The six warning signs as crypto is welcomed into the US mainstream

The crypto markets were already surging ahead. The price of a bitcoin, by far the most popular crypto asset, has risen to about $110,000 (£83,000), nearly seven times where it stood at its low point at the end of 2022. Then there are the stablecoins, digital tokens that are supposed to be protected against wild fluctuations in their purchasing power because they are backed by conventional assets such as treasury bills. Tether, the market leader, said it was holding $127bn in US treasuries at the end of June as backing for the stablecoins it had sold. This makes it one of the world’s largest investors in US government debt.

Overall, the value of the global crypto market has risen to more than $4tn, a rise of roughly three-fifths since the start of Donald Trump’s second term.

But for anyone with an interest in financial history, parts of this story sound familiar. Red lights have been flashing in the crypto market for some time, and they are not getting any dimmer.

Here are six warning signals.

Dodgy financial institutions have a natural tendency to set up shop in places where regulators take a relaxed view of life. The Panama papers, leaked in 2016, showed how hundreds of thousands of wealthy individuals, corporations and criminals were using offshore havens to conceal assets, avoid taxes and launder money. The crypto industry is much attracted to such spots. Before it went bust, the crypto exchange FTX was based in the Bahamas, a place that has welcomed financial adventurers since the pirate Blackbeard cast his anchor there in 1716. FTX’s former boss, Sam Bankman-Fried, is serving 25 years on various fraud charges.

Tether, which has been described as the quasi-central bank of crypto, moved its headquarters earlier this year from the British Virgin Islands to El Salvador.

With Trump rolling out the red carpet, it is possible crypto companies will start to relocate to the US. The White House has instructed regulators to “embrace the opportunity of digital assets”, and appointments are being made with that in mind, starting with Paul Atkins, the new crypto-supporting chair of the US Securities and Exchange Commission. But if you are an investor rather than an operator, friendly regulators have obvious drawbacks.

In the early 18th century, the South Sea Company was determined to become a central part of Britain’s financial establishment. The Prince of Wales was appointed to the post of governor of the company in 1715, followed a few years later by the king himself, who enjoyed a significant shareholding in the company.

After the South Sea bubble burst in September 1720, it emerged that in the previous few years the company had laid out about £1m – an astonishing sum in those days – in the form of bribes to politicians, the king’s mistress and other people of influence.

Another way to do the job: employ members of parliament and peers as your company directors. Nearly 30 MPs were on the boards of South American mining companies during the speculative boom of the 1820s. The writer Harriet Martineau deplored “the decline of the character of the House of Commons” where too many had “sacrificed their legislative conscience to the interests of themselves and their friends”.

Nothing like that could happen today, of course. But the crypto industry is estimated to have accounted for almost half of all corporate spending in last year’s US election. It also put at least $10m into Trump’s inauguration fund.

So the US administration is now full of crypto enthusiasts. Just one example – Howard Lutnick, the secretary of commerce, was the former boss of Cantor Fitzgerald, a significant shareholder in Tether, and his two sons are running the business today.

Meanwhile, the United States’s very own Prince of Wales, Donald Trump Jr, is busy building the family’s crypto empire with a dizzying array of transactions in the past few months. The New Yorker magazine estimated in August that the president’s family had already profited to the tune of $2.4bn in various crypto businesses by trading on his re-election to the presidency.

Buying the right crypto assets is a way to the president’s heart. Changpeng Zhao, the boss of the world’s largest crypto exchange, Binance, served four months in prison last year for money-laundering violations and is hoping for a pardon from the US president. As luck would have it, an Abu Dhabi company has chosen a stablecoin backed by the Trump family for its $2bn investment in Binance.

And the president has room for manoeuvre. The Genius Aact, setting out regulations for trading in stablecoins, was approved in July. Among other things, it included conflict-of-interest provision barring members of Congress and federal employees from entering the stablecoin business. There was one exemption: the president himself.

Transparency is a quality that really matters in the financial business – but it’s not a great feature of the crypto world.

Louis D Brandeis, a former US supreme court justice, made the point back in 1913. Building his case against the secretive ways of the big Wall Street money trusts, he famously argued: “Sunlight is said to be the best of disinfectants; electric light the most efficient policeman.”

When they are not there, bad things can happen. Bernie Madoff was an investment manager who swindled thousands of clients out of billions of dollars and who operated through opaque disclosures signed off by an obscure accounting firm. He also made sure that no outsiders looked at the books. In 2009, he was sentenced to 150 years in prison, where he died 12 years later.

Largely unregulated and with thousands of new entrants in the market, the crypto industry is not much bothered with transparency. In particular, potential conflicts of interest are everywhere.

For example, Bankman-Fried ran a hedge fund that was one of the biggest traders on his crypto exchange. In the words of journalist Zeke Faux: “Imagine if the top executives of an online poker site also entered in big stakes tournaments – the temptation to cheat by peeking at other players’ cards would be huge.”

It certainly proved too much for Bankman-Fried. After the crash, it emerged that billions of dollars had been diverted from the exchange’s customer deposits to help bail out the hedge fund.

That was an extreme example, but there are obvious risks elsewhere. The Trump family is now in almost every corner of the business – bitcoin, stablecoins, and tokens, with no obvious guardrails to protect against potential conflicts of interest. In one recent transaction, World Liberty Financial (WLF), a Trump-backed business, acquired shares in a publicly listed company that in turn was going to buy $1.5bn of WLF’s crypto tokens. The president is listed as “co-founder emeritus” of WLF as is his Middle East envoy, Steve Witkoff, while other co-founders include Trump’s three sons and two of Witkoff’s sons. If that all looks very cosy, that’s because it is.

When it comes to disclosure, Tether has been in existence for more than 10 years and has become a large financial institution. Yet it has never published a fully audited set of accounts. Instead, it produces what it calls an “attestation”, signed by accountancy group BDO. Close examination of the footnotes reveals that the statement amounts to not very much at all.

Critics have been grumbling about this for years, but nobody seems to care. In August, Tether hired the former director of the White House crypto council as a strategic adviser.

Crypto enthusiasts are thrilled by the idea of innovation. This is how the White House policy paper starts: “The American story is one of innovation. From the railroads that linked sea to shining sea, to the internet that connected the entire world, American entrepreneurs have led the buildout of next generation technologies in every generation since our founding. Crypto should be no different.”

History shows that innovation in finance is by no means an unmixed blessing. In the spring of 1637, a Dutch merchant called François Koster paid 6,650 guilders for a small collection of tulip bulbs. This was at a time when a family might live for a year on about 300 guilders. Tulips had become a sophisticated market, based on promissory notes rather than boxes of brown bulbs. Koster had only to make a down payment of roughly an eighth of the purchase price, and intended to sell the notes for a profit before the rest of the money was due. Sadly for him, the tulip mania came to a sudden end a few weeks later, and he was ruined. John Law was one of history’s great financial innovators (he was also a brilliant gambler, and a swordsman, who escaped from Newgate prison after killing an adversary in a duel). His book, Money and Trade Considered, published in 1705, was generations ahead of its time.

Starting in 1716, Law’s plan to take over the national debt of France was as beautiful as it was daring, and it might have worked too if trading in his Mississippi Company had not got a little out of hand on the Paris stock exchange. When it all blew up in 1720, Law escaped from France with his life, leaving a wrecked economy behind him.

More recently, financial innovation undoubtedly played a part in the banking crash of 2008-9. Credit default swaps and a host of other complex products seemed to make financial risks disappear – until they didn’t.

The question that was asked then about financial innovation could be put to the crypto industry today: what is its social use? Would anyone outside the world of finance be worse off if it did exist? As Paul Volcker, the former chair of the Federal Reserve, growled in 2009: “The most important financial innovation I have seen in the last 20 years is the ATM.”

A fifth red light can be summed up by two words uttered in 1996 by Alan Greenspan, then chair of the Fed, as the dotcom bubble was beginning to inflate: “irrational exuberance”. This has been a feature of all financial manias in the past, and it is certainly becoming visible in the crypto sector today.

For example, over the past year roughly 150 US companies from a variety of sectors have raised money through debt and equity issuesto buy bitcoin and similar assets: they call themselves bitcoin treasury companies. The idea is to fire up their share price by offering investors an easy way into crypto with the extra boost of financial engineering – and so far it seems to be working. The model is a company called Strategy, which was recently valued at more than $100bn. Remarkably enough, that is a lot more than the value of the bitcoin it actually owns.

The fun fact is that this looks very like the notorious investment trust business launched by Goldman Sachs just as the Wall Street equity market was reaching rocket speed in 1928. Boosted by Goldman Sach’s own purchases and with some nifty deal-making, the shares reached $222 by February 1929, at which point the business was valued at roughly twice its net assets. Eight months later came the great crash, and a few years later you could pick them up for 50 cents. It took Goldman Sachs decades to recover its reputation.

Paul Krugman, the Nobel prize-winning economist, likens stablecoin issuers to banks back in the days before the US civil war, when gold and silver were the only official forms of money and there was no central bank in Washington. Back then, banks issued paper currency which they promised to redeem for gold and silver, in just the way that stablecoin companies today issue tokens they promise to redeem for dollars. Some of these banks served a useful purpose, others were intent only on fraud.

As is the case with stablecoins, these supposed antebellum banks were largely unregulated, and there were no safety nets for customers when they failed. So the system repeatedly experienced panics with people rushing to get their money out if they possibly could.

But there is a crucial difference. Unlike antebellum bank notes, Krugman says, stablecoins do not serve any useful purpose. They cannot be used to make ordinary purchases, and there is nothing you can do with them that cannot be done more easily and with more security than with a MasterCard or Visa. If things go wrong, there are no government guarantees to back the customer.

So why buys them?

Krugman’s answer is blunt. “The only economic reason for stablecoins is to facilitate criminal activity.” That is too harsh a view. Stablecoins can be useful for merchants operating in countries with broken-down banking systems who could not otherwise move their money across borders. And if you want to speculate in crypto, stablecoins are a handy way into the marketplace.

The White House claims that only a tiny fraction of digital asset activity is to do with crime. Against that, the United Nations Office on Drugs and Crime said last year that “powerful criminal networks have developed a range of sophisticated mechanisms, structures and techniques to launder stolen funds, particularly using stablecoins”. Tether was the “preferred choice” for Asian crime syndicates servicing a wide range of criminals in and beyond the region.

With all these warning lights from history, will the crypto story end in tears? The answer is – probably not. Nearly 400 years after tulip mania, there is a steady if dull tulip trade in Amsterdam. The same may well be true for crypto over the long term. And with the huge push coming from the Trump administration, today’s party may well go on for some while to come. But this seems a good moment to recall the words of the journalist Walter Bagehot, written in 1873: “The good times too, of high price, almost always engender much fraud. All people are most credulous when they are most happy; and when much money has just been made, when some people are really making it, when most people think they are making it, there is a huge opportunity for ingenious mendacity. Almost everything will be believed for a little while, and long before discovery, the worst and most adroit deceivers are geographically or legally beyond the reach of punishment.”

Nothing much changes in the world of finance.

Sir Richard Lambert was editor of the Financial Times and chair of the British Museum. He is chair of The Observer’s editorial board

The Trump family generated as much as $5bn in paper wealth on Monday after putting digital tokens from their crypto venture, World Liberty Financial, up for sale. Donald Trump said last year that the company would help “make America the crypto capital of the world”. The US president’s digital tokens are thought to be worth more than his property holdings.

On Wednesday, American Bitcoin, a crypto company linked to Donald Trump Jr and Eric Trump, debuted on the Nasdaq. Shares more than doubled, valuing the brothers’ stake at $1.5bn.

Last month, Trump Media & Technology Group, the company behind the social media app Truth Social, announced a deal with Crypto.com to set up a new public company that would buy and hold $6.4bn of the exchange’s in-house digital coin.

Three days before Donald Trump was elected for a second term, he announced his own meme coin, $TRUMP, which is hosted on the Solana blockchain. Within three weeks, it had netted more than $300m in fees. The New Yorker estimates that the meme coin, alongside $MELANIA, has yielded a profit of $385m for the Trump family.

Photographs by Adam Gray/Bloomberg. Other photographs by Shawn Thew-Pool/Getty