This is an edition of the Revolving Door Project’s “Hack Watch” newsletter. Subscribe to the Revolving Door Project on Substack.
Crypto was always a scam. Now, as Sam Bankman-Fried, the industry titan who especially sought a cloak of legitimacy, flails into bankruptcy, the farce is more apparent than ever. This past Monday, our own Timi Iwayemi had a great piece in The Nation looking into Bankman-Fried and the crypto “empire” he built upon pillars of sand and financial trickery. If you haven’t already, give it a read.
But the rise of the crypto industry didn’t happen in a vacuum; it was made possible by the willing complicity of high-profile endorsers, and an uncritical press corps. How many people fell victim to the industry’s hype and predatory commercials featuring Tom Brady, Matt Damon, and Larry David? How much goodwill did the industry curry from the thumbs up of lawmakers like Senators Kirsten Gillibrand and Cynthia Lummis?
Figures like these helped launder the legitimacy of these imaginary monies to the general public. But to the supposedly sophisticated financial press and industry, one of the most prominent boosters was Larry Summers.
Summers said that he saw Bitcoin having a future as “digital gold”. After this year, that prediction doesn’t look so good. But Summers also actively lent his reputation as a Harvard professor and former treasury secretary to firms that were deeply involved in the crypto market.
In particular, Summers has been heavily involved with the Digital Currency Group and Block. DCG is an investment firm specializing in — you guessed it — digital currency. Summers got a special title of “Board Advisor” which came with his own section of the webpage, because with him, DCG didn’t need any more advising. DCG’s portfolio includes the who’s who of the digital asset space, including Coinbase, Ripple and the now-bankrupt FTX. Interestingly, in the wake of the FTX-driven collapse, they’ve deleted their “who we are” page (here’s an archived version) because nothing makes you look more above board than hiding basic information following a massive collapse in your industry.
Block is the rebranded version of mobile payment processor Square — a move made last year to usher the company’s entry into crypto. Led by Jack Dorsey, who weirdly considers Bitcoin to be the “open standard for global money transmission,” (and who thought Elon Musk was the perfect guy to run Twitter, which is an opinion that has aged like warm milk) the company has embarked on a number of crypto related projects since the rebrand. Block offers Bitcoin trading to customers through Cash App and holds the asset as an alternative to cash. Block’s foray into the industry extends well beyond promoting speculation; Dorsey’s company is also developing systems for Bitcoin mining, the environmentally destructive process through which bitcoins are created.
Last summer, we sent a letter to Harvard’s president asking for Larry Summers to be required to disclose this sort of conflict of interest. We’re still waiting to hear back.
But that’s besides the point. Summers has been getting paid by firms that are deeply entrenched within crypto markets, and media outlets that have quoted him on the FTX collapse haven’t been informing their viewers, much less asking themselves whether Summers deserves this free airtime. Even in the wake of the FTX crash — which should obviously serve as a humbling moment for everyone affiliated with the industry — publications elected to ignore his business relationships. Many outlets ran full stories that were just rewriting a quote from Summers on Bloomberg TV, where he compared the FTX collapse to Enron saying it “whiffs of fraud.” As far as these outlets were concerned, Larry Summers saying a thing was in and of itself newsworthy, headline-worthy even! And no one so much as Googled whether Summers had any prior crypto relationships!
And this isn’t just a conflict-of-interest question. Summers’ assurance that the FTX collapse is more like Enron than Lehman Brothers directly misleads the public in ways from which he stands to profit.
There are certainly reasons to think that the FTX collapse was at least as much Lehman as it was Enron. For starters, as our Timi Iwayemi has written, the ploy Bankman-Fried was engaged in is an industry hallmark; it’s the same way Celsius, Voyager and Three Arrows Capital went down this year. And the reason is quite simple: without government backing, synthetic money like crypto tokens can only maintain their value if demand holds up. That requires two things: continued entry of new consumers and sustained holding of the “assets.” In short, you need enough people to believe that crypto is worth something for it to be worth something.
To that end, firms often rely on exchanges and market makers like FTX and Alameda Research to simulate the appearance of demand by buying and selling large quantities of their tokens. That boosts the token’s price, allowing firms to mark the elevated token price to market. The coins show as balance sheet assets, which can then be posted as collateral for loans. It’s essentially a giant show: the value of the crypto token rises because the market-maker makes it look like the value is rising, regardless of any actual change in demand.
However, as Timi explains, this strategy immediately falls apart in the face of a market downturn. When creditors and customers come calling for their funds, these firms often realize that their token assets are paper wealth they can’t actually exchange for fiat. In FTX’s case, Coindesk’s reporting of a leaked balance sheet showed how deeply exposed FTX partner organization Alameda Research was to FTT, the FTX token. This reasonably prompted rival exchange Binance to begin selling off its FTT holdings, triggering a run on FTX’s assets, and sure enough, the company didn’t have enough liquid cash on its books.
This is important, because even a crypto exchange that wasn’t siphoning cash to its owner’s other companies would face the same vulnerabilities FTX did. In theory, these exchanges are solvent as long as there isn’t a big negative shock to the value of the digital coins they trade. But, even with high prices, crypto assets are functionally illiquid. If an exchange attempts to cash them in at a rapid pace to honor redemption requests, it would tank the token’s value and undermine the rest of the exchange’s balance sheet. No amount of showmanship can cover-up an actual plummet in demand, in other words.
The fact that this is an inherent part of crypto is why comparing FTX to Lehman Brothers is apt. Lehman went under because too much of its balance sheet was tied up in risky mortgage-backed securities that were overvalued. Sound familiar? (And hey, at least mortgage-backed securities had some sort of connection to houses, which actually do something for the world.) When the mortgage-backed securities bubble popped, it spread beyond Lehman because those risky assets — and derivatives of them, and derivatives of derivatives of them — were held across the financial sector. That’s what caused a bubble in the housing sector to spread into a global financial crisis.
FTX’s own in-house token is not nearly as widely held as bad mortgage-backed securities were in the late aughts. But just a year ago, crypto was a near $3 trillion dollar industry, and there’s not much true value in any of the other cryptocurrency assets either. Unlike Enron, this was not only fudging the financials, it was also built on a business model that inappropriately took on more risk than was being let on.
All of this finally brings us back to Summers. As we’ve noted before, there’s often a parallel between the ideas Summers espouses in public and his personal interests. Given his involvement with Block and DCG, Summers stands to suffer a material loss if the FTX scandal brings down the entire crypto industry. Going on television and rebutting people comparing FTX to Lehman Brothers in the Great Recession, saying it more resembles Enron’s accounting fraud, will protect his own material wealth and reputation in at least two ways:
- Focusing attention on firm-level fraud shifts focus away from industry-wide issues. The value of cryptocurrency is based almost entirely on speculation. If this was an individual accounting issue, there’s no inherent implication for other firms with better, more ethical accountants.
- Because Summers’ role with DCG and Block is public information, any widespread recognition of crypto’s categorical Ponzi scheme nature would harm his reputation and compromise his credibility.
Summers also tweeted that the FTX collapse exemplifies the need for more forensic accountants to root out this sort of behavior. That’s a great point. It’s also a reason why crypto, if it is to exist at all (we’d prefer not), needs a strong regulator with demonstrable capacity to oversee financial markets, such as the Securities and Exchange Commission. But crypto industry players have been vocal about their wish to ensure full oversight authority lies in the hands of the weaker and friendlier Commodities Future Trading Commission.
This type of involvement with predatory finance companies is nothing new for Summers. But that just makes the outright failure of his media platformers to disclose these conflicts of interest even worse.
Whether this will trigger more collapses at other crypto brokerages remains to be seen. Either way, it is irresponsible for any serious pundit to minimize the potential risk. Just as it is irresponsible for the press constantly quoting someone who works for DCG without saying they are.