Sam Bankman-Fried conviction doesn’t quash crypto regulation debate

Bankman-Fried and FTX came undone when someone leaked a balance sheet to the crypto news site, Coin Desk, which revealed how exposed Alameda was to FTX.

As FTX and Alameda tumbled into insolvency, it became apparent that Alameda had siphoned billions of dollars from FTX’s customers’ funds to essentially gamble on crypto assets to try to fill in a yawning hole in Alameda’s balance sheet.

The fact that the assets were crypto suggest[s] sophistication … but what Bankman-Fried and his co-conspirators did [wasn’t sophisticated].

It also became apparent that the management and the book-keeping of both entities was shambolic, there was little, if any, management of risks and there had been extensive co-mingling of FTX’s customer funds with Alameda’s.

While the fact that the assets involved were crypto assets tends to suggest sophistication, there was nothing sophisticated about what Bankman-Fried and his co-conspirators did. There’s nothing novel in a promoter using – effectively stealing – client funds for personal use.

It’s very conventional, old-fashioned, fraud. The only high-tech aspects were the unconventional nature of the underlying assets and the use of coding to create Alameda’s backdoor access to the software under-pinning FTX’s platform.

When FTX and Alameda collapsed and the extent of the multi-billion fraud became clear, the obvious conclusion was that it would, finally, lead to a wave of legislation that would see the crypto sector regulated similarly to conventional financial institutions, as the US Securities and Exchange Commission has long-advocated.

In some jurisdictions that is happening. The Albanese government has decided to create a regime for regulating crypto here, mainly using existing financial services laws. Crypto exchanges will be required to obtain licences, manage conflicts, disclose financial accounts and face prudential requirements.

In the UK, the government is also close to imposing regulation. Like Australia, it will largely use existing laws to do so while beefing up the rules for exchanges and custodians and for disclosures.

The European Union’s “Markets in Crypto Assets” legislation is due to take effect next year, with perhaps the world’s most detailed and prescriptive regulation. There are already calls by influential policymakers like the European Central Bank’s Christine Lagarde for follow-up legislation.

In the US, nothing has been settled. There is still a debate about who should regulate crypto – if crypto is to be regulated – with the Securities and Exchange Commission vying with the Commodity Futures Trading Commission for the role.

Some in the sector, and the libertarians in Congress, have seized on the verdicts in Bankman-Friedman’s case (which he can and probably will appeal) as a reason for not creating any new regulations.

In the absence of crypto-specific rules, they argue, Bankman-Fried was investigated, prosecuted and convicted and faces quite draconian penalties. In their view, and it is quite a rational one, the FTX scandal was simple fraud and the fact that it involved crypto assets is an irrelevancy. Existing laws were sufficient to deal with it.

Others, including many in the sector, believe that crypto-specific regulation is needed to drive out the “Wild West” characters in the industry and therefore enable the more credible characters and organisations to rehabilitate the industry’s reputation and gain some trust.

They want to end crypto’s reputation for the chaos and volatility generated by booms, busts, scams, money laundering and the financing of illegal activity, hacks and other lawlessness.

What the Bankman-Fried trial did demonstrate is that fraud, whether conventional or otherwise, can be successfully prosecuted. Prosecutions, however, occur after the event. FTX customers’ money, the $US8 billion-plus, has been lost.

That would suggest, as Australia, the UK and Europe have concluded, that there does need to be some regulation, whether light touch (to avoid killing off a sector that does have some promise) or intrusive, to provide some protection for investors and others using crypto exchanges or buying tokens from promoters or using crypto intermediaries.

The “sunlight principle”, which is using disclosures and transparency as regulatory tools, is the most obvious approach to regulating an immature industry, albeit one backed by harsh penalties for any breaches.

The rug was pulled from under FTX and Alameda when another crypto exchange, Binance, initially decided to sell its holdings of tokens issued by FTX then, after subsequently saying it was considering acquiring FTX, walked away from it. FTX and Alameda filed for bankruptcy a day later, a little over a week after CoinDesk had published the article that precipitated its downfall.

It didn’t take much sunlight to blow up FTX and reveal the fraud but it would be better if investors didn’t have to rely on industry insiders’ actions or leaks from insiders to understand the risks of their investments, which is why some disclosure requirements ought to be the bare minimum of the regulatory response to the FTX saga.

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