Reviews | FTX’s Collapse Demands a Balance Sheet in the Crypto Industry



The supposedly responsible face of cryptocurrency turns out to have been anything but picky about its dealings – which should be a wake-up call for sleepy regulators and lawmakers.

Sam Bankman-Fried’s empire died young last week, when his Cryptocurrency exchange FTX has filed for bankruptcy. Details remain scarce, but the gist is this: FTX was supposed to act as the custodian of the funds that customers traded through the service. Instead, he took billions of dollars of that money and lent itincluding trading company Alameda Research too belonging to Mr. Bankman-Fried. To make matters worse, Alameda’s assets were largely linked to the TTF, FTX’s own digital currency. Alameda used this FTT as collateral for a boatload of loans, possibly including customer funds it received from FTX.

When a CoinDesk Report revealed some of that, what ensued was a death spiral: Investors worried about FTX’s solvency rushed to buy back their assets, sending FTT’s value plummeting. But FTX didn’t have its assets – it had the FTT digital currency and a massive loan to Alameda that the company couldn’t repay, as it too had mostly FTT.

This could classically be called a run on the bank. The problem is, FTX wasn’t supposed to work like a bank at all. Aside from the convoluted details surrounding double-dealing and poor bookkeeping, the larger scheme looks like an old-fashioned scam. FTX customers probably thought their money was being held securely, but the exchange apparently passed it off as speculation. Now, Mr. Bankman-Fried (who blamed most of the problems over accounting errors) resigned as CEO, and he and his executives will likely face civil lawsuits and maybe criminal charges too — in the Bahamas where FTX Offshore is headquartered or in the United States, or both.

The Department of Justice, the Securities and Exchange Commission and the Commodity Futures Trading Commission are apparently everything now investigate FTX; the SEC says it had already started before the scandal broke. They should pursue these cases vigorously. What’s baffling is that the SEC and CFTC have done so little so far, even though Mr. Bankman-Fried (also a Democratic Party megadonor) courted them and everyone in Washington with proposals this would supposedly bring the crypto industry to heel.

The entire cryptocurrency industry has proven itself vulnerable to liquidity crises, or even a total collapse in solvency like the one FTX seems to have suffered. These calamities could have landed Alameda in the hole from which he will never be able to get out. Yet despite all the talk about the need for new laws to regulate cryptocurrency, there are existing rules that authorities could have — and haven’t — used.

Crypto-assets are just traditional assets, but on the blockchain, a digital ledger. The key to determining which rules to apply is to find the right analogies: What about cryptography as equivalent to a security, what is a commodity, what is an object of collection ? What is a broker, what is a bank? Crypto entities sometimes blur these lines, playing brokerage, exchange, and clearinghouse all at once without registering as one of the above – claiming that because they look like nothing regulators have seen before, they cannot be regulated without congressional action. So far, the dodge has mostly worked: SEC defenders blame agency’s slowness to act pressure from lawmakers delay enforcement until new laws are written. This cannot go on.

The responsible agencies, from the SEC and the CFTC to the Federal Trade Commission and the Consumer Financial Protection Bureau, with or without the help of Congressshould develop tips which draws clearer lines defining which of them has jurisdiction over new products and their various attributes. Next, they need to define the applicable requirements – tweaking the rules they wrote for the traditional financial system to fit the crypto realm if necessary. They should demand registration and go to court when companies refuse to come to the negotiating table.

Some things are already clear. FTX, for example, should never have been allowed to hand over its customers’ money to a third party that also belongs to its owner. Other questions are more complicated. Should exchanges like FTX be allowed to accept their own token as collateral? Should they be allowed to make leveraged bets? What level of reserves should be required and what should these reserves consist of? Candied and combustible tokens probably shouldn’t be an acceptable answer.

Even the most sensible guidelines and the most robust enforcement won’t change the reality that crypto is inherently risky – because the value of all those tokens ultimately depends on what people think they’re worth. rather than something tangible in the real world. Regulators and legislators who craft crypto rules cannot allow consumers to believe their money is safer than it really is or lead companies to believe they are entitled to bailouts. Mr. Bankman-Fried created the illusion that the cryptocurrency market might actually be a place where ordinary people could safely and responsibly invest their assets. The truth may be that it never will. Either way, investors deserve a stricter and more transparent regime than what they got.

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