controls and
    enabled affiliates to conceal the movement of money and take on
    enormous liabilities, enabling the misuse--well, the misused
    customer assets that were supposed to be appropriately
    safeguarded. FTX, in its terms of service, said, ``Title to
    customer digital assets always remain with the customer.'' Now
    that, we know, is a lie, and now millions of FTX customers
    around the world will suffer.
        So FTX is a failure of people, safeguards, and regulation.
    It is not a failure of technology. The people in the digital
    asset industry need to get really serious about risk management
    and compliance with things like anti-money laundering laws, and
    that is why we have seen a failure of a number of firms engaged
    in riskier practices, even for the digital markets this year.
        So one question people should ask themselves is how FTX
    grew so quickly? They were founded in 2019, and grew to be one
    of the largest digital asset exchanges in just 2 years. So you
    look at other companies like Kraken, Coinbase, and Bitstamp.
    They have been around for a decade. They have grown
    organically.
        This Committee needs to be focused on putting legislative
    solutions in place that would have prevented FTX's collapse and
    other firms like it. This means things like regulation of
    digital asset trading, providing consumers with adequate
    bankruptcy protection, disclosures, and stablecoin regulation.
        So let us not conflate topics here. Mismanagement, failure
    of people, inadequate controls is what is on trial. We need to
    regulate this business and lay digital assets on top of our
    existing financial regulatory framework.
        Questions. Ms. Schulp, why do digital assets and
    distributed ledger technology have the power to make our
    capital markets safer and more efficient?
        Ms. Schulp. There are multiple ways that they can do that,
    and one of them is by removing the intermediaries that we have
    been talking about, where there are potential for such things
    as an FTX to take customer assets and misuse them. When those
    intermediaries do not exist in digital asset systems then you
    do not have the same risks.
        You can also have faster, cheaper payment systems than we
    currently have, and a more global payment system, which allow
    people to send money cross-border in a way that should be very
    important for a country like the United States, which sends a
    lot of remittances across the world.
        Senator Lummis. I know I am out of time, but I want to make
    a plug for the Responsible Financial Innovation Act that
    Senator Gillibrand and I have cosponsored, that we have been
    talking to our colleagues about. This is a case study in why we
    need the Responsible Financial Innovation Act. We will be
    reintroducing the bill next year. We are absolutely delighted
    and willing to take your comments, suggestions, ideas. And it
    is time to move, time to move to regulate the digital asset
    industry. Thank you.
        Chairman Brown. Thank you, Senator Lummis.
        Senator Warren, of Massachusetts, is recognized.
        Senator Warren. Thank you, Mr. Chairman.
        So Sam Bankman-Fried and other crypto billionaires argue
    crypto is special, but a basic principle of our financial
    system is same kind of transactions, same kind of risks means
    same rules apply. Right now, if a bank takes money from
    terrorists and the bank and the banker then have broken the
    law, and that is why banks spend so much time and so much
    energy identifying who their customers are and reporting
    suspicious activity to authorities.
        A lot of crypto firms are not doing these kinds of checks,
    so crypto has become the preferred tool for terrorists, for
    ransomware gangs, for drug dealers, and for rogue States that
    want to launder money.
        In 2021, at least $14 billion in digital assets went to
    criminals. Now that is a lot of drugs and a lot of ransoms and
    a lot of bombs and a lot of nuclear materials, but it is likely
    only the tip of the iceberg. A new report finds that one crypto
    exchange alone helped launder over $10 billion for criminals
    and countries like Iran. Even so, the crypto industry continues
    to take the position that nothing should change.
        Professor Allen, the crypto industry claims that it does
    not need to do all of the know-your-customer and other anti-
    money laundering checks that banks do and stockbrokers do and
    even Western Union does because crypto is uniquely transparent.
    Everything is on the blockchain so criminals and rogue States
    that try to launder money in crypto will quickly be found out.
        Does the fact that the blockchain is public mean that it is
    more difficult for criminals to launder money using crypto?
        Ms. Allen. In many ways the blockchain is the worst of all
    words. For everyday people, the blockchain is a permanent
    public record of all their transactions, which is a privacy
    nightmare. But for sophisticated players with a vested interest
    in hiding their transactions there are all kinds of tools
    available--mixers, tumblers, et cetera, that can hide the
    provenance of their crypto assets. And far from being difficult
    for criminals to use crypto to launder money, the fact that
    there are not KYC checks is the point.
        Senator Warren. OK. So crypto is actually easier to do
    money laundering.
        Let us look at another crypto industry argument. Professor
    Allen, crypto industry claims that it would be too much trouble
    and maybe even technologically impossible for them to check
    customers the way that banks and stockbrokers and even Western
    Union does. But let me ask, do banks and stockbrokers and
    Western Union have to invest money and resources to make sure
    that they are set up to conduct those checks?
        Ms. Allen. Yea. I mean, KYC requirements are simply part of
    operating a financial services business. But avoiding those
    requirements, as you say, is critical to many crypto business
    models. Blockchain-based transaction processing, as we have
    discussed, is very clunky and expensive. Ms. Schulp has just
    told us that it can be more efficient. The only way it is more
    efficient is if it actually avoids the KYC checks that can slow
    things down. So this crypto business model is in many ways a
    regulatory arbitrage play.
        Senator Warren. Right. So actually it is an interesting
    question. If banks and Western Union said they should not have
    to follow any money laundering rules, so that they could make
    more money, they could improve their profitability, what would
    our country say and what does every country around the world in
    the financial system say?
        Ms. Allen. No.
        Senator Warren. Right. OK. So Mr. O'Leary, I know that you
    are a big supporter of crypto, even after you lost $10 million
    in FTX's collapse, but you are an experienced investor. So let
    me ask you, do you believe that the potential benefits of
    crypto are so promising that we should accept weaker anti-money
    laundering rules and weaker compliance from crypto firms than
    we require from banks, from brokers, and from Western Union?
        Mr. O'Leary. No. I think we should apply the same
    regulatory structure that we apply to existing trading of
    stocks and bonds and exchanges tied to broker-dealers. That is
    not complicated. It has already been implemented in other
    countries.
        And I take issue, Senator, with your concept that it makes
    it easier to do money laundering. Currencies have been used for
    drug trafficking since the '60s, and the American dollar, when
    it was thrown out of a Piper aircraft in a duffle bag. The
    American dollar is also used by bad actors all the time.
        Senator Warren. Mr. O'Leary, I appreciate your point that
    everyone tries to engage in money laundering. That is what
    terrorists do, that is what drug dealers do, and that is what
    States like Iran and North Korea have done.
        The only point I am trying to make is should the same rules
    against money laundering apply to crypto in the way that they
    apply to banks, to stockbrokers, to credit card companies, to
    Western Union?
        Mr. O'Leary. You know----
        Senator Warren. And I think your answer to that was yes. Is
    that right?
        Mr. O'Leary. No.
        Chairman Brown. Mr. O'Leary, you have 30 seconds. Keep your
    answer short.
        Mr. O'Leary. It is not yes. I am just saying if you know
    your client rules on both sides of the transaction and use a
    crypto such as USDC, that is regulated, you solve this problem,
    Senator, overnight.
        Senator Warren. Well, I appreciate that you want the same
    kind of rules to apply to everyone, and we can talk about what
    is needed to make that happen.
        You know, the dark underbelly of crypto is its critical
    link to financing terrorism and human trafficking and drug
    dealing and helping rogue Nations like North Korea and Iran.
    Crypto does not get a pass to help the world's worst criminals,
    no matter how many television ads they run or how many
    political contributions they make.
        It is time for Congress to make the crypto industry follow
    the same money laundering rules as everyone else. That is why
    Senator Marshall and I introduced a bipartisan bill today that
    requires crypto to follow the same money laundering rules that
    every bank, every broker, and Western Union all have to follow
    today.
        Thank you, Mr. Chairman.
        Chairman Brown. Thank you, Senator Warren.
        Senator Van Hollen, of Maryland, is recognized.
        Senator Van Hollen. Thank you, Mr. Chairman, and let me add
    my words of appreciation to Senator Toomey for his leadership
    on all sorts of issues. I have disagreed with Senator Toomey
    many, many times, but I have also had the opportunity to work
    with him closely on lots of issues. So Pat, thank you.
        And thank all of you for being here. You know, over the
    last more than 2 years I think this Committee has been trying
    to take a crash course on crypto, and understand all its
    implications. And I think the fact that we have four very
    bright individuals here, with diametrically opposed views, is
    an illustration of the challenges we are facing as a Committee.
        But I do want to pick up where my colleague, Senator
    Tester, did, because the question is where do we go from here.
    And on the one hand, the impulse is, of course, to want to
    protect consumers. On the other hand, we want to make sure that
    in the process of trying to do that we do not give a Government
    imprimatur to a system that is so inherently risky and without
    necessarily any, at least as two of our witnesses said,
    underlying in value.
        So Professor Allen, if you were king, queen for the day,
    what would you do right now? And let me just say, we have got
    the SEC. The SEC clearly has the authority and power to go
    after fraud, and we need to make sure they have the resources
    to go after fraud in this area because it has grown very fast.
    But beyond using the existing tools, what would you do, going
    forward?
        Ms. Allen. If I were queen for a day I would ban crypto,
    but if I were someone who was dealing with multiple
    constituencies and realize that that might not be viable, I
    think the path I would take would be to strengthen banking law,
    what I have been calling Glass-Stegall 2.0, and make it quite
    clear that banks simply may not touch crypto in any way, shape
    or form. And then I would give the SEC more money. I would pass
    legislation that makes it clear, abundantly clear, that all
    crypto is a security. And to be clear, the definition section
    in the securities legislation does not just list investment
    contract. This is not just about the Howey Test. There are all
    kinds of securities that do not go through the Howey Test.
    Bonds are just listed. If it is a bond, it is a security. So we
    could say if this is a crypto asset it is just a security. You
    do not have to go through the Howey Test framework. And then we
    apply all the securities laws, you know, robustly, and I think
    that is the best way forward.
        Senator Van Hollen. Thank you. And is it Mr. Schenkkan,
    McKenzie Schenkkan?
        Mr. Schenkkan. Yes, sir. You can also call me Ryan.
        Senator Van Hollen. All right. Well, in that case, listen.
    I appreciate your testimony. The bottom line, as I understood,
    is you said we should just deal with this and regulate it like
    it is gambling. And, you know, I have been listening. I have
    been listening to analogies to Enron, and even analogies to the
    mortgage meltdown, you know, mortgage-backed security meltdown.
    At least in those cases they were backed by real assets, right?
    In the case of Enron you have got an energy-producing company.
    In the case of mortgage-backed securities it was an outrageous
    scandal. At the end it was supposed to be backed.
        What is this backed by, if I could ask you? What is this
    backed by, at the end of the day?
        Mr. Schenkkan. Nothing. It is a story. Robert Shiller, the
    Nobel prize-winning economist talks about how economic
    narratives form. They are in response to real events. In this
    case, with cryptocurrency, I would argue the genesis was the
    subprime crisis. The Bitcoin white paper, released in October
    of 2008, was perhaps well intentioned. It was intended to be a
    peer-to-peer currency that would avoid all intermediaries.
        So the story has understandable appeal. I think if crypto
    serves any function it is to highlight the myriad failures of
    our regulated system and our banking system, and our American
    economic system, to provide people with a fair shot at the
    American dream, or what is left of it.
        That does not make the story true, however, the story of
    cryptocurrency. What it does is lend it enormous power, and
    these stories spread, as Shiller describes, like viruses,
    infecting one person to another, much like a multilevel
    marketing scheme. But, you know, for the digital era, instead
    of a 5-hour Tupperware party you get a 60-second TikTok video.
    And you are encouraged to invest because you see other people
    investing. They call it FOMO--fear of missing out. We used to
    call it greed.
        People get very excited, these bubbles buildup very big,
    but then they collapse very swiftly, and I think that is what
    we are seeing now today.
        Senator Van Hollen. Thank you.
        Chairman Brown. Thank you, Senator Van Hollen.
        Senator Cortez Masto, of Nevada, is recognized.
        Senator Cortez Masto. Thank you. Thank you, Mr. Chairman. I
    too, my kudos to our Ranking Chairman. Thank you so much. It
    has been a pleasure to work with you. We have not agreed on
    everything, but you are a gentleman, and I do always appreciate
    the opportunity to have an open line of communication with you,
    so thank you.
        To everyone here, thank you. This obviously is something we
    have been working on for a period of time here, and really
    appreciate the insight you all bring.
        I do want to follow up on my colleague, Senator Van
    Hollen's line of questioning with Professor Allen. I want to
    ask the rest of you. Clearly she is supporting banning it. If
    we do not ban it, how do we regulate it? She put forth a
    proposal which is isolate it from the banking system and then
    define it as a security. Does anybody disagree with that or
    have any other ideas about how it would be regulated? Mr.
    O'Leary.
        Mr. O'Leary. The concept of pressing legislation that would
    ban banks from integrating cryptocurrencies and crypto
    technology, if that were to happen, as an investor, I would
    short every American bank stock because it would make it the
    most uncompetitive financial services sector in the world.
        The innovation that is coming forward, once regulated, is
    going to be profound in terms of how it changes the cost, the
    efficiency, the auditability, the productivity of the banking
    sector. Just look at things as simple as ACH transfers, how
    archaic they are. Look at the Fed wire.
        Senator Cortez Masto. So let me just stop you there. I only
    have so much time. So you do not agree with isolating it from
    the banking system.
        Mr. O'Leary. That is insanity.
        Senator Cortez Masto. OK. Ms. Schulp.
        Ms. Schulp. I also do not agree with isolating it from the
    banking system. I do think that if I were queen for a day to
    regulate I would ask Congress to make some clear lines here
    with respect to what is and is not a security, and I think a
    lot of crypto tokens do fall under the category of security,
    but it is not always clear.
        I also would ask Congress to draw clear lines as to which
    market regulator handles secondary trading, giving the
    commodities segments to the CFTC and the securities segments to
    the SEC. That should put good guardrails in place in order to
    apply similar risk frameworks to similar risks.
        Senator Cortez Masto. Thank you. Mr. Schenkkan?
        Mr. Schenkkan. If we allow cryptocurrency to infect our
    banking system we will be back here.
        Senator Cortez Masto. Thank you.
        Mr. Schenkkan. We will be back here, not in a good way.
        Senator Cortez Masto. And Professor Allen, anything else to
    add. So I am going to ask you, because I also appreciate your
    conversation with Senator Tester, and it really focuses on why
    we should isolate it from the banking system.
        But let me ask you this. Many crypto advocates have taken
    this scandal that we are talking about today as an opportunity
    to suggest that the failure of FTX was due to its
    centralization, and argue for decentralization finance, or
    DeFi. Can you talk a little bit--would that have made a
    difference, and what impact would the DeFi lead to possible
    greater centralization of wealth? I mean, can you talk a little
    bit about what that means, if anything?
        Ms. Allen. Sure. So DeFi stands for decentralized finance,
    but that is a marketing term because it is not actually
    decentralized. As I mentioned earlier, technological
    decentralization and economic decentralization are not the same
    thing. First of all, DeFi is highly integrated with the
    centralized crypto ecosystem and it is not sure that it can
    survive without it.
        And then even within DeFi there are so many intermediaries.
    At the underlying blockchain level you are trusting the core
    developers of the software that runs the blockchain and the
    validators who implement the software changes. On the next
    level up, you are trusting the people who program the
    application that runs on that blockchain.
        Now the people who program that are controlled by the
    people who own the DAO governance tokens. So you may have heard
    about these DAOs, these decentralized autonomous organizations.
    They are basically like creating a partnership on the
    blockchain.
        The ownership of those tokens, it is meant to be
    decentralized and disbursed, but that is not the reality. The
    economic reality is that for a lot of these things, like 90
    percent of the tokens plus are owned by a single person. So
    saying that I could--you know, me, having one governance token
    in a DAO, is like me buying a share in Tesla and trying to tell
    Elon Musk what to do.
        So economically it is very centralized, the whole way up
    and down. So much like many of the stories that Mr. Schenkkan
    has been talking about, it is a story. You know, I really get
    why people want these things. Would it not be nice if we could
    create a world where we did not have to trust the
    intermediaries who have made so many mistakes, so many times?
        But the reality is that economic power concentrates in
    these places, and we cannot avoid intermediaries. So what is
    the point of DeFi?
        Senator Cortez Masto. Thank you. I noticed my time is up.
    Thank you, Mr. Chairman.
        Chairman Brown. Thank you, Senator Cortez Masto.
        Senator Smith, of Minnesota, is recognized.
        Senator Smith. Thank you, Chair Brown. I am going to direct
    my first question to Professor Allen. The collapse of FTX is
    shocking, but it is hard to say that it is surprising, right? I
    mean, it is hard not to conclude that this crypto exchange and
    its related firm, Alameda Research, completely failed to
    safeguard the money of the people they entrusted their money to
    there. And we should not lose sight of the fact that millions
    of dollars disappeared overnight and that this is money that
    belonged to people who could not afford to lose their money.
        So Professor Allen, I want to get at this question of
    consumer protection, just pretty quickly. People are free to
    invest their money pretty much however they want to, but they
    deserve to know that the market is fair and that there are
    rules that protect them from bad actors, so they are not
    getting ripped off. Exchanges and firms that buy and sell
    stocks and commodities are required to keep company money
    separate from their customers' money. They do not get to gamble
    with their customers' money without asking permission first. Is
    that correct?
        Ms. Allen. Yes.
        Senator Smith. And that is not the case with what we saw
    with FTX, what we see often in crypto. Is that true?
        Ms. Allen. I mean, they often say in their terms of service
    that they will not do it, but they do it anyway.
        Senator Smith. Yeah. I think that is right. And when a firm
    is being paid to give advice to their customers on how to
    invest their money, they have to put their customers' interests
    first, right? That is basic fiduciary responsibility. Is that
    the case in crypto right now?
        Ms. Allen. So, I mean, I think there is a big concern here
    about crypto being incorporated into things like pension funds
    and also into 401(k) plans. So the Department of Labor is being
    very clear that they do not think that this is the type of
    thing that belongs in any kind of sort of retirement savings.
    Unfortunately, Fidelity has made the move to allow people to
    invest in Bitcoin through their 401(k) plans, and I think that
    is highly problematic.
        Senator Smith. Yes, and Senator Warren and Senator Durbin
    and I have sent letters to Fidelity and have urged the
    Department of Labor to follow up on this, because they have
    this highly volatile asset that does not appear to be--it seems
    to be exactly the wrong kind of thing to put in a retirement
    account, where you are looking for more stability over the long
    term. Right?
        Ms. Allen. Right.
        Senator Smith. And let me just ask, just following up on
    what Senator Warren was focusing on, banks and other financial
    services firms have as their responsibility the duty to know
    who their customers are. That is how we protect against money
    laundering. Is that the case in crypto?
        Ms. Allen. No. I mean, I think generally speaking there is
    sort of a failure of gatekeepers all over the crypto industry.
    We have talked about we do not have the auditors being able to
    exercise oversight. We do not have KYC functions there.
        Another failure of oversight is the venture capital firms.
    We sort of expect them to exercise a restraint and exercise
    diligence before lending their reputation to these businesses.
    But venture capital firms were throwing money at FTX and
    similar firms without doing their diligence.
        So as I explored in my written testimony, one of the things
    we can achieve by enforcing the securities laws is actually
    holding venture capitalists to account a little more because of
    potential liability as statutory sellers of unregistered
    securities.
        Senator Smith. Yep. So I agree with that. I think that the
    crypto world at FTX shows us what can happen when we do not
    have basic consumer protections in place. And, you know, crypto
    is a relatively new thing, but we know what to do to make sure
    that our markets are fair and that financial institutions know
    their customers. So it seems to me that our job here is to
    enforce the laws that we have, make sure that we are plugging
    holes where they exist, and making sure that our enforcement
    agencies have the authorities and the resources they need, or
    we are going to see more disasters like this.
        Mr. Schenkkan, I would like to follow up and ask you a
    question. I want to talk about the external impacts of crypto.
    So crypto mining and verification is a highly energy-intensive
    process that requires more electricity annually than many
    individual countries. The worst offender is Bitcoin, but this
    is a widespread problem. In the U.S. alone, crypto operations
    require as much electricity as all home computers or
    residential lighting, and this is, of course, contributing to
    our challenges around carbon emissions. And then there is the
    issue about crypto mining exacerbating local noise and air and
    water pollution as well. So lots of externalities, as we say.
        As I understand it, crypto mining is built on a process
    that becomes more and more energy-intensive over time. Is that
    correct?
        Mr. Schenkkan. Yes.
        Senator Smith. So it is inherently inefficient. Is that
    correct?
        Mr. Schenkkan. Yes. The technology is bad.
        Senator Smith. And so where is the benefit of this kind of
    innovation and how should we think about the impacts of this
    when it comes to the climate and energy use impacts? Because in
    fact, when crypto mines are located in communities, those
    communities often see their energy prices go up, their energy
    rates go up. Is that correct?
        Mr. Schenkkan. That is right. I visited the largest crypto
    mine in the country, Whinstone, which is in Rockdale, Texas,
    just outside of my hometown of Austin, Texas. Local citizens
    are upset. It raises the cost of electricity for all citizens,
    and it also uses an enormous amount of energy. It took over a
    former Alcoa aluminum smelting plant that had been abandoned,
    and now we are using it to mine ephemeral digital assets of no
    productive value. I think that says a lot.
        Senator Smith. Thank you. Thank you, Mr. Chair.
        Chairman Brown. Thank you, Senator Smith.
        My understanding is Senator Sinema is joining us remotely.
    Senator Sinema, from Arizona.
        Senator Sinema. Thank you, Mr. Chairman, and thank you to
    our witnesses for being here today.
        You know, Arizonans are always interested in investment
    opportunities that allow them to build better lives for
    themselves and their families, especially in the last few
    years. In conversations at the grocery store, the gym, the
    coffee shop, or the kitchen table, Arizonans have been talking
    about cryptocurrency--the hype, the skepticisms, the questions
    of how it works and how it will work going forward.
        Like most Arizonans, I am a skeptical optimist. I believe
    in the future and the potential of this technology, that it can
    be a force for good, and that it can ultimately make people's
    lives better, but also clear-eyed about what is happening right
    now, how technology and anonymity can be misused and abused and
    how people are being deceived and defrauded.
        The collapse of FTX is just one of many recent market
    events that are shaking investors' faith in the ecosystem. Some
    will say this is about the ecosystem as a whole. Others will
    say this merely applies to centralized entities and that this
    criticism should not apply to more decentralized projects.
        But even in the context of decentralized projects, we need
    to understand how dispersed ownership truly is. This is a
    complex issue but I want to put the focus where it should be,
    on everyday Arizonans, many of whom put their faith in a
    technology that appeals to our independent leanings and our
    natural skepticism of Government and centralized control.
        So I believe we have some obligations to everyday
    Arizonans. First, to make sure they have the information they
    need to understand risks and opportunities, and ultimately to
    make investment decisions that work for themselves and for
    their families. Second, to grow the U.S. economy and protect
    the integrity of our capital markets. Third, to provide a
    regulatory framework that responsibly promotes innovation here
    in the U.S. while increasing funding through enforcement to
    ensure that any bad actor is pursued quickly and harshly. So
    protect investors, protect the economy, promote innovation, go
    after the bad guys--it is pretty fundamental.
        So I would like to turn to Professor Allen and thank him
    [sic] for being here. Your testimony cites a Financial Times
    article entitled ``Let It Burn'', that calls for crypto to do
    just that, to burn down as a fully unregulated business. So let
    us be specific. In the cases of FTX, Terra Luna, Celsius, and
    others, who exactly got burned?
        Ms. Allen. It was the investors.
        Senator Sinema. That is right. I also want to apologize,
    Professor Allen. I misnamed you there for a moment. I
    apologize.
        Ms. Allen. That is fine.
        Senator Sinema. In other words, it was investors, right,
    everyday Arizonans, people who work hard for the money they
    make and are just trying to provide for their families, save
    for their kids' college, or take that vacation they have always
    dreamed of.
        The founders did not get burned, even if ultimately they
    got arrested. It is regular people who got burned. And that is
    why it frustrates me when people say, flippantly, ``Let it
    burn'' because that is the hard-earned savings that everyday
    people invested in good faith, with promises of big returns.
    And for FTX customers, all of that is now gone.
        Most people had no idea they find themselves as unsecured
    creditors, unlikely to get back the investments they entrusted
    to Mr. Bankman-Fried, and others, and they are last in line
    behind banks, lawyers, other lenders, and venture funds.
        For months, I have had people in Washington tell me and my
    staff that new legislation is not necessary here. They say that
    there is sufficient regulatory authority and that the
    regulators should just handle it unimpeded. But my question is,
    where were the regulators? I was encouraged to see fraud
    charges pressed against Mr. Bankman-Fried and his subsequent
    extradition and arrest, but let us be serious--that was
    reactive, not proactive, and frankly, it is the least that
    Government could do. And perhaps most importantly, for all
    those regular Americans, it is not going to get them their
    money back.
        And others will say that this is a classic case of buyer
    beware. It is clear that due to murky jurisdictional issues,
    unanswered legal questions, and a lack of regulatory clarity,
    investors are having a difficult time accurately pricing risk.
    In finance, we learn that the return on your investment should
    be related to the risk that you bear, but if you cannot price
    the risk it is hard to understand what return you should
    expect, and that cuts at the core of how a healthy market
    should function.
        Professor Allen, your testimony highlights a number of ways
    that greater regulation enforcement can be valuable for
    investors, and I am interested in identifying specific ways
    that we can assist investors in quantifying the risks they may
    be taking on. Are there specific disclosure or registration
    requirements that you believe may assist investors in more
    accurate price discovery?
        Ms. Allen. Thank you, Senator. So first of all I want to
    point out that the ``let it burn'' argument may seem harsh, and
    it is not one that I advocate for this reason. But it may seem
    harsh to the individual investors. But it is advocated in a
    sense of trying to protect people who have not invested in
    crypto from broader financial failure. So it is not as harsh as
    it might seem. We are trying to find a regulatory regime that
    can protect noninvestors as well as investors, and that is what
    I have tried to advocate for in my testimony.
        In terms of protecting investors, as I have said, I do not
    know how you can really protect them from crypto assets with
    more disclosures because what are you actually disclosing about
    an asset that nothing behind it? I think that the securities
    laws are effective in requiring registration, which means
    people who have assets with nothing behind them will not be
    able to offer them in the first place, and that, I think, is
    the value, the ex ante value, as you said, instead of an ex
    post enforcement action. I think that is the value of applying
    the securities laws here.
        And yes, I wish they had been enforced more aggressively in
    the lead-up to this. I think the SEC has not had enough
    resources. I also think that the SEC has faced a lot of
    significant political pressure to back off from the crypto
    industry. It received letters from Congresspeople last year,
    saying, ``Don't look at FTX.''
        So I think that full-throated support from Congress for the
    SEC's investor protection mission could be very effective in
    increasing enforcement in this space.
        Chairman Brown. Thank you, Professor Allen. Thank you,
    Senator Sinema.
        Senator Toomey has one last question, as I do, and then we
    will wrap. Thank you.
        Senator Toomey. Thanks, Mr. Chairman. I think during the
    course of this hearing we have not talked as much as we ought
    to about some of the, I think, really exciting and terrific
    applications that the crypto ecosystem makes possible. One of
    the categories that comes to mind is the ability to use
    stablecoins in conjunction with smart contracts. Basically it
    turns into what I think of as programmable money, where you can
    write into the code a payment that will occur, based on some
    exogenous and verifiable event, and the payment requires no
    human intervention. It just happens when the exogenous event
    occurs.
        So, Ms. Schulp, I wonder, first of all, could you comment
    on whether you think there is a lot of future in this idea of
    programmable money, and then second, I think you are familiar
    with the legislative framework that I have laid out for
    stablecoins. I think the heart of that is the requirement that
    we have 100 percent cash and cash equivalence as a backing for
    a stablecoin and oversight by the OCC, but not the Fed. And I
    wonder if you would comment also on whether you think that is
    the right approach to regulating stablecoins?
        Ms. Schulp. Of course. I do believe that stablecoins have a
    lot of promise, not only I terms of the programmable money
    concept that you state but also in terms of just being a faster
    and more stable way to work within a digital ecosystem rather
    than relying on kind of creaky payment rails. Stablecoins can
    offer a lot of alternatives in that space, where we have truly
    digital money.
        I am familiar with your legislation, and I think that it
    addresses what is one of the, I think the most obvious risks in
    the stablecoin space, which is the concern that stablecoin
    issuers do not have stable coins, because the reserves that
    they have behind them might not be what they say they are.
        I think that there are a number of ways that you can go
    about creating a regulatory regime to take account of that
    risk. I myself have proposed kind of a disclosure-based
    framework that could be put into place by something like the
    SEC. In fact, it is very similar to the disclosure framework
    that you have proposed with the OCC.
        I do think it is important to separate that type of
    regulatory function from the Federal monetary regulator so that
    the Federal Reserve is not the one charged with handling
    regulation of kind of a money substitute here. There are a lot
    of conflicts of interest that can exist in that space, and I
    think it is wise to keep stablecoin regulation, which is
    something that I think is kind of low-hanging fruit at this
    point. There are obvious risks, and I think there are pretty
    obvious ways to deal with those risks in a pretty simple
    fashion. But we should keep that type of regulation separate
    and apart from monetary regulation.
        Senator Toomey. Thank you.
        Chairman Brown. Thank you. And my question--in fact, thank
    you for that answer--Professor Allen, my question is, in part,
    a follow-up with your answer to Senator Sinema about the
    difficulty of regulating crypto. Crypto firms have called for
    regulatory clarity, is a term that some of them use. Do you
    think crypto platforms could mostly comply with actual
    regulations?
        Ms. Allen. No, I do not, and I think when they are calling
    for regulatory clarity what they are asking for is actually
    bespoke regulation that they can comply with.
        Chairman Brown. OK. Good answer. Thank you.
        Thanks to the witnesses for your testimony. The events of
    this week should be a warning to others about accountability,
    not just in crypto. How we discuss crypto from this point
    forward will define crypto markets for the future.
        For Senators who wish to submit questions for the record,
    those questions are due Wednesday, December 21st. Witnesses, we
    ask you within 45 days to respond to any questions.
        Thank you again. The Committee is adjourned.
        [Whereupon, at 12:54 p.m., the hearing was adjourned.]
        [Prepared statements, responses to written questions, and
    additional material supplied for the record follow:]
                  PREPARED STATEMENT OF CHAIRMAN SHERROD BROWN
        Today's hearing is in a hybrid format. Our witnesses are in-person
    and virtual, and Members have the option to appear either in-person or
    virtually.
        First, I want to express my gratitude to the Department of Justice,
    the SEC, the CFTC, and the Bahamian authorities for taking this
    critical step to hold Sam Bankman-Fried accountable for his misdeeds.
    I'd also like to thank Ranking Member Toomey and his staff for working
    with me and my staff to try to secure Mr. Bankman-Fried's testimony.
        I trust that Mr. Bankman-Fried will soon be brought to justice. It
    is clear he owes the American people an explanation.
        Meanwhile, our job is to keep learning more about the collapses of
    FTX and other crypto firms, and work with regulators to put consumers--
    not the crypto industry--first.
        This isn't just about crypto. This is about protecting the
    consumers and the regulated financial sector from bad actors who think
    rules don't apply to them.
        Two-and-half years ago, I explained why I thought Facebook's Libra
    currency was dangerous.
        At the time, Facebook was moving full steam ahead to create its own
    ``currency'' to impose on its billions of users.
        Congress, regulators, and policymakers saw Facebook Libra for what
    it was: a shiny new tool Facebook could use to reach into Americans'
    pockets and profit from--no matter the risk to consumers or our
    economy.
        Members of this Committee, and others in Congress, responded.
    Republicans and Democrats alike made it clear that Facebook couldn't be
    trusted, and our financial system was not to be played with.
        The risk of a company creating its own currency to compete with the
    U.S. dollar was obvious.
        Ultimately, Facebook shut down its crypto project, but this
    Committee's work to protect consumers continues. Even though Facebook
    shelved its crypto plans, in the last two-and-a-half years, the
    stablecoin market has grown five-fold to become a tool for rampant
    speculation.
        The number of crypto tokens has exploded, even as the total value
    of all crypto assets fell by two-thirds in the last year.
        In the past, I've noted the similarities that cryptocurrencies
    share with risky mortgage bonds and over-the-counter derivatives during
    the lead up to the financial crisis. In all these cases, they told us
    how great innovation is and how derivatives make markets efficient.
        Wall Street made it easy for everyone to get a mortgage so bankers
    could create more mortgage bonds and increase profits. Making money in
    crypto seemed easy, too easy--every crypto token could double or triple
    in value in a matter of hours or days.
        It didn't matter if it was created with vague details or as a
    joke--money poured in. But no one is laughing now.
        The weekend before our stablecoin hearing last February, we saw
    crypto companies spending big money on Super Bowl ads to attract more
    customers and pump up crypto tokens.
        Crypto, like Facebook's Libra before it, was the shiny tool that
    was supposed to capture our imagination and revolutionize our lives.
    Wealthy celebrity spokespeople told Americans, if you're not buying
    crypto, you're missing out.
        Crypto platforms created dozens of investment products. Products
    that look and sound like bank deposits, and that used words like
    ``lend'' and ``earn.'' Or tokens that resemble securities and have a
    ``yield'' or governance rights. Yet these products had none of the
    safeguards of bank deposits or securities.
        Crypto firms, and their backers, argued that billions of dollars
    invested in lending programs, or earning yield, should be exempt from
    basic oversight and regulatory protections.
        That's not how regulation works. The things that look and behave
    like securities, commodities, or banking products need to be regulated
    and supervised by the responsible agencies who serve consumers.
        Crypto doesn't get a free pass because it's bright and shiny. Or
    because venture capitalists think it might change the world. Or its TV
    ads campaigns were witty and featured celebrities.
        Especially when so many consumers are at risk of losing their hard-
    earned money.
        And that's before we even consider how crypto has ushered in a
    whole new dimension of fraud and threats to national security that
    support dangerous Nation States, embolden criminals, and finance
    terrorists.
        North Korea uses crypto stolen in hacks to finance its ballistic
    missile programs. Human traffickers and drug cartels and gunrunners
    launder their proceeds using crypto assets, and some of these laundered
    funds end up bankrolling terrorists bent on undermining the United
    States.
        The ability of rogue States, cyber criminals, and terrorists to use
    crypto for their own malign purposes is a feature of the technology.
    That's the point.
        Crypto also has made it easier for fraudsters and scammers to steal
    consumers' money. Hacks and complex crypto transactions made it easy to
    steal billions of dollars of investors' money.
        That's what we saw with FTX. That's what will continue as long as
    we allow crypto firms to write their own rules.
        The myth of Sam Bankman-Fried and his crypto trading success was
    supposed to impress us.
        We are still learning how he shuffled money between FTX and his
    trading firm, Alameda Research. A name calculated to sound as generic
    as possible to avoid raising eyebrows while sending money across the
    world.
        FTX and Alameda Research took advantage of the crypto industry's
    appetite for speculation.
        They were able to borrow and lend from other platforms and invest
    in other crypto firms--inflating the crypto ecosystem and growing their
    own profits.
        Even this summer as crypto values crashed and platforms began to
    fail, FTX and Alameda found ways to benefit. In one case, FTX made a
    $250 million loan to a platform using its proprietary token, and
    Alameda borrowed client deposits worth more than twice that from the
    platform.
        All the while, venture capitalists and other big investors fell for
    it. They were caught up in the speculative frenzy, missed the red flags
    at FTX, and showered Mr. Bankman-Fried with money.
        And now it is all most likely gone.
        It's no surprise that in 2018, Alameda solicited investors by
    guaranteeing 15 percent returns with quote ``no downside.'' That's more
    than the guaranteed 11 percent that Bernie Madoff offered.
        With Madoff and with Sam Bankman-Fried, investors didn't ask
    questions for fear of missing out. It's a good reminder that most
    guaranteed investments are too good to be true.
        In this story, Sam Bankman-Fried was also the shiny object. Now
    he's the villain, possibly worse. But this story is bigger than one
    person or even one firm.
        This is not just about misconduct at FTX, but about how to protect
    consumers and the financial system from unregulated crypto products.
        For many investors, it might be too late. I've heard from Ohioans
    who have money stuck at FTX.US--that they tried to get out before it
    filed for bankruptcy. But despite Mr. Bankman-
        Fried's assertions that the U.S. side of FTX should be fine, the
    court proceedings are likely to drag on.
        If we are going to learn from FTX's meltdown, we must look closely
    at the risks from conflicts at crypto platforms that combine multiple
    functions.
        It means thinking about the kinds of disclosure that consumers and
    investors really need to understand how a token or crypto platform
    works. We can look to existing banking and securities laws for time-
    tested approaches to oversee and examine entities that want Americans
    to trust them with their money.
        To protect consumers and the financial system we need a
    comprehensive framework that looks at crypto products for what they
    are, not what crypto executives want them to be.
        I look forward to working with Treasury Secretary Yellen and all
    the financial regulators to ensure there is an all of Government
    approach--just as we've done in the past. Anything less just won't
    work.
                                     ______

                PREPARED STATEMENT OF SENATOR PATRICK J. TOOMEY
        We're here today to discuss the fallout after the collapse of FTX.
    Some Americans likely suffered significant losses from the bankruptcy
    of FTX and Sam Bankman-Fried's misconduct.
        On Monday, we saw the arrest of Mr. Bankman-Fried. This came as a
    surprise to no one, save for maybe Mr. Bankman-Fried. We owe it to each
    customer to get to the bottom of the FTX implosion, and any violations
    of the law should be aggressively prosecuted. The Department of Justice
    and other enforcement agencies should expeditiously investigate the
    unseemly relationship between a company that was effectively a hedge
    fund, and an exchange entrusted with customer funds.
        While all the facts have not yet come to light, we've clearly
    witnessed wrongdoing that is almost certainly illegal. There was
    unauthorized lending of customer assets to an affiliated entity, and
    there were fraudulent promises to investors and customers about FTX's
    operations. These are outrageous and completely unacceptable. The SEC
    also believes FTX committed fraud against equity investors. They're
    going to pursue this, as they should.
        But I want to underscore a bigger issue here: The wrongful behavior
    that occurred here is not specific to the underlying asset. What
    appears to have happened here is a complete breakdown in the handling
    of those assets.
        In our discussion of FTX today, I hope we are able to separate
    potentially illegal actions from perfectly lawful and innovative
    cryptocurrencies.
        Now it's important to define this space. Cryptocurrencies are
    analogized to tokens, but they are actually software. The software
    foundational to the crypto ecosystem are like operating systems.
    Applications then run on top of these operating systems. Currently
    there are many competing operating systems, and apps running on them.
    There is nothing intrinsically good or evil about software; it's about
    what people do with it.
        With this analogy in mind, what we should all understand here is
    one simple thing: The code committed no crime. FTX and cryptocurrencies
    are not the same thing. FTX was opaque, centralized, and dishonest.
    Cryptocurrencies are open-source, decentralized, and transparent.
        To those who think that this episode justifies banning crypto, I'd
    ask you to think about several examples. The 2008 financial crisis
    involved misuse of products related to mortgages. Did we decide to ban
    mortgages? Of course not. A commodity brokerage firm run by former New
    Jersey Senator John Corzine collapsed after customer funds--including
    U.S. dollars--were misappropriated to fill a shortfall from the firm's
    trading losses. Nobody suggested that the problem was the U.S. dollar,
    and that we should ban it. With FTX, the problem is not the instruments
    that were used. The problem was the misuse of customer funds, gross
    mismanagement, and likely illegal behavior.
        Let's talk about what comes next. Some of my colleagues have
    suggested pausing cryptocurrencies before we can address it. This is
    profoundly misguided, not to mention impossible. Short of enacting
    draconian, authoritarian policies, cryptocurrency cannot be stopped. If
    we tried, the technology would simply migrate offshore; cryptocurrency
    does not need brick and mortar facilities to operate. And typing
    computer code should clearly be seen as a form of protected speech.
        Are we going to decide to pause our Constitution to stop crypto?
    This is exactly the kind of mindset that has driven this activity to
    the dark and less regulated parts of the world.
        Now, if Congress had passed legislation to create a well-defined
    regulatory regime with sensible guardrails, we'd have multiple U.S.
    exchanges competing here under the full force of those laws. It's not
    clear that FTX would have existed, at least at its scale, if we had
    domestic guidelines for American companies. The complete indifference
    to an appropriate regulatory regime by both Congress and the SEC has
    probably contributed to the rise of operations like FTX.
        Others have suggested we refrain from addressing cryptocurrency at
    all, so as to not legitimize its use. This is not only misguided, it's
    irresponsible. Congress can and should offer a sensible approach for
    the domestic regulation of these activities.
        We could start with stablecoins. This is an activity that my
    colleagues can analogize to existing, traditional finance products.
    There's clear bipartisan agreement that stablecoins need additional
    consumer protections. There are virtually none now. I've proposed a
    framework to do that. As have Senators Lummis and Gillibrand.
        Congress also needs to determine the criteria by which the issuance
    of digital assets will be regulated. And we should acknowledge the
    possibility that certain token issuances, like Bitcoin, don't need any
    further regulation. We should also clearly delineate regulations for
    secondary market trading of these assets, including at exchanges like
    FTX.US. Some of my colleagues have begun this important work.
        We can provide sensible consumer protections for which there would
    be very broad agreement, while still allowing for the development of
    applications that are going run on operating systems that we can't even
    imagine today. Just as we never imagined applications like Uber
    operating on iOS today.
        Let me conclude with this. It's absolutely essential to investigate
    any fraud and violations of existing law, and prosecute those who are
    committing those crimes. Congress owes it to the American people to do
    so here. But this is fundamentally not about the kind of assets that
    were held by FTX. It's about what individuals did with those assets.
        Individuals can also be tremendously empowered when they use
    cryptocurrencies. They can protect against inflation when Governments
    irresponsibly manage their own currencies. They can provide useful
    services without the need for a company or middleman. And they can let
    individuals preserve the freedom to transact privately.
        Mr. Bankman-Fried may have well committed multiple crimes. The SEC
    and DOJ will determine that. But let's remember to distinguish between
    human failure and the instrument with which the failure occurred. In
    this case the instrument is software. And the code committed no crime.
    And while Sam Bankman-Fried very well may have, it is very important we
    do not convict the code of anything but preserving and protecting
    individual autonomy.
                     PREPARED STATEMENT OF HILARY J. ALLEN
            Professor, American University Washington College of Law
                               December 14, 2022

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                      PREPARED STATEMENT OF KEVIN O'LEARY
                                    Investor
                               December 14, 2022
        Chairman Brown, Ranking Member Toomey, and Members of the
    Committee, thank you for inviting me to testify about crypto and the
    collapse of FTX.
        I am the Chairman of O'Shares, an ETF indexing firm and also a
    private equity and venture investor. I support entrepreneurs at every
    stage of their journeys. I have dozens of family-run businesses in our
    investment portfolios. My extensive social media platform enables me to
    tell the stories of their products and services to help reduce their
    customer acquisition costs. It is a model that has worked well for over
    a decade and helped support so many small American businesses, which
    create over 60 percent of jobs in the American economy.
        In 2017, I was a public critic and skeptic of crypto and blockchain
    technology. After observing the extraordinary advances in these
    technologies and watching the amount of intellectual capital that was
    being invested in them and the innovation they were producing, I
    completely reversed my position. I am now of the opinion that crypto,
    blockchain technology, and digital payment systems will be the twelfth
    sector of the S&P within a decade. Today, I am a shareholder in
    multiple companies involved in crypto technology, including WonderFi/
    BitBuy, the largest and first regulated broker/dealer crypto exchange
    in Canada, Immutable Holdings, a developer of NFT technology, and
    Circle, the company that brought USDC stablecoin to market. I have also
    invested in multiple crypto tokens, infrastructure and Level 1 and
    Level 2 blockchains.
        Many of these technologies are going to disrupt the existing
    financial services sector with faster, more efficient, more productive
    and more secure ways of investing, paying, transferring and tracking
    assets. If properly regulated and implemented, they will undoubtedly
    make the entire American economy more competitive and productive.
        As you are aware, Bitcoin--a store of value--is not a coin, it is
    software. Ethereum is software. Blockchain is software. In the last 30
    years every American enterprise has driven major efficiencies using
    various versions of enterprise software and crypto is no different. The
    potential of these crypto technologies is astronomical in scale.
        In August of 2021, nearly 3 years after I started allocating
    capital to the crypto sector, I entered into an agreement with FTX to
    be a paid spokesperson. I was paid approximately $15 million for these
    services; plus approximately $3 million to cover a portion of the taxes
    due. Of the remaining amount approximately $1 million was invested in
    FTX equity and approximately $10 million in tokens held in FTX wallets.
    The equity is now most likely worthless and the accounts have been
    stripped of their assets and financial records. I have written them off
    to zero. Because I was a paid spokesperson, I never invested any
    capital from our partners or LPs. The capital lost was from an
    operating company that I had 100 percent ownership in.
        I am using my own capital to pursue record recovery of the FTX
    accounts so that I can conduct a forensic audit. The truth of this
    situation will be discovered by following the transaction trail after
    obtaining the records. I have applied for membership on the FTX
    creditors' committee, in connection with the bankruptcy proceedings,
    because I feel obligated to pursue the facts on behalf of all
    stakeholders and believe my perspective of this situation will be
    helpful to the other creditors' committee members.
        The collapse of FTX is nothing new. While this situation is painful
    for shareholders, employees and account holders, in the long run, it
    does not change this industry's promise. Enron came and went and had no
    impact on the energy markets. Bear Stearns and Lehman Brothers demise
    had no impact on the long term potential of American debt and equity
    markets.
        I am only one of many investors that has experienced this loss.
    However, this changes nothing in terms of the potential of crypto. In
    fact, the recent collapse of crypto companies has a silver lining. This
    nascent industry is culling its herd. Going or gone are the
    inexperienced or incompetent managers, weak business models and rogue
    unregulated operators. Hopefully, these highly publicized events will
    put renewed focus on implementing domestic regulation that has been
    stalled for years. Other jurisdictions have already implemented such
    policies and are now attracting both investment capital and highly
    skilled talent. In the U.S., we are falling behind and losing our
    leadership position.
        I guest lecture graduating cohorts of engineers all across the
    country because approximately a third of each class will start their
    own company. Where do they want to work? On blockchain technology and
    the new emerging digital economy. These are the best and brightest
    hands over keyboards. I ask you to consider this: how is it possible to
    invest this much intellectual capital into a sector, and not expect
    extraordinary outcomes in the future? Now is the time to embrace the
    potential of crypto, regulate it, and allow its potential to be fully
    realized for the benefit of the entire economy.
        I understand why many leaders in the banking industry are open
    skeptics, calling for the banning of these new crypto software
    technologies. Disruption is always uncomfortable at first, and
    entrenched businesses abhor new competition, but it has been proven
    time and time again that disruption is absolutely necessary in
    advancing the economy.
        There is the risk of investing in crypto and there is also the risk
    of not investing in it and letting others accrue its benefits first,
    essentially gifting them a competitive advantage that could be hard to
    recapture.
        So where to start? We need clear policy and regulation for the
    crypto industry, its entrepreneurs, its developers and its users.
    Congress should start by passing bipartisan legislation that creates a
    sensible regulatory framework for digital stablecoins backed by the
    U.S. dollar. Why? A well-regulated stablecoin backed by the U.S. dollar
    and other high quality, liquid assets could become the global default
    payment system over time.
        The U.S. dollar already denominates the price of oil and other
    commodities, why not everything else? What could be more bipartisan?
        Let me close with this: we need to get to the bottom of what
    happened at FTX, but we can't let its collapse cause us to abandon the
    great promise and potential of crypto.
                    PREPARED STATEMENT OF JENNIFER J. SCHULP
       Director of Financial Regulation Studies, Center for Monetary and
                     Financial Alternatives, Cato Institute
                               December 14, 2022

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                  PREPARED STATEMENT OF BEN MCKENZIE SCHENKKAN
                                Actor and Author
                               December 14, 2022
        Chairman Brown, Ranking Member Toomey, and Members of the
    Committee:
        Thank you for your invitation to testify before the Committee on
    matters relating to the growth of crypto trading and lending, as well
    as the recent collapse of FTX/Alameda and the broader implosion of the
    cryptocurrency markets.
        A little over a year ago I embarked on a journey to explore the
    inner workings of the cryptocurrency industry. My initial reaction was
    one of confusion. I am an actor, and therefore words are the tools of
    my trade. I also hold a degree in economics. When I began to look at
    the cryptocurrency industry, many of the words used did not correlate
    to their functional reality, economically or otherwise.
        ``Cryptocurrencies'' are not currencies by any reasonable economic
    definition, as they are unable to fulfill any of the three functions of
    money. They are a poor medium of exchange, unit of account, and store
    of value. Bitcoin cannot work as a medium of exchange because it cannot
    scale. The Bitcoin network can only process 5 to 7 transactions a
    second. By comparison, Visa can handle tens of thousands. To facilitate
    that relatively trivial amount of transactions, Bitcoin uses an
    enormous amount of energy. In 2021, Bitcoin consumed 134 TWh in total,
    comparable to the electrical energy consumed by the country of
    Argentina. Bitcoin simply cannot ever work at scale as a medium of
    exchange.
        Other blockchains are more efficient, but suffer from other
    problems, such as hacks and periodic outages. Even amongst
    cryptographers, blockchain technology is considered to be of limited
    use, only potentially applicable in small systems requiring low
    throughput. Some view it even more dimly. Bruce Schneier is one of the
    leading cryptographers in the field, a lecturer at the Harvard Kennedy
    School and a board member of the Electronic Frontier Foundation:

            What blockchain does is shift some of the trust in people and
            institutions to trust in technology. You need to trust the
            cryptography, the protocols, the software, the computers and
            the network. And you need to trust them absolutely, because
            they're often single points of failure.

            I've never seen a legitimate use case for blockchain. I've
            never seen any system where blockchain provides security in a
            way that is impossible to provide in any other way.

        Blockchain technology is at least 30 years old, not some new
    invention with a still-promising future.
        I interviewed cryptographer David Chaum recently. Chaum's work in
    the early 1980s laid the intellectual foundation for blockchain, and he
    is widely credited with being a pioneer of cryptographic methods of
    payment. Even he referred to blockchain as ``primitive''.
        Cryptocurrencies are similarly unable to serve as an adequate unit
    of account or store of value, primarily because of their volatility.
    For a currency to be consistently useful, it must remain relatively
    consistent over time. Bitcoin and all other cryptocurrencies have never
    been able to do so. Despite the industry's insistence to the contrary,
    their volatility has not lessened over time. The precipitous collapse
    of the entire cryptocurrency market over the last year provides a good
    example. Imagine a scenario in which the U.S. dollar lost 70 percent of
    its value in less than a year. Pandemonium--and a global recession--
    would ensue.
        Unfortunately, the problems with crypto as money run even deeper
    than that. What cryptocurrency wants to be is private money,
    unencumbered by interference from a Nation-State issuer. We have tried
    private money before, during the Free-Banking Era (1837-1864) when
    banks were allowed to issue their own notes. It did not work very well.
    In many States, banks failed at alarming rates, often due to fraud.
        The need for a trusted third party to backstop the banks was the
    impetus behind the creation of the Federal Reserve in 1913, as well as
    the Federal Deposit Insurance Corporation. Since the FDIC's creation in
    1933, not a single penny of insured deposits has been lost. People
    trust that when they put their money in a licensed U.S. bank, it will
    be there when they need it, and the Federal Government provides that
    assurance in times of crisis. In exchange for that FDIC license, banks
    must comply with a litany of regulations.
        Crypto's stated goal of creating a ``trustless'' form of money by
    removing all intermediaries between individuals wishing to transact
    directly holds understandable appeal. Everyone is aware of the myriad
    flaws in our current financial system, and banks are rarely looked upon
    favorably by the general public. There are many reasons for this, not
    the least of which is their complicity in the debacle that was the
    subprime crisis.
        However, that does not mean that cryptocurrency is any better. In
    fact, it cannot function as a currency, and for a very simple reason.
    You cannot create ``trustless'' money because money is trust. We made
    it up; it's a social construct. Like all social constructs, money
    relies on trust forged through social consensus. You can no more create
    a ``trustless'' money than you can a governmentless Government or a
    religionless religion. The applicable words are anarchy and cult.
        What ``trustless'' means in practice in crypto is placing your
    trust in the people who run the exchanges, or issue the coins, or
    anyone else who takes your real money in exchange for lines of computer
    code stored on ledgers called blockchains. Code does not fall from the
    sky; people write it. I believe few of the people in the cryptocurrency
    industry have earned the trust of the public.
        Cryptocurrencies are not currencies, and they are not used like
    them. Alongside my colleague, journalist Jacob Silverman, I visited the
    only country in the world trying to use cryptocurrency as money: El
    Salvador. It is not working. The Chivo wallet system set up by the
    Government is largely ignored. According to the Government's own
    figures, less than 2 percent of remittances use Chivo. Instead, El
    Salvador's president, Nayib Bukele, has reportedly gambled some of his
    Government's money--meaning his people's money--on Bitcoin. If this is
    true, then much like the overwhelming majority of cryptocurrency
    investors, Bukele has lost money on his wager.
        How are cryptocurrencies used by the wider public? Tens of millions
    of Americans, and supposedly hundreds of millions of people worldwide,
    have bought and sold crypto primarily through centralized exchanges
    such as Binance and until recently, FTX. To state the obvious,
    transacting through a centralized exchange run through shell
    corporations in the Caribbean and elsewhere is the antithesis of the
    stated goal of cryptocurrency to create a peer-to-peer currency that
    would avoid all intermediaries.
        The cryptocurrency industry is in fact heavily centralized, and a
    few key players wield enormous power. For example, according to recent
    reporting from the New York Times and The Wall Street Journal, a small
    group of elite crypto executives communicate via the encrypted app
    Signal. It would be wise to remember the words of Adam Smith:

            People of the same trade seldom meet together, even for
            merriment and diversion, but the conversation ends in a
            conspiracy against the public, or in some contrivance to raise
            prices.

        Because cryptocurrencies don't really do anything in the real world
    they are at best an exercise in a zero-sum game of chance, much like
    online poker. Fittingly enough, several key players in the
    cryptocurrency industry cut their teeth in the online poker craze of
    the late 2000s. Chairman Gensler of the SEC has referred to stablecoins
    as ``the poker chips in the casino'' and I believe his metaphor is apt.
    The largest stablecoin in crypto by a country mile is Tether. Stuart
    Hoegner, Tether's general counsel, was once the compliance officer for
    Excapsa, which was the holding company of Ultimate Bet, an online poker
    website from the era. Ultimate Bet was ultimately revealed to have a
    secret ``god mode'' where insiders could see the other players cards so
    as to cheat them.
        Working alongside Mr. Hoegner at Excapsa/Ultimate Bet was Daniel
    Friedberg, former general counsel of FTX and now its chief regulatory
    officer. Stuart Hoegner's company Tether counts as its biggest client
    Alameda Research, the sister company of FTX. According to reporting
    from crypto media company Protos, Alameda purchased some $36.7 billion
    worth of Tether coins. Given Alameda's current insolvency, it would be
    wise to ask where this money came from and what arrangement existed
    between the two companies.
        So if cryptocurrencies are not currencies, then what are they?
    Well, what do they do? How do they function in the real world? People
    put money into them and expect to make money off of them, through no
    work of their own. As Members of this Committee well know, that is an
    investment contract under American law. More precisely, it is a
    security: (1) an investment of money (2) in a common enterprise (3)
    with the expectation of profit (4) to be derived from the efforts of
    others. To my mind, every coin or token easily satisfies the four
    prongs of the Howey Test.
        The rapid rise of cryptocurrency both in purported value and number
    of tokens issued should give us all pause. There are now over 20,000
    cryptocurrencies, more than all the securities offered for sale through
    the major U.S. stock exchanges. An estimated 40 million Americans have
    bought or sold cryptocurrency at some point. According to the
    industry's own polling, the majority of investors who have ever
    purchased Bitcoin did so in 2021. Given the recent collapse in the
    price of Bitcoin, it is reasonable to assume most of them have lost
    money.
        When added to the millions already locked out of their accounts at
    places like FTX and Celsius those numbers soar even higher. A
    nonexhaustive list of crypto players who have stopped or paused
    withdrawals just this year includes BlockFi, Voyager Digital, Genesis,
    CoinFlex, Gemini, Three Arrows Capital, Hodlnaut, Poolin, Digital
    Surge, Orthogonal Trading, AAX, Hoo, SALT, Babylon Finance, Nuri,
    Bithumb, Upbit, Coinone, Babel Finance, WazirX/CoinDCX, Bexplus, AEX,
    Vauld, 2gether, Finblox, and well, you get the point.
        There are many reasons that so many customers cannot get their
    money back, but the simplest one is that much of it was never there to
    begin with. The prices of these speculative so-called `digital assets'
    were bid up/manipulated far beyond the actual real money backing them.
        You don't have to take my word for it. In March of this year, I
    asked Alex Mashinsky, CEO of the now failed crypto lending firm
    Celsius, how much real money was in crypto and he estimated: ``10 to 15
    percent. The rest is speculation.'' Given crypto's market cap at the
    time (about $1.8 trillion), that would imply only a few hundred billion
    dollars of actual money was backing these assets. When I asked Sam
    Bankman-Fried the same question in July of this year, he broadly
    concurred with Mashinsky, estimating around $200 billion was left in
    crypto. Personally, I suspect the true number to be far, far lower, but
    even taking these assessments at face value there is no denying that
    the amount of nominal value of crypto far exceeds the actual dollars in
    the crypto ``ecosystem.''
        Leverage accounts for some of this disparity, and is not unique to
    crypto. It exists in our regulated markets as well. But as Professor
    Hilary Allen points out, with crypto the potential leverage in crypto
    is far higher:

            The amount of leverage in the system can also be increased by
            simply multiplying the number of assets available to borrow
            against. That is a significant concern with DeFi, where
            financial assets in the form of tokens can be created out of
            thin air by anyone with computer programming knowledge, then
            used as collateral for loans that can then be used to acquire
            yet more assets.

        Of course leverage is not the sole culprit behind the collapse of
    crypto. One of the other contributing factors is fraud. Cryptocurrency
    has attempted to assemble a parallel financial universe that in some
    ways mirrors our regulated one, only absent meaningful regulations. Be
    careful what you wish for. The simple truth is that in an unregulated
    market, at every juncture where value is transferred from one party to
    another, not only is there nothing preventing one or more parties from
    committing fraud, there is often very little even disincentivizing them
    from doing so. If you can rip people off and get away with it, why not
    do it?
        If you lose money in cryptocurrency, advocates proudly state the
    only person you have to blame is yourself. DYOR (Do Your Own Research)
    is their motto. The system cannot fail; you can only fail the system.
    The language of crypto is eerily reminiscent of multilevel marketing
    schemes. Words such as ``community'' obscure the financial nature of
    these endeavors, cloaking them in a false sense of shared purpose. The
    illegal version of multilevel marketing schemes are called pyramid
    schemes.
        Now that tens of millions of Americans have lost money in crypto,
    and millions more have been prevented from withdrawing their money as
    crypto companies shut down, seemingly on a daily basis, we are left
    with an obvious question: is any of this worth it?
        Our securities laws have been on the books since the 1930s. They
    were written broadly on purpose; ever since there has been money,
    people have been interested in gathering quantities of it and putting
    it to productive use so as to make more of it. Most of these endeavors
    are well-intentioned, if not always successful. But some are nothing
    more than lies designed to separate people from their money.
        Securities that have no underlying value are often described as
    Ponzi schemes. As such, under American law Ponzi schemes are regulated
    by the Securities and Exchange Commission.
        I submit to you today that the entire cryptocurrency industry
    resembles nothing more than a massive speculative bubble built on a
    foundation of fraud. In my opinion, it is the largest Ponzi scheme in
    history by an order of magnitude.
        Cryptocurrency is in fact only a story, or rather a constellation
    of stories that form an economic narrative. As Nobel prize-winning
    economist Robert Shiller has observed, an economic narrative can be
    defined as:

            a contagious story that has the potential to change how people
            make economic decisions, such as the decision to . . . invest
            in a volatile speculative asset.

        Shiller's first example? Bitcoin.
        If cryptocurrency is only a story then it is fitting that I am
    here, for I am a storyteller at heart. I know a few things about money
    and lying. I learned about money from my economics degree, as well as
    by making a bit of it during my two decades spent in showbusiness. I
    know about lying because as an actor I do it for a living.
        Unfortunately for the tens of millions of Americans who have lost
    money in cryptocurrency, the reality behind the story has become
    apparent to all who care to see it. The economic narrative surrounding
    cryptocurrency is untrue. In fact, it is a story meant to deceive.
        We should give the SEC, DOJ, OFAC, and other relevant agencies the
    resources and support they need to enforce laws already in existence
    today. They should act swiftly before more Americans are hurt.
        Let the chips fall where they may.
            RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN
                          FROM HILARY J. ALLEN

    Q.1. Professor Allen, some have claimed that FTX, and other
    failed crypto platforms, collapsed because they were
    centralized. Your written testimony addressed that issue,
    explaining that decentralized platforms share the same problems
    as centralized ones. Can you elaborate on why the problems in
    crypto are so fundamental that they impact both decentralized
    and centralized platforms?

    A.1. The issue here is that most so-called ``DeFi'' or
    ``decentralized'' offerings are not, in fact, decentralized
    from an economic perspective (research from the BIS has
    therefore labelled DeFi's claims of decentralization as an
    ``illusion''). \1\ If the offering is technologically
    decentralized, it will rely on software to operate: if power
    over that software is concentrated in the heads of one or a few
    individuals, there is no reason to expect those individuals to
    behave any better than the individuals operating more openly
    centralized crypto platforms. The people who control DeFi
    platforms have the same incentives and opportunities as the
    operators of centralized platforms to take advantage of
    investors--in fact, they may have more opportunities as the
    technological complexity of decentralized offerings may confuse
    investors and obfuscate who is in charge. This complexity and
    obfuscation may also make it more challenging (although by no
    means impossible) for regulators to enforce existing law
    against the operators of DeFi platforms. DeFi's increased
    technological complexity also offers many opportunities for
    hacks and other operational problems. \2\ Finally, as I explore
    at length in my law review article ``DeFi: Shadow Banking
    2.0?'', there are plenty of opportunities for leverage and
    automation in DeFi that make DeFi inherently fragile and
    susceptible to runs--just as more openly centralized crypto is.
    \3\
    ---------------------------------------------------------------------------
         \1\ https://www.bis.org/publ/qtrpdf/r-qt2112b.pdf
         \2\ See https://web3isgoinggreat.com for examples.
         \3\ https://papers.ssrn.com/sol3/papers.cfm?abstract-id=4038788

    Q.2. Many crypto advocates have talked about the potential of
    blockchain technology to revolutionize financial services. You
    testified that the Australian Stock Exchange tried to use this
    technology, but found it unworkable. Are there other examples
    where blockchain technology has been deemed not fit for
    purpose? Please discuss if there potential applications for the
    blockchain in financial services that you believe are
    ---------------------------------------------------------------------------
    improvements over current processes.

    A.2. With regard to your question ``are there potential
    applications for the blockchain in financial services that you
    believe are improvements over current processes,''
    respectfully, I think a better question to ask is ``are there
    potential applications for the blockchain in financial services
    that you believe are improvements over other existing
    technological alternatives?'' There are certainly places where
    our current financial infrastructure needs updating--sometimes,
    the need is so acute that almost any change might be an
    improvement. When choosing a solution, though, we can choose
    between the blockchain and many other available technological
    solutions (in other words, the blockchain isn't the only
    alternative to our status quo). Given the menu of technologies
    currently available, it would be rare (if ever) that a
    blockchain is the best technological solution. As I have
    written previously, ``it does not seem possible that a
    technology that has been intentionally made more complex (in
    order to nominally decentralize) could ever be more efficient
    than a simpler, centralized alternative.'' \4\
    ---------------------------------------------------------------------------
         \4\ DeFi: Shadow Banking 2.0?
    ---------------------------------------------------------------------------
        To elaborate some more on the technological limitations of
    blockchains, no matter which consensus mechanism is chosen for
    a decentralized ledger (proof-of-work, proof-of-stake, or
    something else), it must always be slower and more cumbersome
    than validation by a centralized intermediary. Otherwise it
    will be too easy for a bad actor to take over: costly
    computations are the sinequanone of decentralized consensus
    mechanisms. This expense and inefficiency mean that it is very
    challenging for decentralized services to scale up--one
    illustration of this is the significant increases in gas fees
    users of the Ethereum ledger experience when it's busy.
    Decentralized ledgers also face limitations because it is not
    possible for software to cater for all possible eventualities:
    intermediaries are often needed to resolve unanticipated
    situations (for example, reversing erroneous or problematic
    transactions). As I mentioned in response to Senator Warren's
    question at the hearing, blockchain technology's main
    contribution to efficiency is avoiding the anti-money
    laundering checks that slow down the processing of traditional
    financial transactions.
        The inefficiencies of blockchain technology ultimately led
    to the Australian Stock Exchange abandoning its blockchain
    project. \5\ It was also recently announced that IBM and Maersk
    are abandoning their logistics blockchain. \6\ In 2020, one
    report from Deloitte indicated that the vast majority (85
    percent) of corporate blockchain projects had failed, while 93
    percent of user led blockchain projects had failed. \7\ While
    most useful technologies have bumps in the road, blockchain
    technology is not just experiencing teething pains: hundreds of
    technologists have warned that blockchain technology is not fit
    for the use cases its proponents espouse. \8\
    ---------------------------------------------------------------------------
         \5\ https://cointelegraph.com/news/aussie-stock-exchange-abandons-
    blockchain-plans-leaving-170m-hole
         \6\ https://www.coindesk.com/business/2022/11/30/ibm-and-maersk-
    abandon-ship-on-tradelens-logistics-blockchain/
         \7\ https://www2.deloitte.com/us/en/insights/industry/financial-
    services/evolution-of-blockchain-github-platform.html
         \8\ https://concerned.tech
    ---------------------------------------------------------------------------
                                    ------

            RESPONSES TO WRITTEN QUESTIONS OF SENATOR TESTER
                          FROM HILARY J. ALLEN

    Q.1. Taxpayer Protection--Is it clear enough to investors that
    making bets in the cryptocurrency space is at their own risk?
    And that the U.S. taxpayers won't be stepping in to bailout
    this industry?

    A.1. It appears that, for many investors, crypto assets seem
    like reasonable alternative investments that are on par--in
    terms of risk--with many other types of investments. For
    example, letters submitted to the judge in the Celsius
    bankruptcy paint a picture of customers who genuinely believed
    their money was safe with Celsius. \1\ Even after the crypto
    failures of the last year, one recent survey suggests that many
    investors still believe crypto investments to be safe and well-
    regulated. \2\ According to this 2022 survey, Black investors
    are more likely than White investors to believe that this is
    the case: ``Black investors are also more likely than White
    investors to believe investments in cryptocurrency are both
    safe (33 percent vs. 18 percent) and regulated by the
    Government (30 percent vs. 14 percent).'' \3\ In short, even
    after what has happened in 2022, it appears that there are
    still some investors who underestimate the risks of making bets
    in the cryptocurrency space. Some members of the public even
    believe that the FDIC protects crypto investments. This
    confusion has sometimes been encouraged by members of the
    crypto industry--in August of 2022, the FDIC issued Cease and
    Desist Letters to five crypto businesses (including FTX.US) for
    making false or misleading representations about deposit
    insurance. \4\
    ---------------------------------------------------------------------------
         \1\ https://blog.mollywhite.net/celsius-letters/
         \2\ https://cepr.net/crypto-and-building-black-wealth/
         \3\ https://www.schwabmoneywise.com/tools-resources/ariel-schwab-
    survey-2022
         \4\ https://www.fdic.gov/news/press-releases/2022/pr22060.html
    ---------------------------------------------------------------------------
        As for U.S. taxpayers bailing out the crypto industry, I
    would note that since I testified before the Committee in
    December, it has been reported that Silvergate Bank (which
    provides payment and other services to the crypto industry)
    significantly increased its reliance on loans from the Federal
    Home Loan Bank of San Francisco in the last quarter of 2022. To
    quote one report, ``FHLB borrowings funded only 5 percent of
    $13.9 billion in total funding (deposits plus borrowings) as of
    Sept. 30 . . . the current industry norm is for FHLB borrowings
    to provide about 5 percent to 6 percent of funding. But that
    ballooned to 41 percent of total funding as of Dec. 31.'' \5\
    This increased borrowing occurred at the same time as FTX's
    failure--if banks were to more fully integrate with the crypto
    industry, we could reasonably expect to see more Government
    funding being used to indirectly support the crypto industry.
    ---------------------------------------------------------------------------
         \5\  https://www.marketwatch.com/story/cryptocurrency-bank-
    silvergate-has-lost-68-of-its-digital-deposits-heres-what-we-know-
    about-its-predicament-11672946903

    Q.2. Contagion--It is clear that there was poor corporate
    governance, and it appears flat-out fraud, at FTX. But over
    this last year we've seen a series of failures and challenges
    in the industry. There may be benefits to some of the related
    technologies, but there have been numerous problems--even just
    in recent months--for cryptocurrency companies and, more
    importantly, investors.
        How could this or other failures in the cryptocurrency
    industry have spread to our other financial institutions and
    systems in the U.S.? What has protected them so far?
        How would this crash have been different if Federal
    financial regulators had allowed our banking institutions in
    this country to do more in the cryptocurrency space?

    A.2. As we learned from 2008, problems in traditional financial
    markets can be transmitted both through contractual
    counterparty relationships and through metastasizing loss of
    confidence in similarly situated firms. The events of 2022
    indicate that those same channels of contagion exist in the
    crypto industry. Fortunately, there were few contractual
    interconnections between the crypto industry and the
    traditional financial system, and the general public had little
    reason to think that the traditional financial industry had
    significant exposure to the crypto industry. As a result, the
    spillover effects from crypto failures have largely remained
    contained within the crypto industry.
        There are many possible explanations for why the banking
    industry was not significantly exposed to crypto. Many people
    believe the narrative that crypto is trying to disrupt banks,
    and that banks therefore see the crypto industry as a kind of
    adversary--and so banks did not invest in crypto for that
    reason. Others believe that banks thought crypto was too risky,
    and avoided investing out of a sense of self-preservation. In
    my view, both narratives are overstated. I believe that many
    traditional financial firms would have integrated more fully
    with the crypto industry had regulators allowed them to do so.
    Even with financial regulators' strong admonitions to be wary
    of crypto, we have seen some integration. For example, the
    Department of Labor provided guidance that strongly cautioned
    against administrators of 401k plans including crypto assets to
    their investment menus: \6\ Fidelity created a Bitcoin option
    regardless. \7\ Banking regulators have been reasonably strict
    about separating banking from crypto, \8\ but have allowed Bank
    of New York Mellon to custody crypto assets for its clients.
    \9\ They also appear to have acquiesced in banks like
    Silvergate and Signature Banks providing services to the crypto
    industry, at least for a time.
    ---------------------------------------------------------------------------
         \6\ https://www.dol.gov/newsroom/releases/ebsa/ebsa20220310
         \7\ https://www.cnbc.com/2022/11/04/fidelity-forusall-offering-
    401k-investors-access-to-cryptocurrency.html
         \8\ https://www.fdic.gov/news/press-releases/2023/pr23002a.pdf
         \9\ https://www.wsj.com/articles/americas-oldest-bank-bny-mellon-
    will-hold-that-crypto-now-11665460354
    ---------------------------------------------------------------------------
        These kinds of banking activities did not create direct
    crypto exposure for banks. Had banks accepted crypto as
    collateral for loans or invested directly in crypto assets
    (particularly if they had used leverage to do so), then the
    events of 2022 would no doubt have had repercussions for the
    banking industry. Still, even indirect exposure to crypto could
    conceivably cause problems in the future because of how
    important confidence is to the banking industry. For example,
    if a bank's revenue were dependent on providing services to the
    crypto industry or crypto custody services to its clients, then
    implosions in the crypto industry might raise concerns about
    the viability of the bank's business model. Or if a bank were
    to make loans secured with traditional assets to large
    institutional customers, and then those customers were to incur
    significant crypto exposure and default on their loans, that
    might raise concerns about the bank's solvency. Or if a bank
    were holding the reserves of a stablecoin on deposit and there
    were a run on that stablecoin, the bank would see those
    reserves withdrawn. Could that be enough to raise liquidity
    concerns about the bank, exposing the bank to the risk of a run
    itself? This is not an exhaustive list of possible contagion
    channels; instead it is a list of examples provided here to
    bolster the case for a complete separation of banking and
    crypto.

    Q.3. Regulation--What are the benefits and drawbacks from
    creating additional regulation, and with it perhaps perceived
    or real Government endorsement, for a product with no inherent
    value?

    A.3. There is a risk that applying any regulatory framework to
    crypto, other than a ban, could legitimize it. However, as I
    outlined in my testimony, I believe concerns about perceptions
    of Government endorsement must be balanced against the need for
    investor protection, and that if lawmakers do not wish to enact
    a ban, then these perceptions can be managed in an investor
    protection regime like the one administered by the SEC. It is
    critical, though, that banking regulation not be applied to
    crypto. While securities regulation does not suggest that any
    investment is a good investment--and it is well understood that
    a share in a corporation, for example, could lose all of its
    value--banking regulation puts Government backing behind
    certain assets (like deposits) in order to ensure that people
    retain confidence in those assets. This kind of regulation and
    Government backing would be extremely dangerous if applied to a
    product with nothing concrete behind it, that serves no real
    capital formation function.
        It is also critical that no bespoke regulatory regime is
    devised for crypto. The creation of a bespoke regulatory regime
    would communicate to the public that there is something special
    about crypto that is worth accommodating. During the hearing,
    witness Kevin O'Leary mentioned several times that the crypto
    industry wants this kind of regulation so that it can attract
    money from institutional investors. This would allow the crypto
    industry to grow--but in my view, if crypto cannot comply with
    existing securities regulation (and much of it probably cannot)
    then it should not exist.

    Q.4. National Security--Are there benefits that outweigh the
    facilitation of crime that we've seen from these products and
    this industry?

    A.4. Proponents of blockchain technology rarely claim it can do
    something new--instead, they claim it can do existing things in
    decentralized ways. However, as I described in my testimony,
    even if the technology is decentralized, it does not operate in
    a decentralized way because economic control of the technology
    is so concentrated. There therefore seem to be few social
    benefits of the technology, except that some people seem to
    enjoy tinkering with blockchain technology on an intellectual
    level. If this tinkering had no social cost to it, I would see
    no reason for regulation to intervene, notwithstanding that I
    see little real decentralization or utility in blockchain
    technology. Unfortunately, this technology creates significant
    negative externalities--from a national security perspective,
    as well as from the perspective of harm to consumers, the
    environment, and the stability of our financial system. In
    other situations, it might be difficult to decide how to
    respond to an innovation that has real promise and real peril:
    this is an easy case, though, given the lack of significant
    benefit and the obvious harm associated with the blockchain.
                                    ------

           RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNOCK
                          FROM HILARY J. ALLEN

    Q.1. According to press reports, FTX Trading Ltd. (FTX)
    collateralized billions of United States dollars in loans using
    the FTX Token (FTT), which functioned similarly to a form of
    stock in FTX. If FTX were a traditional bank, this practice
    would seem to be prohibited under the National Banking Act of
    1864. \1\
    ---------------------------------------------------------------------------
         \1\ 12 U.S.C. 83(a) (``No national bank shall make any loan or
    discount on the security of the shares of its own capital stock.'').
    ---------------------------------------------------------------------------
        In your view, is there a conflict of interest for a
    cryptocurrency exchange to issue its own token, given the lack
    of public markets and other methods of ensuring transparency
    and price discovery?

    A.1. In general, crypto exchanges are vertically integrated,
    offering multiple services that are typically disaggregated in
    traditional finance. For example, while stock exchanges do not
    do not take proprietary trading positions opposite their
    customers, this kind of practice is common in crypto exchanges.
    Housing brokerage, exchange, clearing, and proprietary trading
    services in one business inevitably creates conflicts of
    interest.
        With that said, there is not an inevitable conflict of
    interest in an exchange issuing its own token. As an analogy,
    the owner of the New York Stock Exchange is International
    Clearing, a publicly traded company (meaning anyone can buy
    shares in the parent company of the New York Stock Exchange).
    Conflicts of interest can arise, however, if the exchange is
    trading in its own token against its customers, or manipulating
    the supply of tokens that its customers have invested in
    (conflicts of interest may also arise if the exchange misleads
    its customers about the relationship between acquiring the
    tokens and accessing exchange functionality).
        In the absence of mandated disclosures and market
    transparency, these kinds of activities can easily go
    undetected. As I stated in my written testimony, ``when assets
    have no fundamentals and trade entirely on sentiment,
    traditional checks on fraud (like valuation methodologies and
    financial accounting) will inevitably break down.'' Using wash
    trading to manipulate the value of a token is a particular
    concern when it comes to exchanges issuing their own tokens.
    Wash trading involves ``simultaneously selling and buying the
    same financial assets to create artificial activity in the
    marketplace, which is known to distort price, volume, and
    volatility, and reduce investors' confidence and participation
    in financial markets,'' and this practice has been found to be
    rife in unregulated crypto exchanges. \2\
    ---------------------------------------------------------------------------
         \2\ https://www.nber.org/papers/w30783

    Q.2. How does allowing cryptocurrency exchanges to issue their
    ---------------------------------------------------------------------------
    own tokens affect fair competition?

    A.2. I am not an expert in competition law, and do not feel
    qualified to speak to this issue.

    Q.3. How does allowing cryptocurrency exchanges to issue their
    own tokens affect systemic risk in financial markets?

    A.3. We know from past experience with the traditional
    financial system that excessive leverage makes the system more
    fragile and susceptible to booms and busts, increasing systemic
    risk. One way of increasing the amount of leverage in a system
    is to multiply the number of assets available to borrow
    against. That is a significant concern with crypto, where
    assets in the form of tokens can be created out of thin air by
    anyone with computer programming knowledge. This concern
    applies to all tokens, including those issued by exchanges.
        In addition, when cryptocurrency exchanges accept their own
    tokens as collateral for margin loans to others, that creates
    wrong-way risk. Bloomberg journalist Matt Levine analogized FTX
    accepting FTT as collateral to a bank accepting its own stock
    as collateral for a loan:

            If you go to an investment bank and say ``lend me $1
            billion, and I will post $2 billion of your stock as
            collateral,'' you are messing with very dark magic and
            they will say no. The problem with this is that it is
            wrong-way risk . . . If people start to worry about the
            investment bank's financial health, its stock will go
            down, which means that its collateral will be less
            valuable, which means that its financial health will
            get worse, which means that its stock will go down,
            etc. It is a death spiral. In general it should not be
            possible to bankrupt an investment bank by shorting its
            stock. If one of the bank's main assets is its own
            stock--is a leveraged bet on its own stock--then it is
            easy to bankrupt it by shorting its stock. \3\
    ---------------------------------------------------------------------------
         \3\ https://news.bloomberglaw.com/banking-law/matt-levines-money-
    stuff-ftx-had-a-death-spiral

        A practice that makes it easy to bankrupt an exchange is
    likely to have systemic ripples in crypto, where the events of
    2022 have demonstrated that crypto exchanges and other
    intermediaries often lend to and borrow from one another and
    thus are tightly interconnected.
                                    ------

            RESPONSES TO WRITTEN QUESTIONS OF SENATOR TESTER
                           FROM KEVIN O'LEARY

    Q.1. Taxpayer Protection--Is it clear enough to investors that
    making bets in the cryptocurrency space is at their own risk?
    And that the U.S. taxpayers won't be stepping in to bailout
    this industry?

    A.1. It is generally understood that investing in the
    cryptocurrency space carries a high degree of risk and that
    there is no guarantee of returns. Additionally, most
    participants now realize that it is unlikely that the U.S.
    Government will step in to bailout the cryptocurrency industry,
    as it is not considered a traditional financial sector.
    However, it is always important for investors to conduct their
    own research and understand the risks involved before making
    any investment decisions.

    Q.2. What steps need to be taken to protect everyday investors
    from schemes like this?

    A.2. An Individual considering investing in crypto should
    follow some pragmatic common sense rules, such as:

      1.  Educating yourself about the basics of cryptocurrency and
            how it works, as well as the risks involved.

      2.  Investing only what you can afford to lose and
            diversifying your portfolio. When asked, I suggest
            starting by investing $100 in a centralized wallet like
            Coinbase and $100 in a decentralized one like Metamask.
            Working with them both is educational and not alot of
            capital is at risk if mistakes are made.

      3.  Being cautious of projects or companies that lack
            transparency or have a history of fraud or misconduct.

      4.  Checking the credentials and regulatory compliance of any
            cryptocurrency exchange or platform you plan to use.

      5.  Staying informed about current events and regulatory
            developments in the cryptocurrency space.

      6.  Consider consulting with a financial advisor or
            professional for guidance.

    Q.3. What additional resources do institutional investors or
    more experienced investors like yourself need to have adequate
    information about investing in companies like FTX?

    A.3. Institutional investors or more experienced investors
    looking to invest in crypto companies like FTX may benefit from
    a variety of additional resources. These can include:

      1.  Company financial statements and regulatory filings,
            which can provide insight into the company's financial
            performance, management team, and overall business
            strategy.

      2.  Research reports from reputable financial institutions
            and industry experts, which can provide in-depth
            analysis of the company and its market position.

      3.  Market data and analytics, such as trading volume, price
            movements, and trading metrics, to gain insight into
            market trends and the overall performance of the
            company.

      4.  Industry news and events, to stay informed about
            developments in the crypto space, regulatory changes,
            and other important news.

      5.  Networking and connecting with other experienced
            investors in the crypto space, to share knowledge,
            insights, and ideas.

      6.  Understanding the legal and regulatory aspects of the
            crypto industry in the country and worldwide.

      7.  Having a solid knowledge of the technology behind the
            coin or token that is being considered for investment.

        It's important to note that even with these resources,
    investing in the crypto space still carries a high degree of
    risk, and investors should always conduct their own research
    and seek professional advice before making any investment
    decisions.

    Q.4. Regulation--What are the benefits and drawbacks from
    creating additional regulation, and with it perhaps perceived
    or real Government endorsement, for a product with no inherent
    value?

    A.4. Benefits of regulation:

        Increased investor protection: Regulation can help
            to protect investors from fraud and other types of
            financial misconduct by requiring companies to disclose
            information and adhere to certain standards.

        Improved market integrity: Regulation can help to
            promote fair and orderly markets by preventing
            manipulation and other types of market abuse.

        Greater legitimacy: By being regulated, a product
            can be perceived as more legitimate, which can increase
            the overall trust and confidence in the market.

        Institutional investors would have greater interest in
    crypto assets if they were regulated. They have a fiduciary
    duty to their clients, which means they are legally obligated
    to act in their clients' best interests. As a result, they may
    be more likely to invest in crypto assets if they feel that the
    market is more secure and less prone to fraud or other types of
    financial misconduct.
        Regulation can provide investors with the transparency and
    oversight needed to assess the risks and potential returns of
    crypto assets. It can also help to create a more stable and
    predictable environment, which is often more appealing to
    institutional investors who are looking for long-term
    investments.
        Additionally, institutional investors are subject to strict
    regulations and compliance requirements, so they are more
    comfortable investing in an asset class that is also regulated.
        It's important to note that the crypto market is rapidly
    evolving and the regulatory landscape is still developing, so
    it's hard to predict how it will affect institutional
    investors' interest. However, as crypto assets continue to
    mature, it is likely that we will see increased institutional
    interest and investment in the crypto space if regulations are
    put in place to protect the investors.
        I don't think there will be material appreciation in the
    value of crypto assets until they are regulated and sovereign
    wealth and pension funds begin to allocate to this new asset
    class.
        Drawbacks of regulation:

        Increased compliance costs: Companies may face
            higher costs in order to comply with regulatory
            requirements.

        Reduced innovation: Regulation can create barriers
            to entry, making it harder for new companies to enter
            the market, which could stifle innovation.

        Slower adoption: Heavy regulation can discourage
            some investors from entering the market, slowing
            adoption and limiting its growth.

        Possibility of Government intervention: Advocates
            of decentralized finance view Government regulation as
            the Government's attempt to intervene or control the
            crypto market. They do not agree that regulation would
            attract institutional capital.

        It's important to note that there is no one-size-fits-all
    solution when it comes to regulating a product like
    cryptocurrency, as the appropriate level of regulation will
    depend on a variety of factors, such as the specific risks
    associated with the product, the overall maturity of the
    market, and the objectives of regulators.
        While many advocates of decentralized finance abhor the
    concept of Governments regulating crypto assets, I believe the
    majority of participants are now fatigued by the almost weekly
    bankruptcy of poorly managed unregulated crypto companies and
    exchanges and are becoming open to a more structured and
    regulated version of the crypto market
                                    ------

                   RESPONSES TO WRITTEN QUESTIONS OF
                SENATOR CORTEZ MASTO FROM KEVIN O'LEARY

    Q.1. Please list the cryptocurrencies you have invested in over
    the past decade. Please note any you currently hold.

    A.1. ETH, BTC, HNT, MATIC, AVAX, FTM, ALGO, SX, MER, SBR,
    ATLAS, AUDIO, USDC, DOGE, LHC, USDC, HBAR.
        I currently hold: ETH, BTC, MANIC, USDC, HBAR, DOGE, LHC.

    Q.2. Please list any cryptocurrencies, crypto companies or
    projects that have provided compensation to you.

    A.2. FTX.

    Q.3. As a frequent contributor on financial topics, how do you
    draw the line between opinion and financial advice? When you
    provide financial advice, do you include a disclaimer in your
    videos and media appearance that you received compensation by
    crypto firms or own the crypto assets you are discussing?

    A.3. If I'm a paid spokesperson for a company's product or
    service I disclose it. When asked about any potential
    investment I talk about how I manage my own money and encourage
    diversification across sectors. Network, cable broadcasters
    usually include standard disclaimers at the head or end of
    programming for almost all contributors, I am no exception.

    Q.4. Have you ever shorted your position in a digital asset
    with a digital asset you have promoted? If so, when and which
    one?

    A.4. No

    Q.5. Prior to becoming a sponsor of FTX, had you invested in
    FTX? If so, how much did you invest--please include all
    compensation including any product you may have received, taxes
    paid on the compensation, etc.?

    A.5. No, I was not an investor in FTX prior to entering into a
    partnership and endorsement services agreement. FTX had already
    closed their most recent round of financing and I insisted they
    open it up and allow me to purchase equity. In most paid
    spokesperson deals I enter into with companies I ask for equity
    participation so that my interests are transparently aligned
    with shareholders. FTX accommodated my purchase of equity in
    FTX International and FTX.US Prior to becoming a paid
    spokesperson to FTX I had been investing in various crypto
    positions on multiple centralized and decentralized wallets.
        I disclosed the details of the FTX contract in previous
    testimony. I also invested in FTX equity. Details of this
    investment were also disclosed in my prior testimony.

    Q.6. What did you see as your role as a sponsor of FTX?

    A.6. I saw my role as an endorser and a spokesperson for FTX.
    Because of my business background, my investments in multiple
    companies involved in crypto technology, and my extensive work
    supporting entrepreneurs at every stage of their journeys, I
    had some calls with FTX regarding the features that
    institutional investors would require in any crypto platform.
                                    ------

           RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNOCK
                           FROM KEVIN O'LEARY

    Q.1. According to press reports, FTX Trading Ltd. (FTX)
    collateralized billions of United States dollars in loans using
    the FTX Token (FTT), which functioned similarly to a form of
    stock in FTX. If FTX were a traditional bank, this practice
    would seem to be prohibited under the National Banking Act of
    1864. \1\
    ---------------------------------------------------------------------------
         \1\ 12 U.S.C. 83(a) (``No national bank shall make any loan or
    discount on the security of the shares of its own capital stock.'').
    ---------------------------------------------------------------------------
        In your view, is there a conflict of interest for a
    cryptocurrency exchange to issue its own token, given the lack
    of public markets and other methods of ensuring transparency
    and price discovery?

    A.1. It is possible for a cryptocurrency exchange to have a
    conflict of interest if it issues its own token. One concern is
    that the exchange may have an incentive to promote its own
    token over other tokens listed on the platform, which could be
    perceived as unfair to other projects and potentially lead to a
    lack of trust in the exchange. Additionally, if the exchange
    has significant control over the supply and demand of its own
    token, it could potentially manipulate the price to its own
    benefit.
        To ensure transparency and price discovery, it would be
    beneficial for there to be multiple, diverse sources of demand
    for the token, such as from external investors or through use
    cases within the exchange's ecosystem. It would also be
    important for there to be clear and transparent information
    about the token's distribution and economic model, as well as
    any potential conflicts of interest that may exist.
        Why do unregulated exchanges issue tokens? Because they
    can. Operating in multiple jurisdictions with no one regulator
    having control over their activity, creating tokens out of thin
    air is easy to do. An equally important question is why would
    anyone buy them? Traditionally, unregulated exchanges use them
    as incentives to give account holders reduced trading fees. If
    you open an account and buy and hold the exchange's token in
    it, you pay less trading fees. Sometimes the more you hold the
    less fees you pay. So there is a rational economic reason for
    account holders to convert currencies into the exchange's token
    and leave it sitting there while the exchange holds the real
    cash.
        These tokens are a form of ``faux'' equity because they
    hold no relevant rights other than trading discounts. They
    should be thought of as discount coupons.
        For example the Binance exchange (symbol BNB) token has a
    fully diluted market capitalization of approximately $61
    Billion however it is tightly held. The top two wallet holders
    own 97 percent of the float. Who are these owners? Unknown. If
    there is a run on BNB and one of these wallets wants to
    immediately convert back to $USD are there sufficient reserves?
    Unknown. Meanwhile this token could be ascribed a $60 Billion
    plus value to the Binance balance sheet. Who audits this and
    where is it held? Unknown.

    Q.2. How does allowing cryptocurrency exchanges to issue their
    own tokens affect fair competition?

    A.2. Allowing cryptocurrency exchanges to issue their own
    tokens can potentially affect fair competition in a number of
    ways.
        First, an exchange's own token may have an advantage over
    other tokens listed on the platform due to the exchange's
    ability to promote it more heavily. This could lead to a
    distortion of the market and an unfair advantage for the
    exchange's own token.
        Second, if an exchange has significant control over the
    supply and demand of its own token, it could potentially
    manipulate the price to its own benefit. This could lead to
    unfair competition with other projects and potentially harm
    investor confidence in the market.
        Overall, it is important for exchanges to be transparent
    about their operations and any potential conflicts of interest
    that may exist, in order to promote fair competition and
    maintain trust in the market.

    Q.3. How does allowing cryptocurrency exchanges to issue their
    own tokens affect systemic risk in financial markets?

    A.3. Allowing cryptocurrency exchanges to issue their own
    tokens can potentially affect systemic risk in financial
    markets in a number of ways.
        First, if an exchange's own token becomes widely used and
    is tightly integrated into the exchange's operations, a failure
    or problem with the exchange could have a cascading effect on
    the value of the token and potentially create losses for token
    holders. This could increase the systemic risk of the overall
    market, as the failure of a single entity could have wider
    implications.
        The FTX exchange token (Symbol FTT) had a material role in
    the collapse of FTX itself. Prior to November 2022 FTX had
    repurchased approximately $2.1 billion of its equity from
    Binance a global competitor also unregulated. A material amount
    of this transaction may have been done using FTT tokens as
    currency. In addition to alleged inappropriate transfers of
    cash between FTX and Alomedia that could have weakened FTX
    balance sheet, Binance attempted to ``dump'' approximately $550
    million of FTT tokens onto the market the week of Nov. 7, 2022.
    It was the proverbial ``straw that broke the camel's back'' as
    FTX did not have the reserves to back that transaction and
    subsequently filed for bankruptcy November 11, 2022.
        Why would FTX deplete its balance sheet of $2.1 billion of
    assets, including FTT tokens, to buy back its own stock from
    Binance? According to FTX management it was to clear regulatory
    hurdles in new geographies where FTX was seeking licenses to
    operate. Apparently, according to FTX management, Binances 20
    percent ownership in FTX made it a material participant in the
    licensing process. However, according to FTX management Binance
    was becoming less and less cooperative in proving the level of
    transparency that regulators required and FTX license
    applications were getting rejected because of is 20 percent
    held by ``opaque ownership''. Who owns Binance? Unknown. This
    became an insurmountable problem for FTX and, according to FTX
    management, they had no choice but to repurchase their stock.
    What valuation was this transaction done at? Records have not
    been released yet but it is alleged by FTX management and also
    detailed in Business cable interviews of Binance management to
    have been done at a 15 percent discount to a $23 billion FTX
    valuation. It seems that at least $550 million of the clearing
    price was done in FTT tokens, which is the block that Binance
    attempted to put to the market the week of Nov. 7th 2022 that
    forced FTX into bankruptcy.
        From my perspective this was a battle royal between two
    giant global unregulated exchanges that together owned over 90
    percent of global crypto market liquidity. One put the other
    out of business. The highly effective weapon of choice? The FTT
    exchange token.
        If an exchange has significant control over the supply and
    demand of its own token, it could potentially manipulate the
    price to its own benefit. This could lead to market instability
    and increase systemic risk, as investors may not have a clear
    understanding of the true value of the token.
        It is not clear what the long term value of an exchange
    token is. If an exchange wants to raise capital why does it not
    just sell its equity into the highly regulated equity markets.
    If it wants to provide discounts on trading fees why not just
    provide discounts? There is no need for a token for this
    purpose. On the regulated on-line stock trading platforms
    competition has driven trading fees to $0. Undoubtedly as
    regulated broker/dealer crypto exchanges emerge fee structures
    will also be determined by the market.
        It is important for exchanges to be transparent about their
    operations and any potential conflicts of interest that may
    exist, in order to minimize the potential impact on systemic
    risk in financial markets. To date this has not been the case
    in the global crypto exchange market. The lack of definitive
    regulation allows these exchanges to continue to operate in the
    ``wild west'' and they will continue to fail when stress tested
    by accelerated liquidations.
        Solving this problem may not be as complex as some have
    suggested. Crypto has one unique attribute as an asset class.
    It does not trade by geography or by schedule. Unlike a stock
    or bond Bitcoin is not listed on the London or NYSE stock
    exchange. It trades freely everywhere 24/7. However, what is
    valuable to exchanges that seek licenses are the on and off
    ramps into and out of the regulated banking system in each
    region.
        One good example of this solution is the highly regulated
    crypto broker/dealer/exchange Canadian market. The OSC order
    that allows exchanges to obtain licenses and operate there
    restricts which tokens can be traded and held in accounts. To
    date approximately 33 are permitted but no exchange tokens.
    Exchanges in good standing can transfer funds in and out of
    regulated bank accounts after appropriate KYC (know your
    client) protocols have been satisfied. The regulatory controls
    come from restricting which tokens can be traded, which can be
    staked or lent and how regulated currency comes on and off the
    exchanges. There is also proof of reserves, audit and ownership
    transparency requirements that must be met and maintained in
    order for the broker/dealer/exchange to continue to operate.
        Regulators in all markets already cooperate together
    developing and maintaining policy in the equity and debt
    markets. Crypto trades everywhere with no regard to political
    or economic borders so the best way to regulate it is to
    control how it's converted into local currencies on and off
    regulated broker/dealer/exchange platforms with a ``passport''
    issued by the local regulator. Under a Passport Program
    regulated banks in the region could only transfer capital to
    broker/dealer/exchanges that have and maintain a Passport.
        The Golden Passport would quickly become the one issued by
    U.S. regulators that would allow its owner to operate within
    the U.S. banking system. To accommodate the global liquidity of
    Crypto regulators that standardized on the cooperative Passport
    system could fast track the issuance of licenses if the
    operator already had a Passport issued in a cooperating
    jurisdiction. There are a handful of markets that make up the
    majority of global liquidity. To reconstruct a regulated global
    exchange under the Passport system, you would need to obtain
    North American, British, Euro, UAE, and Asian Passports. To
    maintain operations operators would need to remain compliant in
    all regions simultaneously. Getting a passport revoked in any
    one region would cause operations to be suspended in all
    licenced markets until the breach was remedied in the market
    the infraction occurred. Passported operators would gain an
    advantage over ``rogue'' exchanges that continued to operate
    free of regulation because the majority institutional capital
    would flow through the regulated exchanges to remain compliant.
        Cutting off unregulated exchanges from dealing with
    regulated banking entities for fiat to crypto fund transfer is
    no different than cancer therapies that cut off blood flow to
    tumors and starve them to death.
        This is not a new policy. Many international trading
    agreements, in multiple asset classes, operate under mandates
    similar to these.
                                    ------

            RESPONSES TO WRITTEN QUESTIONS OF SENATOR TESTER
                        FROM JENNIFER J. SCHULP

    Q.1. Taxpayer Protection--Is it clear enough to investors that
    making bets in the cryptocurrency space is at their own risk?
    And that the U.S. taxpayers won't be stepping in to bailout
    this industry?

    A.1. Investors should understand the risks associated with
    investing in the cryptocurrency space. There is certainly an
    opportunity for better investor education about cryptocurrency
    investment and usage, and private market solutions have been
    growing to address this need. \1\ Where individuals or entities
    have misrepresented those risks or misrepresented the
    availability or applicability of Federal Government backstops,
    like deposit insurance, such misstatements should be subject to
    appropriate liability either through private causes of action
    or through Government enforcement action.
    ---------------------------------------------------------------------------
         \1\ See, for example, the work being done by the Blockchain
    Foundation (https://theblockfound.com/) and educational resources that
    are provided by popular crypto marketplaces (https://www.coinbase.com/
    learn and https://www.gemini.com/cryptopedia).
    ---------------------------------------------------------------------------
        It is unfortunate that some investors have the expectation
    that the Government, and by extension taxpayers, will act to
    bail out any industry. Market forces should be permitted to
    drive the success--or failure--of the industry.

    Q.2. Contagion--It is clear that there was poor corporate
    governance, and it appears flat-out fraud, at FTX. But over
    this last year we've seen a series of failures and challenges
    in the industry. There may be benefits to some of the related
    technologies, but there have been numerous problems--even just
    in recent months--for cryptocurrency companies and, more
    importantly, investors.
        How could this or other failures in the cryptocurrency
    industry have spread to our other financial institutions and
    systems in the U.S.? What has protected them so far?

    A.2. It is difficult to predict the impact of any particular
    event on other actors within the financial system. Not
    surprisingly, the effects of FTX's bankruptcy have first been
    felt by entities that engaged directly with now-bankrupt FTX-
    related entities. This includes customers of the crypto trading
    operation and those who invested in FTX, as well as companies
    that lent to or borrowed from FTX. Second order effects were
    felt by entities that engaged with those who had direct contact
    with FTX. And so forth. The magnitude of FTX's failure means
    that effects were significant. But not all effects were
    catastrophic, and protection from such effects could come in
    many forms, including a variety of good risk management
    practices on the part of the entities that interacted with FTX
    and its connections. The goal should not be to legislate to
    prevent failure.

    Q.3. How would this crash have been different if Federal
    financial regulators had allowed our banking institutions in
    this country to do more in the cryptocurrency space?

    A.3. This counterfactual is difficult to answer because it
    requires a host of assumptions about what regulation would look
    like and what effect such regulation would have on both banking
    institutions and cryptocurrency projects. On the one hand,
    allowing additional touchpoints between banking institutions
    and crypto may have limited the extent to which FTX and other
    crypto entities were engaging in poor risk management practices
    (or outright fraud), including by allowing for customer crypto
    assets to be custodied by regulated banking institutions. In
    this way, more integration between the banking and crypto
    spaces may have limited the impact of the crash. On the other
    hand, allowing additional touchpoints may have also imported
    some risks from FTX's crash to the traditional financial
    sector. But risks by themselves do not mean catastrophic
    failure, and the purported benefits of isolating the banking
    industry from cryptocurrencies must be examined in connection
    with the costs of doing so.

    Q.4. Regulation--What are the benefits and drawbacks from
    creating additional regulation, and with it perhaps perceived
    or real Government endorsement, for a product with no inherent
    value?

    A.4. This question, at least as stated, begs the question that
    crypto--writ large--has no inherent value. This assumption is
    not warranted. In addition, it treats ``crypto'' as a monolith
    and does not take into account the wide variety of projects
    that can be generally grouped under the ``crypto'' banner.
    Moreover, the Government's role is not to determine whether
    crypto has value; rather, regulation should do no more than
    support the free market's ability to determine whether a
    project succeeds or fails. Thus, regulation should not be
    understood as a Government endorsement of any kind. The
    benefits and drawbacks of additional regulation are highly
    dependent on the type of regulation that is created; such
    regulation should seek to neither advantage nor disadvantage
    crypto projects vis-a-vis more traditional financial products.
                                    ------

           RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNOCK
                        FROM JENNIFER J. SCHULP

    Q.1. According to press reports, FTX Trading Ltd. (FTX)
    collateralized billions of United States dollars in loans using
    the FTX Token (FTT), which functioned similarly to a form of
    stock in FTX. If FTX were a traditional bank, this practice
    would seem to be prohibited under the National Banking Act of
    1864. \1\
    ---------------------------------------------------------------------------
         \1\ 12 U.S.C. 83(a) (``No national bank shall make any loan or
    discount on the security of the shares of its own capital stock.'').

    A.1. Before addressing the specific questions below, I note
    that it's not clear that FTX Trading is easily analogized to a
    ``national bank'' to which the National Banking Act is
    applicable. FTX engaged in a number of lines of business, the
    primary of which was serving as a cryptocurrency exchange
    specializing in leveraged and derivative products. Other
    services offered, including yield-bearing accounts, look more
    akin to traditional banking, but it is difficult to generally
    ---------------------------------------------------------------------------
    characterize FTX Trading's business as bank-like.

    Q.2. In your view, is there a conflict of interest for a
    cryptocurrency exchange to issue its own token, given the lack
    of public markets and other methods of ensuring transparency
    and price discovery?

    A.2. Regardless of whether a token issued functions like a form
    of stock in the exchange, the mere issuance of a token does not
    signal a conflict of interest. Using such a token as collateral
    for an exchange's borrowing or lending activities, or for other
    purposes, may raise conflict of interest questions,
    particularly where there is a lack of methods for ensuring
    reliable rice discovery or assignment of value to such a token.
    Such activity also raises questions about the exchange's risk
    management practices.

    Q.3. How does allowing cryptocurrency exchanges to issue their
    own tokens affect fair competition?

    A.3. There is nothing inherently anticompetitive in allowing
    token issuance by cryptocurrency exchanges. To the extent such
    tokens function as stock in the exchange itself, allowing such
    issuance is akin to allowing the public ownership of stock
    exchanges, which is currently how most major stock exchanges
    are owned in the United States.

    Q.4. How does allowing cryptocurrency exchanges to issue their
    own tokens affect systemic risk in financial markets?

    A.4. The issuance of tokens by cryptocurrency exchanges does
    not itself necessarily have a systemic effect on financial
    markets. As noted above, where such a token is used
    inappropriately as collateral by the exchange or by others,
    there may be broader implications relating to risk management.
                                    ------

            RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN
                      FROM BEN MCKENZIE SCHENKKAN

    Q.1. Many crypto advocates have talked about the potential of
    blockchain technology to revolutionize financial services and
    other industries. Based on your research, do you agree?
        Are there any uses that you believe are on the horizon?

    A.1. I do not agree. Blockchain technology is old, dating back
    at least 30 years. It has not gained widespread adoption
    because it suffers from several fundamental weaknesses.
    Distributed ledger technology has thus far been unable to scale
    without significant costs attached. Similarly, the
    irreversibility of the blockchain, which advocates promote as a
    selling point, makes it unsuited to human interaction. People
    make mistakes, and tying the fate of our financial system to an
    append-only ledger is unwise in the extreme.
        The only use for blockchain technology on the horizon that
    I have found in my research is potentially for small systems
    with low throughput such as the wholesale side of the banking
    system. But even there, it is unclear if the benefits outweigh
    the drawbacks. More than 30 years after its invention,
    blockchain is a still searching for a use case that does not
    involve speculation and criminal activity.
                                    ------

            RESPONSES TO WRITTEN QUESTIONS OF SENATOR TESTER
                      FROM BEN MCKENZIE SCHENKKAN

    Q.1. Risks of Crypto Products--As I've discussed in this
    Committee previously, I have long had concerns that aspects of
    the crypto market reminded me of synthetic financial products
    ahead of the Global Financial Crisis. I'm glad that our Federal
    financial regulators have focused on safety, soundness, and
    fairness in approaching these new products--I think taxpayers
    could be in a much different position right now if regulators
    had handled it differently in recent years.
        On this and other occasions in the Banking Committee I have
    discussed my concerns around these similarities with synthetic
    products, which Professor Allen and I have discussed: What
    concerns do you have about the risk posed to institutions and
    individuals who invest in these products?

    A.1. I have myriad concerns, but first and foremost it troubles
    me that the cryptocurrency market is opaque to the point of
    incomprehensibility to those not within the small circle of
    meaningful players in the industry. Institutions and
    individuals are at a severe disadvantage when investing in
    these products. Prior to the last bull market in 2017, the
    cryptocurrency industry was incredibly small. Since then it has
    ballooned in size, in part because I believe regulators did not
    properly classify cryptocurrencies as securities and regulate
    them and the exchanges that sell them robustly. Investors have
    little understanding of what transpires behind the scenes to
    inflate the purported value of these cryptocurrencies, and even
    less recourse to get their actual money back should they lose
    it.

    Q.2. Taxpayer Protection--Is it clear enough to investors that
    making bets in the cryptocurrency space is at their own risk?
    And that the U.S. taxpayers won't be stepping in to bailout
    this industry?

    A.2. It is not. Investing in cryptocurrency is extremely risky,
    but it is not marketed as such. In fact, many claims by
    cryptocurrency companies appear to be deliberately misleading.
    Multiple players in cryptocurrency, including the now defunct
    FTX, implied their accounts were FDIC-insured when they were
    not. Cryptocurrency has been sold as a bet on technology and
    innovation. It has been described as ``the future of money'', a
    way of building generational wealth, and a method of banking
    the unbanked. Unfortunately, none of those stories are true.
    Investing in cryptocurrency is at best a zero-sum game of
    chance, much like its predecessor, online poker. And much like
    the early days of online poker, fraud is rampant.
        Similarly, investors in cryptocurrency should be aware that
    it is highly unlikely that the majority of taxpayers who have
    not invested will be willing to bail out those who have been
    defrauded. The blame lies with those who have committed fraud,
    and no one else.

    Q.3. Contagion--It is clear that there was poor corporate
    governance, and it appears flat-out fraud, at FTX. But over
    this last year we've seen a series of failures and challenges
    in the industry. There may be benefits to some of the related
    technologies, but there have been numerous problems--even just
    in recent months--for cryptocurrency companies and, more
    importantly, investors.
        How could this or other failures in the cryptocurrency
    industry have spread to our other financial institutions and
    systems in the U.S.? What has protected them so far?

    A.3. The bright red line between our regulated banking sector
    and the wild west of cryptocurrency has thus far spared the
    majority of the public from suffering a fate similar to the
    majority of those who have invested in cryptocurrency. That
    said, if cryptocurrency were to ever become embedded in our
    regulated financial systems despite not following the same laws
    as other financial products, the damage to our economy could be
    immense.

    Q.4. How would this crash have been different if Federal
    financial regulators had allowed our banking institutions in
    this country to do more in the cryptocurrency space?

    A.4. It is not hyperbole to imagine that a subprime crisis 2.0
    could emerge from a cryptocurrency crash in the future were it
    infect our banking institutions. At a minimum, cryptocurrency
    must not be allowed to avoid laws that have served the public
    well for nearly a century.

    Q.5. What steps need to be taken to protect everyday investors
    from schemes like this?

    A.5. We need to properly classify the nearly 20,000
    cryptocurrencies as securities and enforce laws applicable to
    them. Additionally, anti-money laundering laws and know your
    customer laws should be enforced. Lastly, American customers
    should not have access to cryptocurrency exchanges registered
    overseas that do not comply with U.S. laws.

    Q.6. What additional resources do institutional investors or
    more experienced investors like yourself need to have adequate
    information about investing in companies like FTX?

    A.6. All investors need the same protections afforded by robust
    enforcement of our securities laws. We should also consider a
    marketing ban on risky investment products sold to the general
    public.

    Q.7. Regulation--What are the benefits and drawbacks from
    creating additional regulation, and with it perhaps perceived
    or real Government endorsement, for a product with no inherent
    value?

    A.7. Despite industry claims to the contrary, cryptocurrency is
    not unique as an investment product. In fact, it is a
    repetition of several failed ideas of the past. The United
    States tried what cryptocurrency purports to be--private
    money--in the 19th century during what has become known as the
    free-banking era. It did not work very well. Similarly, the
    drawbacks of selling unregulated securities to the general
    public became clear during the stock market crash of 1929 to
    1932 and the ensuing Great Depression, which led to the passage
    of Federal securities laws in 1933 and 1934.
        Rather than creating unnecessary additional regulation, we
    should rigorously enforce the laws on the books so as to
    protect the public.

    Q.8. National Security--Are there benefits that outweigh the
    facilitation of crime that we've seen from these products and
    this industry?

    A.8. No.
                                    ------

           RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNOCK
                      FROM BEN MCKENZIE SCHENKKAN

    Q.1. According to press reports, FTX Trading Ltd. (FTX)
    collateralized billions of United States dollars in loans using
    the FTX Token (FTT), which functioned similarly to a form of
    stock in FTX. If FTX were a traditional bank, this practice
    would seem to be prohibited under the National Banking Act of
    1864. \1\
    ---------------------------------------------------------------------------
         \1\ 12 U.S.C. 83(a) (``No national bank shall make any loan or
    discount on the security of the shares of its own capital stock.'').
    ---------------------------------------------------------------------------
        In your view, is there a conflict of interest for a
    cryptocurrency exchange to issue its own token, given the lack
    of public markets and other methods of ensuring transparency
    and price discovery?

    A.1. Yes. Conflicts of interest abound in cryptocurrency, but
    overseas exchanges with little transparency issuing their own
    tokens is problematic to say the least. The public is largely
    unaware of how the price of those tokens may be manipulated by
    the exchanges issuing them.

    Q.2. How does allowing cryptocurrency exchanges to issue their
    own tokens affect fair competition?

    A.2. Because the cryptocurrency exchanges issuing their own
    tokens are largely domiciled overseas, it's virtually
    impossible to know whether they are complying with applicable
    U.S. laws. The fair competition American investors have become
    accustomed to in domestic regulated markets is largely absent
    in cryptocurrency, where the majority of the volume flows
    through those overseas exchanges.

    Q.3. How does allowing cryptocurrency exchanges to issue their
    own tokens affect systemic risk in financial markets?

    A.3. Thankfully, the exchanges that issue these tokens are
    domiciled overseas. Thus far, they are largely isolated from
    our regulated markets. That said, the more cryptocurrency
    becomes intertwined with our regulated financial markets, the
    more the systemic risk to them grows.
                  Additional Material Supplied for the Record

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