[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



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            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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