Over the course of less than 48 hours, the collapse of the crypto trading firm FTX has shaken the crypto industry to its core. FTX is a joint exchange/broker of crypto assets owned and operated by the young crypto “wizard” Sam Bankman-Fried, also known as SBF. By losing up to $10 billion of customer assets, FTX shows just how unregulated finance can deeply harm customers and why oversight of the industry by the SEC is of the utmost importance.
What Happened.
Last week, the trade publication CoinDesk published a leaked copy of the balance sheet of SBF’s personal trading firm, Alameda. Not only are FTX and Alameda intimately connected given their shared owner, but the leaked balance sheet showed that most of Alameda’s assets were comprised of FTT, FTX’s native token, and that Alameda had $14.6 billion of assets against $8 billion of liabilities. Following CoinDesk’s report, Changpeng “CZ” Zhao, the founder of the competitor exchange Binance, tweeted that his firm would sell all FTT it held.
This tweet started a run on FTX. As the public learned that the price of FTT would drop from Binance’s selling, depositors began withdrawing funds from FTX. These withdrawals, eventually totaling more than $6 billion in a 72-hour period, required FTX to sell its reserves for cash, driving crypto prices down further, until FTX halted withdrawals.
FTT, which peaked at around $78 in September 2021, was trading at close to $25 the day before Zhao’s tweets; by Thursday, the token was trading at around $3.80.
After several hours of silence following the decision to halt withdrawals, FTX signed a non-binding letter of intent with CZ to have Binance buy FTX for $1 and take on its liabilities. After less than a day of reviewing FTX’s financials, Binance decided not to complete the acquisition, sending Bankman-Fried looking for funding elsewhere. Alameda reportedly owes FTX about $10 billion in FTX customer funds that were lent to it.
FTX says that customers on its US trading platform, FTX.us, are unaffected by FTX’s collapse, but clearly there are US customers on FTX’s non-US platforms. Accordingly, the SEC, CFTC, and DOJ are investigating FTX’s potential legal violations. Regulators in Europe are similarly investigating.
On Thursday morning, SBF tweeted that he is “sorry,” admitting that he “f—ed up” and “should have done better.” In the same tweet thread, he said his No. 1 priority “by far” is “doing right by users.” To that end, he said, the team is spending the week doing everything it can to raise liquidity. “I can’t make any promises about that,” he said. “But I’m going to try.” “Every penny of that–and of the existing collateral–will go straight to users, unless or until we’ve done right by them.”
Shaken To The Core.
For years, Bankman-Fried was the “expert” face of crypto to Washington policymakers and venture capitalists and institutional investors nationwide. His knowledge and history as a Jane Street trader helped convince legislators that the crypto industry was professional, and convinced investors that their money was as safe in crypto as in other assets. FTX was thought to be a blue chip investment: With former Wall Street traders on staff; a large lobbying presence on Capitol Hill; advertisements with Tom Brady, Stephen Curry, and Larry David; and $100+ million contracts with the Miami Heat, Golden State Warriors, and Major League Baseball, FTX served to convince the skeptical that crypto was an industry just like any other.
For that reason, FTX’s collapse and Bankman-Fried’s faults have shaken the crypto industry and its investors. Industry participants and lobbyists are expecting regulators to be more aggressive in requiring crypto exchanges and brokerages to comply with the nation’s securities and derivatives laws. Crypto traders expect both retail and institutional investors to withdraw their funds from the markets. Venture capitalists are expected to not only significantly curtail their investments but also conduct more detailed due diligence.
“This is an absolutely stunning turnaround from somebody who was the darling of Washington policy circles,” said Blockchain Association Executive Director Kristin Smith. “It was built on a house of cards.”
Where was the Regulation?
There is no doubt that FTX was—and other crypto firms are—insufficiently regulated. The only question is why.
One reason is jurisdictional fights between regulators and Congressional committees. The Chairman of the SEC, Gary Gensler, has argued that the “vast majority” of crypto tokens are securities, while the Chairman of the CFTC, Rostin Behnam, has argued that “many digital assets” are commodities. Without a consistent position from the government, the crypto industry claimed with a straight face that their tokens were exempt from the securities laws. Similarly, Congress did not enact new laws because of a divide over which committees would draft legislation—the Senate Banking and House Financial Services Committees or the Senate and House Agriculture Committees.
Another reason is slick lobbying by the crypto industry. Beyond presenting crypto as mainstream and self-regulating—and providing massive campaign donations—industry lobbyists have sowed confusion about whether crypto assets are sufficiently “decentralized” to avoid being considered securities and about whether “decentralized” crypto exchanges should be regulated differently than traditional exchanges like FTX.
The Future of Crypto Regulation.
If nothing else, the days of cozy relationships between Congress, regulators, and the crypto industry are most likely over. CFTC Commissioner Pham—who has been dubbed Commissioner Instagram by critics—recently removed photos of her and crypto industry executives from her social media feeds. Legislators have expressed feeling duped by Bankman-Fried’s presentations. Regulators will not want to be seen as doing nothing following FTX’s collapse.
Meanwhile, speaking on Wednesday during in a “fireside chat” at Healthy Market Association’s Annual Conference in Washington DC, SEC Chairman Gary Gensler warned against the passage of legislation by Congress that would limit his agency’s authority to subject digital assets, and especially so-called “crypto exchanges” like FTX, to the full force of the federal securities laws.
The following day, Thursday, House Financial Services Committee Chairwoman Maxine Waters (D-CA) release a statement addressing the “recent FTX and Binance events,” observing: “The recent fall of FTX.com – a major international cryptocurrency trading platform – is just the latest example in a string of incidents involving the collapse of cryptocurrency companies and the impacts these failures have on consumers and investors. Although FTX’s U.S.-facing company is reportedly operational, FTX’s FTT tokens are now worthless, and even worse, FTX.com customers are completely unable to access their funds. Now more than ever, it is clear that there are major consequences when cryptocurrency entities operate without robust federal oversight and protections for customers.”
By Friday, the Senate Agriculture Committee’s top Republican, Sen. John Boozman of Arkansas, was calling for a “top-down” revisiting of his crypto regulation bill, which was expected to be considered and passed by the Committee later this month. “The events that have transpired this week reinforce the clear need for greater federal oversight of the digital asset industry,” Boozman said in a statement. “In light of these developments, we are taking a top-down look to ensure [the bill] establishes the necessary safeguards the digital commodities market desperately needs.”
We expect Congress to investigate FTX’s collapse. Perhaps there will be a crypto version of the Pecora report and hearings, examining just what went wrong and requiring Bankman-Fried to testify. Congress’s desire over the past several years to enact crypto legislation is unlikely to wane, and we expect additional legislation to be quickly considered.
We also anticipate that FTX’s collapse will go a long way toward giving the SEC the political capital it needs to force the crypto industry to comply with the securities laws. The securities laws have extensive rules governing how brokers custody of client funds and protect customers, requiring corporate policies and procedures to protect against mismanagement, and mandate disclosures. Although we expect the debate over jurisdiction between SEC and CFTC to continue, the SEC has the authority to require all firms that custody crypto assets to comply with these customer protections as at least some crypto tokens held by these firms’ customers are securities.
Conclusion.
The collapse of FTX in under 48 hours shows the dangers of leaving crypto assets unregulated. It has also demolished Sam Bankman-Fried’s credibility, and his ability to serve as a go-to resource for policymakers writing rules for crypto. This is important because FTX, and specifically Bankman-Fried, have been at the vanguard of a year-long lobbying campaign that sought to establish the famously light-touch CFTC as the primary regulator of digital assets. Today, that lobbying effort – alongside the $40 million in political contributions by Bankman-Fried alone to crypto friendly candidates in 2022 midterm election cycle – looks as worthless as a investment as FTT. Until this week, the the FTX led lobbying push had been gaining significant traction with Republicans and Democrats eager to draft new laws to accommodate digital asset startups. Now, Congress and the SEC are likely to try to take this opportunity to bring strong regulations to bear on the industry.
