Decentralised Finance: The Democratisation of Financial Crime

On Wednesday 15th December, House Speaker Nancy Pelosi stated that members of Congress should be allowed trade stocks. Pelosi argued that “We’re a free market economy, they should be able to participate in that”. This comes after a Business Insider investigation revealed that over 50 members of Congress had violated the STOCK Act, which was designed to combat insider trading. It is pertinent to highlight that Nancy Pelosi made over $11.9 million worth of trades last year, which puts her fifth highest out of the House of Representatives. Pelosi also had a mean stock price increase of 10.6% in the month after her purchase.

Unsurprisingly, this has drawn criticism from those who seek to combat financial corruption. Former Director of the US Office of Government Ethics, Walter Schaub, argued that while it may be a free market economy, your average citizen does not get access to confidential briefings full of non-public information directly related to the price of stocks. Congressional players have been characteristically quiet with respect to this, only 10 out of 535 members of Congress did not directly engage in stock trading and instead use what is known as a Qualified Bind Trust (QBT). These individuals, nine Democrats and one Republican, use an independent body that they have no direct contact or influence with to trade stocks, if they trade them at all.

Historically, Capitol Hill has never been a stranger to financial corruption. As recently as 2020, an insider trading scandal rocked Capitol Hill, after several members of the House and the Senate benefitted financially from the outbreak of the COVID-19 pandemic, with no notable punishments being doled out. Prior to this, more subtle forms of corruption have taken place, the financial crisis of 2008 highlighted how corruption at the highest level goes unpunished and, in some respects, gets rewarded. The key example here being Henry Paulson, former CEO of Goldman Sachs, who became the Treasury Secretary under George W. Bush. Paulson oversaw the federal bailout packages for the major banks when they made the decision to let Lehman Brothers, Goldman Sachs biggest competitor, collapse; one of the driving factors in the 2008 financial crisis.

Traditionally, financial crime has been limited, but not exclusive, to the large corporations on Wall Street. Alongside bailouts from the US government, this power balance has been kept intact for generations. Widespread corruption and constant examples of a revolving door have characterised for many, the inherent problems with America’s financial centre. Recently though, new forms of financial investment such as the app, Robinhood and the individual control that comes with trading cryptocurrency have played a key role in the rise of person-centred trading devices. However, the decentralisation of finance has also paved the way for your average Joe to engage in previously unattainable fraudulent activities.

Examples of this decentralisation being the GameStop Short Squeeze. This has shown that the establishment is fearful of decentralised power structures forming, power structures that exist separate of established financial institutions. Robinhood’s decision to freeze trades on GME and other related stocks advanced the belief that successful investing was for established corporations and hedge funds. Investigations were launched and the Wallstreetbets discord server was shutdown citing hate-speech. The investigations launched looked into whether Redditors had manipulated the market. This declaration was met with vehement criticism, retail investors who had bought GME to keep a beloved company afloat in opposition to debilitating shorting practices by major firms were now under investigation for a crime that major hedge funds had been guilty of for years.

Together with bringing power back to the people, decentralised finance also opened the door for increased financial crime at lower levels. Cryptocurrency has fostered an almost meme-based, cult like existence for those involved in it. Schemes like pump and dumps, rug-pulls and stop-loss fishing continue to impact millions involved in crypto. Despite the fraudulent nature of activities, the culture surrounding them is comical and humorous, a key example of this being the squidcoin rug-pull. A rug-pull is where a new token gets minted, the creators own the majority of the supply and then hype it up only to dump it on their loyal lemmings. Regarding squidcoin, the creators set rules which meant investors could buy but only the creators could sell, why anyone would willingly invest in such a deal is beyond me. When the price reached a certain point the creators sold it and the price fell to zero without the buyers being able to sell, so they lost the money they invested. This led to several hilarious reaction videos of investors watching the price to fall zero in real-time. Note the individual who invested $56k prior to the crash.

Pump and dumps have characterised financial crime for a long time. The practice was immortalised for many amateur investors in Martin Scorsese’s Wolf of Wall Street. Stratton Oakmont’s use of pump and dumps, a form of microcap stock fraud, characterised their business throughout the late 1980s and early 1990s. Pump and dumps are a result of artificial inflation of the price of a stock/coin through misleading and often false positive statements in order to sell the inflated stock at a higher price. As a result of cryptocurrency residing in a legal grey area, pump and dumps are generally left unpunished – a result of the anonymity and unregulated nature of crypto trades.

Crypto regulation is a major discussion in most governments. Most countries with strong financial centres would like to see crypto regulated because it threatens the established financial order. The IMFBlog wrote an extensive article on how crypto is affecting the stability of the established financial world. The article argues that a third-party regulator is required to stabilise the volatility of crypto, “overseen by securities regulators, central bank or an oversight authority”. This is in direct contradiction to Satoshi Nakamoto’s Bitcoin white paper. Regulation will not protect consumers from a fraudulent, volatile market. It will serve only one group. The established financial order that crypto is successfully destabilising. Unnecessary over-regulation goes against everything cryptocurrency was designed to combat.

This is just it though. I am not advocating for no regulation, I am not promoting the statements of Michael Saylor; do not go out and mortgage your house to buy crypto. However, we cannot and should not pointlessly over-regulate crypto to make it an unviable and unproductive option for many a retail investor because we fear potential, temporary instability like we have seen with the current crypto crash. CZ Zhao, the CEO of Binance, has argued for a clear and dedicated commitment to evaluating the effectiveness of crypto regulation. Zhao believes there are many separate examples of varying degrees of regulation and with crypto, as with anything, it will take time understand what methods and models are most effective.

This is where we find ourselves in the midst of a debate about good regulation and over-regulation. Good regulation, in theory, should protect the investor and the exchange. Many criticise the anonymity of cryptocurrency, which facilitates the vast amounts of fraud that can take place and regulators often advocate for KYC (Know-Your-Customer) policies to curtail this. However, if we are hard-lining support for Nakamoto’s White Paper, KYC is the antithesis of crypto’s role as an anonymous consumer trade platform. Obviously, consumer protection and reduced volatility will be valuable in stabilising the market but the excitement and unpredictability of the investments is originally what brought a vast majority of traders in.

The fear I harbour is that severe regulation will have the opposite of its intended effect. It is no doubt that crypto has experienced an astounding downfall over the last few months, but increasing and then preying on fears of market volatility and consumer manipulation will not serve the community in any positive way. My fears lie in the centralisation of a currency that was designed and cultivated as a successful detachment from established financial institutions. Consumer protection is fundamentally important but it cannot come at the cost of barring entrepreneurs and the regular person from the market.

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