Long march to serfdom
Is regulation really the answer Americans are looking for?
Immediately upon the spectacular meltdown of Sam Bankman-Fried’s magic money empire FTX last week, widespread consensus converged on one simple conclusion: The crypto market needs more government oversight. “[W]ithout proper oversight, cryptocurrencies risk harming everyday Americans,” White House Press Secretary Karine Jean-Pierre warned on Thursday. “The most recent news further underscores these concerns and highlights why prudent regulation of cryptocurrencies is indeed needed,” she added.
This isn’t just the opinion of Democrats, either. In a nation divided on everything else, concerning the issue of crypto regulation the two major parties agree wholeheartedly. “The recent events show the necessity of Congressional action,” Representative Patrick McHenry (R-NC), the ranking member of the House Financial Services Committee, wrote on Tuesday. “It’s imperative that Congress establish a framework that ensures Americans have adequate protections.” Even CEOs of major crypto companies agree. Binance CEO and SBF rival Changpeng Zhao told attendees at the B20 summit in Bali that “we do need some regulations,” and on Friday Coinbase’s CEO Brian Armstrong penned an op-ed titled, “Crypto markets need regulation to avoid more washouts like FTX.” It’s not an unusual stance to take; less than a month ago even SBF himself was proposing regulations—ones favorable to his own activities, of course. Pundits from CNBC to Fox News seem as certain today about the need for regulation as they were in June that Bankman-Fried was “the new J P Morgan.” Everyone agrees that increased government oversight is the smart move.
But is it?
The answer, unsurprisingly, depends on the goal and on the time horizon by which outcomes are judged. Putting aside ethical considerations of government intrusion in the marketplace, if Americans aim merely to decrease short-term pain experienced by potential losses in crypto gambling, then more extensive regulation sounds like a perfectly reasonable move. But any resulting benefits also accrue longer-term costs, the consequences of which are potentially severe enough that it behooves anyone concerned about America’s future (and anyone wondering how the U.S. administrative state grew to such unwieldly proportions in the first place) to take a few moments to reconsider. There is a standard narrative about completely free markets, according to which they inevitably climax in an FTX-level conflagration. An unavoidable conclusion quickly follows: To fight future fires, the government must urgently raise a small army of finger-wagging do-gooders who can swoop in to handcuff the next batch of bad guys before they light the match. But this narrative is short-sighted and incomplete, and it’s one of the reasons that the fat, clumsy, ubiquitously molesting fingers of today’s government would land our horrified founding fathers on an FBI watchlist.
Beverly and Sam
A free market begins with voluntary interaction between two entities: a (potential) buyer, and a (potential) seller. Let’s call the buyer Beverly, and the seller Sam Bankman-Fried, or “Sam” for short. Whenever Beverly considers making a purchase, she is faced with a risk management decision and necessarily employs a process of due diligence (DD) commensurate with her risk tolerance. That might sound like an overly complicated way of explaining Beverly’s trip to her local chocolate shop, Sam’s Sweets, during lunch hour, where she buys handmade peanut butter cups so that she can post pictures of them in Discord. But it’s not.
Even if not consciously, Beverly weighs risks and performs DD. Some potential bad outcomes are small: this next batch might not be as delicious as yesterday’s, or the clerk might snatch her $4.50 and head for the hills without delivering the chocolate-y goodness she was expecting. Other failure scenarios are huge, but highly improbable: This next batch might be laced with strychnine. Beverly performs DD accordingly, almost always choosing to trust that the transaction will go well. But if she waltzes into Sam’s Sweets one sunny day to discover a sea of fellow patrons gasping and convulsing on the floor and a creepy new guy in a prison jumper behind the counter offering her free samples, she might wisely decide to head to Wawa and settle for Reese’s instead. Her DD process is simple, straightforward, trusting, and often unseen, but it’s always there ready to fly the red flag in case perceived risk outweighs Beverly’s tolerance for it. Of course, the risk that Sam’s Sweets intentionally poisons patrons is miniscule, not because of FDA oversight, but because–thankfully–serial killers are rare. (And for the record, their murders don’t always follow regulatory guidelines.)
Beverly’s risk tolerance varies depending on expected rewards and potential losses, which means she adapts her DD process to fit the situation. She recently purchased a house, which cost more than $4.50, and for which her DD process was much more extensive. If Sam were to offer her complex financial instruments in a brand-new asset class promising 1000% annual returns, before plunking down her life savings (or even $4.50) Beverly might demand a significant amount of financial transparency and painstakingly scrutinize all the executives involved, including their various relations to the web of entities behind such an amazing deal. This process would take a long time to complete, and if Sam tried to hurry it up by pressuring her to decide by Thursday at 2pm, then her decision would probably be, “no.” Because Beverly is not irresponsible with her hard-earned money. She recognizes that high complexity makes both fraud and incompetence harder to detect, and without an overwhelming amount of information to convince her otherwise, she’ll assume that Sam’s new magic money is too good to be true.
But Beverly isn’t perfect. Sometimes failure will happen as a result of externalities (war, macroeconomic conditions, an unexpected competitor, etc.). Other times, Sam will turn out to be incompetent in a way that her DD process couldn’t detect. And even more rarely, sometimes Sam will prove to be an effective lying fraudster intentionally evading careful DD so as to hoodwink Beverly into participating in his tropical digital Ponzi scheme. In either case, Beverly will lose, and if her loss represents a significant chunk of her wealth, it may devastate her.
It’s at this point that the story typically ends with pundits, politicians, and podcasters impotently lamenting that “someone needs to prevent this from happening” to Beverly–or future Beverlys–ever again. And by “someone,” they mean no person in particular, but the vaguely parental apparatus of an imagined benevolent bureaucracy: a plodding, semi-inept but well-meaning government regulator, surely better than nothing at all. His mission will be to detect incompetence or fraud before it happens, thus rescuing Beverly from the consequences of her failed DD process and applied risk tolerance. But instead of abandoning the story at this point, what happens if the time horizon for measuring outcomes is expanded–not just by a few years, but significantly? What happens if the goal isn’t avoiding short-term pain, but enabling the long-term preservation of a culture capable of sustaining individual rights and political freedom? What if the goal of Americans was to cultivate the American spirit?
The “Wild West”
Imagine that, aside from perhaps prosecuting Sam after the fact for outright theft or fraud, the government takes no prophylactic action whatsoever. Instead of increasing Washington’s reach and scope, politicians do absolutely nothing. No new regulations, no expansion of powers, no additional funding. Zip. Nada. Zilch. They don’t even show up to vote.
Beverly may be poorer after her bad investment, but she’s not a moron. (If she is a moron, there’s little anyone can do to keep her money from eventually quitting and looking for new management.) She’s taken to heart the advice so eloquently delivered by former President George W. Bush: “Fool me once, shame on…shame on you. Fool me–you can’t get fooled again.” Next time Sam or his ilk come knocking, Beverly’s DD process will be much more stringent. Not only is Beverly more risk averse now, so are people who witnessed but didn’t directly participate in her calamity. They will retain (and hopefully grow) more of their wealth as a result. By contrast, people who ignore reality and don’t effectively refine their DD process will perpetually crash into similar hazards, resulting in more and more loss over time. Wealth will slowly accumulate into more responsible hands.
In this unfettered environment, incompetent sellers get weeded out with increasing effectiveness as DD processes evolve. Particularly arduous or complex DD processes may get outsourced, but in a free market such service providers exist under constant pressure to accurately measure risk, thanks to both competition and the possibility that Beverly may always perform DD on her own. In the end, it doesn’t matter who actually performs the DD, so long as Beverly views it as her responsibility. With respect to fraud, this evolving DD process requires increasing effort from dishonest actors in order to evade detection. If the work required for Sam to bamboozle Beverly becomes too risky or outweighs his expected return, he won’t do it. If Sam does continue his attempts to dupe her increasingly effective DD, then his Ponzi scheme must become commensurately more complex, often leading to greater fragility. He’ll also have an incentive to corrupt outsourced DD providers, and although he may at times succeed at bribing individuals, the competitive market environment drastically reduces the likelihood that a DD firm would participate in knavery at an institutional level, since any exposure would be catastrophic. Further, to avoid discovery Sam must corrupt multiple firms, forcing him to divide scarce resources.
Culturally, the long-term result is much more important and profound: a gradual shift in behavioral and attitudinal norms. Just as whether haggling over the price of a shirt is either unremarkable or uncouth depending upon whether shopping in Shanghai or Cincinnati, so, too, are assumed levels of personal responsibility part of a cultural norm. An environment in which people suffer the consequences of their own poor judgment or lax standards leads to increased risk aversion, less speculation, greater acceptance of responsibility, and a deeper sense of individual sovereignty. It’s a move towards rugged individualism and personal independence. It’s a move toward individual competence and confidence. And since these attributes are necessary components of self-governance, it’s a move toward liberty. It’s the reason good parents don’t complete homework when children procrastinate, bribe gymnastics judges, or micromanage the chaotic, error-prone lives of their teenagers: In order to grow into capable adults, children must suffer the consequences of their own behavior as much as is reasonably possible. Likewise, risk analysis and due diligence are (partially) learned responses to failure.
Government to the rescue
Instead of allowing the long-term fallout from Sam’s treachery to fertilize the societal seeds of political autonomy, what if Beverly, embarrassed and hurt, starts a letter writing campaign to convince her Senator, and then other Senators, and then the rest of Congress, to “do something” to prevent the Sams of the world from harming anyone else? And what if, because everyone feels bad for her and thinks Sam is a jerk, Beverly succeeds? The immediate impact is either the creation of a new bureaucratic arm of the executive branch, or the expansion of an existing one. Both require funding, which theoretically might mean a reduction in government spending elsewhere. But since there is no evidence that anyone in D.C. is capable of speaking the words “reduction in government spending,” it’s more likely that money is printed, borrowed, or harvested in the form of taxes or other fees. And since not all buyers are Beverly, any of these options amounts to a transfer of wealth from people who behave responsibly to an organization that only benefits people who don’t. It’s a form of subsidizing failure, and Americans will get what they pay for.
These new regulators are determined to root out the next Sam before he wreaks havoc, so they consult–and possibly even hire–Sam’s colleagues. They write complex, intricate rules designed to ensnare anyone who tries to replicate Sam’s chicanery. Because they ultimately answer to politicians, updates to rules will necessarily be torpid and infrequent, but at least there will be rules backed by the power of the armed enforcers. Beverly will be safe(r). New rules often increase the cost of overhead for legitimate actors in Sam’s industry, but large corporations appreciate this because to them these costs barely constitute a speed bump, while for smaller upstarts–who may pose a threat to the comfy status quo–the costs pose a real barrier to entry. It’s worth a few dollars to leverage the power of the state to solidify one’s market position.
General ineptitude, as well as the more bungling copycat scammers, will be dutifully weeded out. Vainglorious lawmakers will parade these successes before the public, bragging about how much they’ve helped Beverly avoid shooting herself in the foot. Fellow Americans will assume the problem is now (mostly) solved. Instead of increased introspection followed by the resolve to improve due diligence, buyers will begin surrendering the burden of responsibility to regulators. The virtuous cycle of evolving DD that was sparked by failure won’t fully materialize. This means that when future Sams come along, future Beverlys will be more complacent; both DD standards and risk tolerance will be relaxed. Instead of growing and stepping into self-responsibility, Beverly shrinks into dependence; Mom has promised to do her homework for her, and as a result she’ll never learn algebra.
Thanks to the distorted environment of government intervention, pressures on con artists diverge as well. Without rapidly evolving DD processes to combat, Sam’s next swindle simply needs to thwart Beverly’s increasingly perfunctory audits and keep pace with the draggy crawl of regulatory revision. Even better (for Sam), if part of his strategy is to corrupt the DD process, he can now focus more of his efforts on a single regulatory body rather than spreading himself thin with courting a covey of competing DD firms. In fact, if he plays his cards right, he’ll be able to participate in the process of writing regulations, either directly or via recommendations.
In the free market, if a DD service provider fails to detect major fraud or is exposed as corrupt, it gets punished via loss of business and reputation; dollars are siphoned away from bad DD firms and into good ones. But government regulators enjoy a perverse reward. If a government employee gets caught, he might be punished (although he might not even lose his job), but the regulatory body as a whole doesn’t suffer. The same is true if regulators simply miss evidence or let rules fall stale. Instead of resigning in disgrace and handing business to a competitor, leaders of regulatory agencies exploit failures of any kind as opportunities to request larger budgets by blaming errors on a lack of resources. Politicians are eager to demonstrate–to a public that now feels entitled to protection rather than responsible for itself–that they’re “doing something” by heaping more money and power on the very regulatory body that struck out in the first place.
Lather, rinse, repeat.
Once Beverly surrenders self-ownership, which happens the moment she abnegates responsibility, her psychological die is cast. Every new encounter with Sam is colored by the false reassurance that a bureaucrat has her back, and not just in the sense that Sam’s apparent regulatory compliance earns him an “official” stamp of approval. Even if Sam still defrauds her, Beverly has a tidy place to dump blame and shirk personal agency; after all, it’s the regulator’s job to protect her, isn’t it? She simply levels-up her self-identified victimhood and starts another letter-writing campaign demanding funding, reform, and expansion of power.
Any suggestion that this cycle be halted or reversed is met with derision and incredulity, chiefly because such a move would require renouncing her victimhood (at least partially) and re-absorbing culpability for bad decisions long since–and blissfully–forgotten. A precedent has been set, and a regulatory norm established. Forevermore, the solution to botched outcomes is set indelibly in stone: double down. This is called, “being reasonable,” and Beverly and her peers learn and adapt to it. Instead of evolving toward increased personal accountability and risk aversion, she and her descendants grow steadily less responsible and more risk tolerant. Instead of a shift in culture toward individual sovereignty and self-reliance, offloading risk to a single third party driven by upside down incentives results in learned helplessness and deeper dependence. Instead of liberty, America gets livestock.
If the goal of Americans is to implement the globalist agenda of World Economic Forum plutocrats; if the goal is to create a class of elites and administrators that manage both economies and lives; if the goal is to sacrifice individuals in the name of the collective but for the ambitions of a political nobility; if the goal is to become well-managed, docile, obedient, productive animals on a tax farm, then the Democrats, the Republicans, the crypto CEOs, and the media pundits are all correct: Intensifying regulation is an eminently reasonable path “forward.” But if the goal of Americans is autonomy; if the goal is to evolve into a populace of self-sovereign individuals; if the goal is to abolish tax farmers and tear down the pen and kick-open the barn door; if the goal is neither to cage others nor to be caged by others; if the goal truly is liberty–the liberty envisioned by America’s founders–then the continued imbibing of toxic government regulation is nothing less than the listless, creeping, inebriate suicide of a hopeless sot.
I’d rather taste freedom.