For many Democrats in Congress, the collapse of the second-largest cryptocurrency trader in the world is symptomatic of a rot at the core of block chain technology. Many Republicans, if Wednesday’s hearing on the implosion of FTX before the Senate Banking Committee is any indication, are not so sure.

Senators on both sides of the aisle are preparing to tee up legislation in the next Congress that would grant regulators broad authority to regulate cryptocurrencies, and the hearing gave some lawmakers opportunity to indict the entire industry for the allegedly illegal activities taking place under the cover of blockchain technology.

“Crypto has become the preferred tool for terrorists, for ransomware gangs, for drug dealers, and for rogue states that want to launder money,” said Senator Warren, a Massachusetts Democrat who said $14 billion in digital assets was funneled to criminals through crypto trades in 2020. “Even so, the crypto industry has taken the position that nothing has changed.”

“I keep trying to have an open mind on the technology innovation. I’m all-in on technology innovation” said Senator Warner, a Virginia Democrat. But “so far, from where I sit on the Intelligence Committee, I see an awful lot of illegal activity.”

The collapse of FTX has taken center stage in the finance world since prosecutors announced charges against 30-year-old FTX founder Sam Bankman-Fried. Mr. Bankman-Fried is alleged to have moved as much as $7 billion deposited by FTX investors into his hedge fund, Alameda Research.

He faces multiple fraud, money laundering, and conspiracy charges from the Commodities Futures Trading Commission, the CFTC; the Securities and Exchange Commission, the SEC; and perhaps others.

Mr. Bankman-Fried is expected to face extradition to America after his arrest on Monday in the Bahamas, home to FTX. The company’s new chief executive, John J. Ray III,  told House lawmakers Tuesday that Mr. Bankman-Fried’s action was an “old-fashioned case” of embezzlement. 

Republicans on the Senate banking committee on Wednesday agreed that crypto regulation is required and indicated that they were as appalled as everyone else at the facts of the FTX case, but they cautioned against hobbling technological innovation because of the actions of a few bad actors.  

“We are conflating topics today,” said Senator Loomis of Wyoming. “Digital assets are not on trial. Fraud and organizations are on trial. So let’s separate digital assets from corrupt organizations.”

“It’s important that we not convict the code of anything,” said the Republican ranking member, Senator Toomey of Pennsylvania. “Some of my colleagues have suggested pausing cryptocurrencies before we can address it. This is profoundly misguided, not to mention impossible. Short of enacting draconian, authoritarian policies, cryptocurrency cannot be stopped.”

Cryptocurrency has gone mostly unregulated since it emerged in 2010. How best to classify the crypto system —  as a currency, a security, or a commodity — remains the sticking point for lawmakers.

Because crypto tokens are “mined,” crypto sounds like a commodity, though the tokens represent no actual artifact. Tokens like Bitcoin can be traded for a limited number of goods or services, similar to a currency, but most activity in the space involves speculation that the asset will increase in value, making it a security in the eyes of some lawmakers.

Regardless of its qualities, crypto contains few, if any, of the safeguards required of bank deposits or securities. 

“The things that look and behave like securities, commodities, or banking products need to be regulated and supervised by the responsible agencies who serve consumers. Crypto doesn’t get a free pass because it’s bright and shiny,” said the Banking Committee chairman, Senator Brown of Ohio, who noted that stolen crypto is used to finance North Korean ballistic missile programs and drug cartels.

Most likely, legislation on the horizon will focus on which regulatory agencies will be charged with culling illegitimate traders from the crypto space. Witnesses said that the tools used to regulate other financial transactions are already in place and can be tweaked for the industry.

Trying to ban the technology altogether, though, could — aside from being futile, as Mr. Toomey noted — come at a much greater cost — a brain drain of technologists familiar with what could turn out to be a sea change for global finance.

“By having a system in the United States that is unclear, that is regulatorily hostile, that could go so far as banning cryptocurrency in the United States, we would be losing the position of having the possibility to maintain American dominance for these technological innovations,” said the libertarian Cato Institute’s Jennifer J. Schulp. “We would also be losing many of the great minds that want to work on these types of projects.”