Taming the Wild West: Crypto Policy in a post-FTX World

November 6 to November 12 will be remembered as a dark eight days for the crypto industry. FTX, then the third largest digital assets exchange globally, collapsed almost immediately. Behind it left a gaping $8 bn hole in its balance sheet, a high-profile prosecution of its founder Sam Bankman-Fried (SBF), and a debacle that has attracted responses from all sides of the market.

In the United States, the discussion quickly descended into finger pointing. JPMorgan CEO Jamie Dimon berated regulators for having ‘done nothing’, while Rep. Ritchie Torres (D-N.Y.) held the Securities Exchange Commission (SEC)’s Gary Gensler ‘singularly responsible’. Meanwhile, Commodity Futures Trading Commission (CFTC) Chair Rostin Benham argued that the proposed bill for The Digital Commodity Consumer Protection Act (DCCPA), which was ironically supported by then-FTX CEO Sam Bankman-Fried, would have prevented FTX's downfall. Benham added that FTX’s registration with the CFTC would have averted the collapse.

The SEC and CFTC have long jousted for the authority to regulate digital assets, with the outcome dependent on whether cryptocurrencies like bitcoin and ether are deemed securities or commodities. As the answer seems to converge on the latter in the majority of cases, the CFTC will likely continue to push for passing through the DCCPA. The proposed federal law intends to give ‘new tools’ to enforce record-keeping and governance requirements on ‘digital commodity trading facilities’. 

Nevertheless, as industry experts point out, the Bahamas-based FTX Trading Ltd., a separate and much larger parallel of the US-based FTX US, would have been outside the CFTC’s jurisdiction anyway. This has led some to underscore the necessity of the US to create an attractive regulatory environment to dissuade crypto firms from offshoring, while pursuing international data-sharing initiatives on things like exchange reserves, similar to the OECD’s current co-operation measures targeting tax evasion and illicit finance.

Sanjeev Bhasker of the Digital Currency Initiative at the Department of Justice and Rep. Jake Auchincloss, (D-Mass.) called on private crypto firms to self-regulate and flag abuse, while criticising FTX investors’ due diligence as inadequate. FTX attracted some $2 billion in investment by major institutions in crypto and finance, including the venture capital fund Paradigm and the asset manager conglomerate Blackrock amongst others. Former SoftBank executive Marcelo Claure recently admitted that ‘fear of missing out’ (FOMO) motivated the fund's investment in FTX, which culminated in a $100 million loss.

In Europe, the response to the FTX debacle has been much the same, as the collateral damage potentially affecting some one million individuals and institutions spurred regulators into action. For the European Commission, the threat of Russian sanctions evasion provided the final momentum needed to finalise the language of the seminal Markets in Crypto Assets (MiCA) bill tabled in October. Widely hailed as a comprehensive framework with the power to pioneer global crypto regulation, its provisions help distinguish between different types of cryptocurrencies, impose limits on stablecoins, and compel token issuers to submit white papers to regulators, amongst other things. Though only scheduled to take effect in 2024, some of its authors have proclaimed it could have prevented the FTX debacle. 

An additional EU crypto bill, which was leaked in late November, aims to improve transparency by requiring crypto and NFT providers to report tax details to EU authorities. Apart from responding to FTX’s collapse, EU regulators’s impetus in cracking down on tax evasion may be part of wider EU efforts to recover pandemic spending. The United Kingdom is likewise in the final stages of implementing a new regulatory framework to restrict foreign firms' sales operations, govern bankruptcy procedures, and control digital assets advertisement, all while simultanouesly striving to become a hub for crypto technology.

The series of spectacular crypto-firm collapses since May — Terra's UST stablecoin, Three Arrows Capital, Celsius Network, Voyager Digital, BlockFi, and  FTX to name a few — has only strengthened the resolve of regulators. Pro-crypto commentators insist these failures represent the excesses of the very centralised institutions that decentralised finance (DeFi) hopes to replace. Had FTX investors been prudent enough to transfer their crypto assets to non-custodial wallets — whether software or cold-storage — they would have not exposed themselves to FTX's instability, they argue. Crypto backers have also pointed to the relative resilience of established DeFi protocols, like Aave, Compound, and Maker, where ‘code is law’. Their ability to remain liquid throughout this turbulent period has been treated as a testament of their viability. However, in the current atmosphere of  regulatory concern, cautionary media coverage, and public alienation, these arguments will elicit little sympathy.

The FTX debacle differs in three fundamental ways from traditional crypto incidents like phishing attacks, scams, and bridge hacks.

First, exchanges are the first point-of-contact between retail investors and the world of crypto. FTX ran major television advertisement campaigns, using stars like NFL quarterback Tom Brady and comedian Larry David under the slogan ‘Don’t miss out’. This placed ordinary, private individuals on the front line to become the first casualties in the event of the exchange's collapse. Currently, FTX has frozen withdrawals for individual account holders. They are expected to recover mere cents on the dollar.

Second, FTX’s failure is largely attributable to basic mismanagement of risk and customer funds — whether intentional or not. As Rep. Jake Auchincloss, (D-Mass)., told the Blockchain Association Policy Summit in November, 'The crimes FTX was committing…were illegal 100 years ago'. This shines a light on just how far crypto oversight must go before it is on par with the traditional finance sector.

Finally, like Terra collapse from a months before, the FTX crash demonstrates that even sophisticated investors and industry veterans, such as Coinbase Ventures, Tiger Global, Temasek and Shark Tank’s Kevin O’Leary, cannot consistently identify and avoid bad actors. Nor are they immune to the charms of crypto’s sensational, high-stakes one-man shows. Mike Novogratz, CEO of Galaxy Digital, embraced Terra CEO Do Kwon and got a Luna-themed tattoo months before Terra algorithmic stablecoin collapsed, erasing $40 billion in value. Sequoia executives praised SBF’s ‘awesome intellect’, before writing off the fund’s $210 million investment after FTX tumbled.

Ultimately, the industry has come a long way since its wilderness days in the early 2010s. Its lobbying power, mainstream adoption, as well as the emergence of crypto-friendly representatives across national legislatures should be enough to ensure that crypto will not be regulated out of existence. But in adding a sense of gravity and urgency to the sector’s lawlessness, the FTX collapse has all but guaranteed that regulators will exercise oversight over the crypto industry. As the European Commission's Mairead McGuinessnoted in June 2022, “…you can't have an unregulated sector, … Those who … are thinking of being innovative will now do it in a way that sits within our regulation rather than in the Wild West.”