The role regulators played in the FTX fiasco

Does Crypto Need a Backstop? On Wednesday, in what in hindsight should be obvious, Binance pulled out of a tentative deal to buy rival FTX, the crypto exchange founded by Sam Bankman-Fried that lost nearly everything in a bank run. .

Changpeng Zhao, CEO of Binance said after a preliminary review of FTX’s books, the risks were too great, the holes in the exchange’s balance sheet too large and the loss of investor confidence “severe”. That left Bankman-Fried looking elsewhere for capital — a monumental request, given that other exchanges have already turned down calls for investments or mergers.

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On Twitter, Bankman-Fried said he would do whatever he could to shore up user losses before reimbursing investors, in part by “liquidating” his hedge fund Alameda Research. FTX, which is now worth around $1, according to Bloomberg’s billionaire team, had raised $1.8 billion from BlackRock, SoftBank, Tiger Global and the Ontario Teachers’ Pension Plan (Canada).

The potential contagion here is severe. Companies like Sequoia and Galaxy Digital are writing off millions of dollars, Solana (aka “SamCoin”) is flailing, and dozens of projects SBF has invested in, often using the FTT exchange token, could have a negative impact. huge cash shortages.

Read more: Who is still exposed to FTX?

As crypto learned with the collapse of hedge fund Three Arrows Capital, the industry is remarkably interconnected. In fact, new evidence suggests that Alameda’s financial troubles began after it lost half a billion dollars to Voyager Digital, which SBF later acquired, which had collapsed after Terra’s implosion.

Instead of using trustless financial protocols, they trusted megalomaniac figures with Wall Street credentials.

The whole point of crypto was to allow people to be “their own bank” through self-custody and autonomy. Instead, the industry recreated the centralized financial system – the “bankers” and all. Instead of directly interacting with blockchains and peers, people place their funds on centralized exchanges. Instead of using trustless financial protocols, they trusted megalomaniac figures with Wall Street credentials.

In the wake of the latest crypto crisis, three US regulators – the Commodity Futures Trading Commission (CFTC), the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) – have reportedly deepened their investigations into FTX, some of which have started months ago.

SEC Chairman Gary Gensler used the moment almost to rejoice, noting the “toxic combination” at play at FTX, in an interview with CNBC. He reiterated familiar lines that cryptos are securities and should be under his agency’s oversight, that the industry has been “significantly non-compliant” and that exchanges should “come in and talk to us.”

To some extent, Gensler is correct that there are already rules that would protect crypto investors. It should be noted that FTX.US, the independent wing of SBF’s trading empire, appears to be solvent. Sure, it might explode tomorrow, but something tells me SBF wouldn’t have played the same shenanigans with funds from FTX.US users as he seems to have done with the parent company – no matter how sleep deprived he was.

And yet, any account of the situation must note the role that US crypto regulation (or lack thereof) played in the FTX fiasco. Coinbase CEO Brian Armstrong argued on Twitter that the strict yet unclear regulatory landscape has pushed the likes of Terra’s Do Kwon and Bankman-Fried overseas, where oversight is lax and taxes are not paid. About 95% of crypto trading happens outside of the United States, he said.

Armstrong is protecting his own interests here now that figures like Sen. Elizabeth Warren (D-Mass.) and Gensler are calling for tighter regulation of U.S. trading. Clearer rules are clearly needed, but they must be applied correctly. Given the inherently borderless nature of crypto, if regulators got too heavy handed, they would only succeed in creating the next Singapore-based Terra or Bahamas-based FTX. “[P]uniting corporate America for this makes no sense,” Armstrong added.

What also doesn’t make sense is the SEC’s enforcement history. This year, while the industry was burning, the SEC sued Kim Kardashian for promoting Ethereum Max (a coin few will remember) and something called Hydrogen Technology Corp. Given the agency’s particularly small budget, even if these prosecutions are successful, it still appears to be a waste of resources.

See also: 8 days in November: what led to the sudden collapse of FTX

Another “victory” for the SEC, this time against the blockchain-based streaming service called LBRY, is likely a loss for all other projects seek to use tokens to reward users and fund development. According to legal experts, the judge handling the case may have set a precedent to punish any project with a stockpile of its own assets, including Beanie Baby maker TY. LBRY CEO Jeremy Kauffman is a New Hampshire homesteader who intends to fight the decision, but how many other projects will simply move elsewhere?

And so, if regulation is an insufficient safety net, and if the growing entanglement and connections between crypto firms only serve to create contagion risks rather than safeties, where does that leave the world? ‘industry ? Could crypto benefit from a central bank, buyer of last resort? Something tells me the answer is to go back to Satoshi’s original proposal.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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