The SEC’s Former Head of Internet Enforcement Fears How the Crypto Story Ends

We talked to one of the most credentialed critics of cryptocurrencies and NFTs about fraud and potential "cataclysmic events" in the industry.
The SEC’s Former Head of Internet Enforcement Fears How the Crypto Story Ends
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John Reed Stark spent nearly two decades at the SEC rooting out online fraud, including 11 years as the founding chief of the agency’s Office of Internet Enforcement. But he’s never seen anything that has concerned him quite like the world of cryptocurrency and NFTs.

“There have been awful frauds from unregulated people and regulated people,” Stark said. “But nothing comes close to the level of fraud in all these Web3 applications.”


Over the last decade, Stark has become one of the most credentialed critics of the burgeoning industry. After studying the industry at length, he has come to believe that it will end in a “financial cataclysmic event” that will hurt the most vulnerable of investors. Stark isn’t an all-out cynic. In the lead-up to the dot-com bubble, it was clear to him that the internet would lead to incredible innovation, he said. But with the world of cryptocurrency, he sees little more than a series of frauds and “get-rich-quick schemes” of remarkable size. 

President Joe Biden signed an executive order Wednesday to develop a plan to regulate the cryptocurrency industry while still allowing for innovation. The news was cheered among many in the crypto world, who saw it as further proof that the industry would be accepted by mainstream institutions and no longer struggle with legal ambiguity. Stark, for his part, had a different perspective. “They always call for clarity,” Stark said. “Be careful what you wish for.”

Motherboard spoke to Stark about his concerns, as well as the difference between buying NFTs and trading cards on eBay, the “cult-like” hatred he receives, the growing partisanship around the issue, and the “regulatory capture” he sees taking over the legal industry.


The below conversation was edited for clarity.

Motherboard: You recently said never in history has so much fraud been so widespread. When was the moment you realized, in your view, something was amiss with NFTs?
John Reed Stark:
The very first time I looked at it, I thought, This is a pet rock. Aside from the market being rigged, and there being no regulatory oversight, it seemed like a silly Beanie Baby thing that made no sense. But initially, I don't think I really had too strong of an opinion. If somebody wants to invest in something really stupid, I don't have a lot of sympathy for him. 

But because I’m a cybersecurity lawyer, usually what I look at is, what could happen? How could this be hacked? It became clear to me that the potential for money laundering was significant. I started to investigate the idea with NBA Top Shot because I’m a big NBA fan and my son is a big card collector. All of a sudden, I thought, This is a market that could really hurt people. It's not just people losing money because they invested in something utterly absurd. But more importantly, this kind of thing could be used by criminal organizations. And it seemed to me that it was being used by criminal organizations to launder money.

If you're trying to explain to someone the issues you see with NFTs, what distinguishes them from just trading physical cards online?
The better question is what's the difference between buying cards on eBay versus buying NFTs. There's a lot of oversight through an entity like eBay. If you use your credit card and you pay through PayPal, that gives you double protection right there, not to mention the eBay authentication guarantee. And if you get cheated on eBay, there's a lot of different avenues of redress. I'm an avid eBay user. Having used eBay for many years and having probably 5,000 transactions on it, I think there's a certain degree of confidence. 


Now, suppose you had a really interesting Omega timepiece up for auction at Sotheby’s. You could probably go into eBay, buy all of those Omegas up at absurd prices, and maybe drum up enough interest so that your physical auction price goes higher—and there have been accusations in the watch industry about that kind of thing. But that takes a lot of work and ingenuity and risk. That's a lot different than what could go on in these NFT marketplaces. The opportunities for fraud are so much more significant when you're dealing with a digital asset. With NFTs, there's no compliance, there's no oversight, and it's global. 

You left the SEC in 2009, the year Bitcoin was created. When did crypto more generally start to come onto your radar?  
I go to all these SEC enforcement conferences, and I remember there was a panel on Bitcoin, crypto, and the decentralized ledger technology. There were like three people at it, and the person talking about Bitcoin was just kind of laughable. So it wasn't something that really got the attention of most securities lawyers. 

In 2016 or so, when Initial Coin Offerings became popular, that's when I became engaged. I wrote in 2017 that every ICO I ever saw was like a driver's ed film of securities violations. It's so stupid on its face. ICO. IPO. They're obviously trying to tap into an investor's notion that they're getting something that's gonna blow up—in a good way. It's so maddeningly transparent. They were going on everywhere, and the SEC wasn't doing anything about it. But I predicted that they would, because they were all unlawful. 


Then they started doing their sort of notification of the marketplace. The SEC wrote the big DAO 21(a) report and put out an investor alert. Then came the SAFTs and Telegram, and those were said to be securities. Then there was Kik, another iteration, and those are said to be securities. Then there was BlockFi, with these lending programs, another iteration that were said to be securities. The BlockFi case is really extraordinary.

What did you see with that case?
The BlockFi product was such that you give them your Bitcoin and they pay you a specific rate of return. There's a million differences between this security and a security of the ilk that's typically offered to people, like a certificate of deposit or something. It's not a regulated entity. It's not federally insured. I wrote that BlockFi was going to get sued, and people said I was crazy. But it was so obvious. So they get enjoined from selling their products in five different states. Now, since when in the history of the SEC has a particular securities product been lawful in one state and unlawful in another? How about never? These aren’t helmet laws. This isn't like cannabis laws. Securities laws are not like that.  


But then, Coinbase comes out and says, “We're going to offer the same kind of product.” They get a mailing list together, they're marketing the heck out of it, and the SEC starts investigating and says, “Look, guys, we're gonna sue you because you're offering a security.” Then the SEC does something that they do all the time, which is they issue a Wells notice to Coinbase. With a Wells notice, you literally write a letter, write a brief, make a video, do whatever you want to tell me why we shouldn't sue.  

Now, any SEC enforcement defense lawyer will tell you that when the SEC issues their Wells notice, it's very rare that you're going to convince them to turn around. They've done a lot of work before that happens. They've talked to litigators. They've talked to the general counsel's office. They might have even talked to the commissioners. So what does Coinbase do? Coinbase’s CEO and general counsel take to social media and say, “The SEC is stupid. They're anti-technology, anti-innovation. They're antiquated in their approach toward new ways of doing business.” All this bravado. Really antagonizing in an unprecedented manner. No one in the history of SEC Wells submissions, even the most outrageous fraud artists, has acted like that. Even those fraud artists listened to their lawyers and they're quiet during this time because there's a lot at stake. All this stuff is unprecedented. I've been doing this for 30 years, and I’ve never seen anything like it.


I can appreciate that something might not be a security and might philosophically seem akin to investing but isn’t, like a multi-level marketing scheme or gambling. But I’ve been teaching law for 20 years. It was clearly a security, under whatever test you wanted. Of course, Coinbase suddenly out of nowhere just said, “We're not doing this.” And they shut everything down. 

The Biden administration just put out an executive order saying we’re going to allow for innovation but we also want sensible regulation. The crypto markets responded like this was good news. What did you think about that?  
I thought to myself, OK, I know the industry is going to respond very positively to this. Because that's how lawyers in this space talk: “We just want to do this right. And this is obviously the government’s endorsement of the many possibilities of blockchain and the endless benefits that cryptocurrency can bring to the planet.” There's lots of room for the industry to make those proclamations. But of course, this is what the government should say. The government should always be trying to foster technological innovation. 

These boasts by the industry that the government is accepting crypto… Be careful what you wish for. They always call for clarity. But when they get clarity, they don't like it so much. These government agencies will look very hard at these questions and come up with the same answers that the people who wrote the infrastructure act came up with—that without transparency and integrity, these marketplaces are dangerous. And in order for there to be transparency and integrity, you've got to have regulation. And regulation isn't fun. It's costly, it's cumbersome, and it can be the death knell for companies.


You've written that the law prohibits anonymity in financial transactions as well. Is there a version of sort of the crypto world or NFTs that you could get behind?  
No, I don’t. When I was chief of the Office of Internet Enforcement, I could see how wonderful the internet was and how many amazing things were gonna happen. We just needed to clear up the crime so it could flourish. You can't see that with blockchain. 

Blockchain is supposed to be some kind of incredible technology that’s gonna transform the world. Blockchain is a glorified spreadsheet. If you think this is going to make the supply chain problems disappear, have at it. But don't use it as a currency. As a means of currency, I don't see a single societal benefit. I don't see a single way that somehow this will work. 

The notion of these entities actually registering is a pipe dream. If you look at the letter that the SEC wrote denying SkyBridge’s application to create a Bitcoin ETF, they give all these reasons. It's like a laundry list of reasons. Some of the reasons are the fact that the cryptocurrency marketplace is so rife with fraud and so lacking in oversight that there's no way to know whether insiders are manipulating the pricing or the pricing is real. CNBC putting a little thing in the corner saying “This is the Bitcoin price” doesn't mean anything. That could be a completely manipulated price. And no one would know the difference. They're not reporting it. The transactions are not being traced by FINRA (Financial Industry Regulatory Authority).


This libertarian notion of decentralization and not wanting the government knowing what I do with my money—it's a policy argument. It's not a defense of your securities offering to say I don’t think these shouldn't be regulated. These laws apply. You can vote to repeal them if you want, but that’s your policy argument.

So the answer to your question is: in terms of currency, no. In terms of the underlying technology to verify transactions, this glorified spreadsheet that they all love to talk about, fine. Go ahead and chase that. Maybe the investment bankers want to take you there. Go ahead and chase that too. But as a currency, it's not just not a good thing. It's a bad thing.

Can you understand why crypto has become so successful?  
People can be vulnerable to get-rich-quick schemes. They always have been. And in the end, how can you sum Web3, NFT, DeFi, and crypto? It's one big giant get-rich-quick scheme. That's why it appeals to people. Some of them might say we're going to use this half of the proceeds to cure cancer or to make neighborhoods better. But the bottom line is, people are investing because they think there'll be some greater fool to pay more than they paid.

Going off of that, a lot of crypto enthusiasts ask how this is any different than the stock market. There have been winners and losers in the stock market forever.
Yeah, there have been frauds in the stock market. There have been awful frauds from unregulated people and regulated people. But nothing comes close to the level of fraud in all these Web3 applications. In my mind, transacting in Bitcoin and other crypto, you might as well be transacting in blood diamonds.  


Sometimes you'll hear this argument: “Well, if the U.S. continues to crack down here, all the money's gonna go offshore.” Know what I say to that? Blah, blah, blah, blah, blah. I’ve heard that forever. Money's not going offshore. Everybody wants to invest in the United States. The markets are the tightest, most efficient, most transparent, most successful on the planet. Everybody looks here for capital. Let the fraud artists go peddle their schemes in some other country, but it’s not going to hurt the U.S. marketplace.

Considering that, have you been surprised by the sort of entrance of mainstream financial institutions, VCs, and lawyers into this space?  
No, because there's huge opportunity. Like someone with my credentials, I get offers all the time to go work with these companies because they just want the window dressing. There's incredible regulatory capture going on with a lot of these companies. You see a lot of regulators going to them. And it's only because of one reason: financial opportunity. The potential to make $20 million in a year—who doesn't want to think about something like that? 

For the VC players and the investment bankers and the private equity firms, it’s painfully obvious. I don't want to vilify private equity or venture capital firms. But when you've got this kind of hype, they're gonna enter like crazy because all they need to do is find an investment that they can say is the next big thing so that some other investment house can buy it from them because of the promise. It’s like that scene in Silicon Valley where they say, “You don't want to have revenue, because once you have revenue, then the predictions about how much revenue you can actually make are going to be too small. But if you don't have any revenue, then you can predict all kinds of incredible things.”


One of the things that's been notable about these companies in recent months is the amount that seems to be going into marketing. They were dominant during the Super Bowl and we saw Matt Damon pushing Considering your experience, what role does that sort of high level of marketing play?
It's awful and really unsettling. And I find it so insulting. When you watch Paris Hilton talking to Jimmy Fallon—I mean, who doesn't like Jimmy Fallon? But all of a sudden, I just have no respect for Jimmy Fallon. To watch Paris Hilton, and he puts up his picture of his ape with a funny hat and glasses, and she's like, “Oh, wow, I really like what you’ve done with the hat and glasses.” It’s nauseating. I just feel like, have you no shame? It's all in plain view. You know, Wolf of Wall Street. What's his name? 

Jordan Belfort.
Jordan Belfort is offering seminars on how to buy NFTs and crypto. You couldn't make that up.

Have you been told you just don't get it? That you don't understand that underlying technology?
If you dare to question crypto, the first thing you're told is you don't get it. You need to do your research. What do you think I've been doing for 30 years? I've been working in technology and law. I've written maybe 150 to 200 articles in the space and taught at Georgetown Law and Duke Law for 20 years. How dare you say I need to do the research? That’s all I do! If you look at all the cases I brought at the SEC, I have all sorts of examples of legal scholarship and experience. So I have done all the research. But I get that all the time, even from friends. 


From friends?
Yeah, I'll write an article about crypto and you'll see legitimate lawyers saying the most absurd things. I mean, how can you with a straight face advise somebody to invest in NFTs?

And why do you think all of these smart lawyers have landed on the other side of you?
Because they have clients in the space who are willing to pay their bills. 

You spent a lot of time focusing on penny stocks earlier in your career. How does this compare to the fraud you saw at that point?
There are remarkable similarities in the shysters, the personalities, and the pitches. The scope and breadth is so much more. This disintermediation, you don't need the phone anymore. You just need to click. You don't need the printing press anymore. You don't need a lot of the typical tools that you used to need. And you can do it from anywhere in the world that has an internet connection. So I see extraordinary similarities in the types of people because the pitches are always the same of every get-rich-quick stream. “Don't worry if you don't understand it. The people who understand say it's amazing.” It's just fear of missing out. 

The thing that's different and that I find really disturbing is the amount of hate that I receive for taking the position that I do. Just incredible hate and vitriol and anger and threats and nastiness. 

At times, it seems almost like an ideology. 
It’s cult-like, but it’s not just cult-like, because it's their financial future, their kids’ future, their family's future, their house. Everything rides on this. So I kind of get it. 

Do you see the SEC as having any potential struggles dealing with this? Considering the agency sometimes suffers from budgetary issues, and they're facing this giant industry, do you see it as an uphill battle?
Yes and no. No, I don't, in that I think the cases are like shooting fish in a barrel. The SEC is, like, 96-0 in these cases. I do know some of the people who are working on these cases, and they're extraordinarily capable.  

The challenges are the commissioners themselves, because I think it's becoming a bit of a partisan issue. Right now, you can see Donald Trump, Elizabeth Warren, and Hillary Clinton all saying the exact same thing about Bitcoin. If you go back to Chairman Clayton under Trump, he brought all those ICO cases. Telegram and Kik and Ripple, they were all done under his watch, and that was a Republican appointee. 

So I always felt this was a nonpartisan issue. But it's unfortunately becoming a partisan one that has caused some issues with the commissioners themselves. I saw Ted Cruz talking about it. He just said, “Liberals don't like Bitcoin because they want the government to know what you're doing.” I just thought that that was so misleading, and I don't like to get partisan at all when I talk about this stuff. It makes me think that if there were a change in administration, all of this enforcement would come to a screeching halt. 

You've described this as a house of cards. What do you expect the fallout for this to be when all is said and done?
I think it'll be like any other financial cataclysmic event where a lot of mainstream investors—meaning investors who don't don't have as much saved up—are going to be the worst hit. Because if the wealthy get hit, they'll sort of be able to continue living. 

I hear some of these shysters saying, “Wow, this is a great thing because it allows the disenfranchised and the poor and the people who can't get credit to participate in the financial marketplace for the first time because it's so democratic.” That couldn't be further from the truth. They’re manipulating people. The people left holding the bag will be the least able to afford that kind of loss. And that's what really is the most disheartening of all of it.