FTX fiasco means coming consequences for crypto in Washington DC

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On Nov. 11, while the rest of the coun­try was cel­e­brat­ing Veteran’s Day, Sam Bankman-Fried announced that FTX — one of the world’s largest cryp­tocur­ren­cy exchanges by vol­ume — had filed for bank­rupt­cy. Law­mak­ers and pun­dits quick­ly latched onto the rapid dis­in­te­gra­tion of FTX to call for more reg­u­la­tion of the cryp­to indus­try. “The most recent news fur­ther under­scores these con­cerns [about con­sumer harm] and high­lights why pru­dent reg­u­la­tion of cryp­tocur­ren­cies is indeed need­ed,” said White House Press Sec­re­tary Karine Jean-Pierre.

It remains unclear what exact­ly tran­spired at FTX. Reports indi­cat­ing that between $1 bil­lion and $2 bil­lion of cus­tomer funds are unac­count­ed for are deeply trou­bling. Wide­spread con­sumer harm and indi­ca­tions of cor­po­rate impro­pri­ety only increase the like­li­hood that Con­gress will take action to reg­u­late the cryp­to indus­try. As Con­gress looks toward over­haul­ing the reg­u­la­to­ry envi­ron­ment around cryp­to, it is impor­tant that law­mak­ers pro­vide reg­u­la­to­ry clar­i­ty with­out hin­der­ing pos­i­tive innovation.

Anatomy of a collapse

Sam Bankman-Fried was once the gold­en boy of the cryp­to world. Launch­ing his career in tra­di­tion­al pro­pri­etary trad­ing at Jane Street, Bankman-Fried left Wall Street and found­ed a cryp­to-focused quan­ti­ta­tive trad­ing firm called Alame­da Research in Novem­ber 2017. Three months lat­er, he rose to fame by being the first to sig­nif­i­cant­ly prof­it by arbi­trag­ing the dif­fer­ence in the price of Bit­coin in Japan and the Unit­ed States, pur­port­ed­ly earn­ing him and his team $25 mil­lion per day. Just over a year lat­er, he found­ed FTX. One needs only read the lauda­to­ry, now-delet­ed pro­file of Bankman-Fried from Sequoia Cap­i­tal (which invest­ed $214 mil­lion in FTX) to see how many believed him to be a finan­cial savant. 

Bankman-Fried even­tu­al­ly left Alame­da to focus on FTX while retain­ing a sig­nif­i­cant stake in the fund. FTX quick­ly grew to become one of the largest cryp­to exchanges in the world as rev­enues grew over 1000% between 2020 and 2021. In Jan­u­ary, FTX was val­ued at $32 bil­lion. But, on Nov. 2, leaked doc­u­ments indi­cat­ed that Alame­da Research held a large about of FTX Tokens (FTT). Four days lat­er, Chang­peng “CZ” Zhao — CEO of rival exchange Binance — tweet­ed that his com­pa­ny would liq­ui­date approx­i­mate­ly $2.1 bil­lion worth of FTT. CZ’s state­ments, cou­pled with fears of illiq­uid­i­ty, led to a clas­sic bank run on FTX. 

Faced with a liq­uid­i­ty cri­sis, FTX and Binance agreed to an acqui­si­tion. But, “as a result of cor­po­rate due dili­gence,” Binance backed out of the deal. Over the next 48 hours, Bankman-Fried delet­ed assur­ances that “assets are fine,” asked investors for $8 bil­lion to save his com­pa­ny and apologized. 

On Nov. 11, Bankman-Fried announced that FTX, FTX.US, Alame­da Research and around 130 oth­er affil­i­at­ed com­pa­nies had filed for Chap­ter 11 bankruptcy.

The impact of FTX’s col­lapse on con­sumers is dev­as­tat­ing. Court fil­ings show that the FTX Group could have “over one mil­lion cred­i­tors in these Chap­ter 11 cas­es,” and legal experts have assert­ed that many cus­tomers may nev­er get their mon­ey back. Fol­low­ing the depar­ture of Bankman-Fried, FTX appoint­ed John J. Ray III — the lawyer who man­aged the liq­ui­da­tion of Enron Corp. fol­low­ing its demise — to over­see the bank­rupt­cy proceedings.

Fallout in Washington, D.C.

Over the last few years in Wash­ing­ton, cryp­to reg­u­la­tion has large­ly been con­sid­ered a “pre-par­ti­san” issue that cuts across polit­i­cal lines in ways that few issues can. It is wide­ly acknowl­edged by law­mak­ers, reg­u­la­tors and the indus­try that cryp­to and blockchain tech­nolo­gies do not fit clean­ly into exist­ing reg­u­la­to­ry struc­tures, leav­ing much of the indus­try in a reg­u­la­to­ry gray area and lead­ing to what many have com­plained is reg­u­la­tion through enforce­ment. These com­plaints have led law­mak­ers to push for new leg­is­la­tion that aims at clar­i­fy­ing the rules of the road for crypto.

While there are numer­ous small­er pieces of leg­is­la­tion that have been put for­ward, there are two major bills that seek to pro­vide clar­i­ty for the cryp­to indus­try. The Lum­mis-Gilli­brand Respon­si­ble Finan­cial Inno­va­tion Act delin­eates the juris­dic­tion over dig­i­tal assets between the Secu­ri­ties and Exchange Com­mis­sion (SEC) and Com­modi­ties and Futures Trad­ing Com­mis­sion (CFTC), allow exchanges to reg­is­ter with the CFTC, and cre­ate new require­ments for sta­ble­coin providers, among oth­er things. The Dig­i­tal Com­modi­ties Con­sumer Pro­tec­tion Act (DCCPA) would grant the CFTC exclu­sive juris­dic­tion over dig­i­tal com­mod­i­ty trades, man­date that exchanges reg­is­ter with the CFTC and cre­ate new dis­clo­sure require­ments for dig­i­tal com­mod­i­ty bro­kers, among oth­er things.

Relat­ed: Sen. Lum­mis: My pro­pos­al with Sen. Gilli­brand empow­ers the SEC to pro­tect consumers

The DCCPA is spon­sored by the chair and rank­ing mem­ber of both the House and Sen­ate Agri­cul­ture Com­mit­tees, which hold juris­dic­tion over com­modi­ties mar­kets, and there are only slight dif­fer­ences between the House and Sen­ate ver­sions of the bill.

With Con­gress wind­ing down, it is unlike­ly that either of these bills will pass before the end of the year. But, law­mak­ers have made clear their intent to revis­it this issue next year, and the col­lapse of FTX has only increased the like­li­hood of leg­isla­tive action on crypto.

In addi­tion to com­ments from the White House and fed­er­al reg­u­la­tors, law­mak­ers have not pulled punch­es when it comes to FTX. Demo­c­ra­t­ic Ohio Sen. Sher­rod Brown said Bankman-Fried should be called to tes­ti­fy before the sen­ate and urged reg­u­la­tors to “crack down” on the indus­try. Demo­c­ra­t­ic Mass­a­chu­setts Sen­a­tor Eliz­a­beth War­ren, who has his­tor­i­cal­ly been crit­i­cal of cryp­to, said the indus­try was most­ly “smoke and mir­rors” before call­ing for more regulation.

Oth­er mem­bers of Con­gress were more nuanced in their com­ments sur­round­ing FTX. “Over­sight is one of Con­gress’ most crit­i­cal func­tions and we must get to the bot­tom of this for FTX’s cus­tomers and the Amer­i­can peo­ple. It’s essen­tial that we hold bad actors account­able so respon­si­ble play­ers can har­ness tech­nol­o­gy to build a more inclu­sive finan­cial sys­tem,” said Rep. Patrick McHen­ry of North Car­oli­na. Sens. Deb­bie Stabenow of Michi­gan and John Booz­man of Ari­zona, who are the orig­i­nal Sen­ate spon­sors of the DCCPA, point­ed to the FTX col­lapse as evi­dence for why Con­gress should pass their bill. 

The indus­try has also ral­lied around FTX to push for more reg­u­la­to­ry clar­i­ty. The CEO of Coin­base, Bri­an Arm­strong, penned an oped the day FTX filed for bank­rupt­cy, call­ing for sen­si­ble reg­u­la­tion of exchanges. “It’s also impor­tant to be clear about why this hap­pened — and what needs to change if we want to pre­vent some­thing like it from hap­pen­ing again,” wrote Arm­stong. “Now, the U.S. has a choice: take the lead by pro­vid­ing clear, busi­ness-for­ward reg­u­la­tion, or risk los­ing out on a key dri­ver of inno­va­tion and eco­nom­ic equality.”

Moving forward

It was already like­ly that Con­gress would take action to reg­u­late cryp­to next year. The col­lapse of FTX makes it near­ly certain.

As law­mak­ers weigh how to pre­vent the next FTX, it is crit­i­cal that they avoid the pit­falls of pan­ic-dri­ven pol­i­cy. As many have already point­ed out, FTX’s impro­pri­ety and sub­se­quent col­lapse are not unique to cryp­to. Pun­dits have been quick to make com­par­isons to Enron and Lehman Broth­ers. As hap­pened fol­low­ing those inci­dents, Con­gress should first inves­ti­gate FTX and then pro­duce leg­is­la­tion that increas­es trans­paren­cy and clos­es the loop­holes that allowed FTX to oper­ate as it did.

Relat­ed: Will SBF face con­se­quences for mis­man­ag­ing FTX? Don’t count on it

Thus far, Con­gress and fed­er­al reg­u­la­tors have been unable or unwill­ing to pro­vide clear reg­u­la­tions for the cryp­to indus­try. But we have also seen instances where poor­ly draft­ed leg­is­la­tion cre­at­ed more con­fu­sion than clar­i­ty. The unwork­ably vague bro­ker def­i­n­i­tion in the Infra­struc­ture Inves­ment and Jobs Act is case and point and has yet to be fixed.

As law­mak­ers draft and redraft leg­is­la­tion tar­get­ed at cryp­to, it is essen­tial that any pro­pos­al be nar­row­ly tai­lored to solve spe­cif­ic issues in a spe­cif­ic con­text. For exam­ple, cus­to­di­al and non­cus­to­di­al wal­let ser­vices oper­ate dif­fer­ent­ly and should be reg­u­lat­ed dif­fer­ent­ly. More impor­tant­ly, law­mak­ers must not con­fuse appli­ca­tions and the pro­to­cols on which they run. 

Hope­ful­ly, Con­gress will avoid a moral pan­ic and will use the cur­rent momen­tum to pro­duce leg­is­la­tion that pro­vides reg­u­la­to­ry clar­i­ty for cryp­to appli­ca­tions with­out ham­per­ing inno­va­tion. Amer­i­can cus­tomers and inno­va­tors should expect noth­ing less. 

Luke Hogg is pol­i­cy man­ag­er at the non­prof­it Lin­coln Net­work, where he focus­es on the inter­sec­tion of emerg­ing tech­nolo­gies and pub­lic policy.

The opin­ions expressed are the author’s alone and do not nec­es­sar­i­ly reflect the views of Coin­tele­graph. This arti­cle is for gen­er­al infor­ma­tion pur­pos­es and is not intend­ed to be and should not be tak­en as legal or invest­ment advice.

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