FTX Fiasco Means Coming Consequences for Crypto in Washington DC

On November 11, while the rest of the country celebrated Veterans Day, Sam Bankman-Fried announced that FTX — one of the largest cryptocurrency exchanges in the world by volume — had filed for bankruptcy. Lawmakers and pundits quickly joined FTX’s rapid disintegration to call for more regulation of the crypto industry. “Recent news further underscores these concerns [about consumer harm] and underscores why prudent regulation of cryptocurrencies is indeed necessary,” said White House press secretary Karine Jean-Pierre.

It remains unclear what exactly happened at FTX. Reports suggesting that between $1 billion and $2 billion in client funds are unaccounted for are deeply troubling. Widespread consumer harm and evidence of corporate impropriety only increases the likelihood that Congress will take action to regulate the crypto industry. As Congress seeks an overhaul of the regulatory environment surrounding crypto, it is important that lawmakers provide regulatory clarity without impeding positive innovation.

Anatomy of a Breakdown

Sam Bankman-Fried was once the gold boy of the crypto world. Bankman-Fried started his career in traditional proprietary trading on Jane Street, 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 from arbitraging the price differential of bitcoin in Japan and the United States, reportedly earning him and his team $25 million a day. A little over a year later he founded FTX. One only has to read the praising, now-deleted, profile of Sequoia Capital’s Bankman-Fried (which invested $214 million in FTX) to see how many thought he was a financial expert.

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

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

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

The impact of the FTX collapse on consumers is devastating. Court filings show that FTX Group could have “over a million creditors in these Chapter 11 cases,” and legal experts have claimed many customers may never get their money back. Following Bankman-Fried’s departure, FTX appointed John J. Ray III – the attorney handling the liquidation of Enron Corp. after its demise – to monitor the insolvency proceedings.

Rainfall in Washington, DC

In recent years, crypto regulation in Washington has been widely viewed as a “pre-partisan” issue that transcends political boundaries in a way few issues can. It is widely recognized by lawmakers, regulators and industry that crypto and blockchain technologies do not fit neatly into existing regulatory structures, leaving much of the industry in a regulatory gray area and leading to what many have lamented: regulation through enforcement . These complaints have prompted lawmakers to push for new legislation aimed at clarifying the rules of the road for crypto.

While numerous smaller bills have been introduced, there are two major bills that aim to bring clarity to the crypto industry. The Lummis-Gillibrand Responsible Financial Innovation Act demarcates jurisdiction over digital assets between the Securities and Exchange Commission (SEC) and the Commodities and Futures Trading Commission (CFTC), allows exchanges to register with the CFTC, and creates new ones, among other things Requirements for stablecoin providers other things. The Digital Commodities Consumer Protection Act (DCCPA) would give the CFTC exclusive jurisdiction over trading in digital commodities, require exchanges to register with the CFTC, and create new disclosure requirements for digital commodities brokers, among other things.

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

The DCCPA is sponsored by the chairman and senior member of the House and Senate Agriculture Committee, which oversees commodity markets, and there are only minor differences between the House and Senate versions of the bill.

With Congress over, it’s unlikely any of these bills will pass before the end of the year. But lawmakers have made clear their intention to revisit this issue next year, and the collapse of FTX has only increased the likelihood of legislative action against crypto.

In addition to comments from the White House and federal regulators, lawmakers have not let up on FTX. Democratic Ohio Senator Sherrod Brown said Bankman-Fried should be summoned before the Senate and urged regulators to “crack down” on the industry. Democratic Massachusetts Sen. Elizabeth Warren, who has always been critical of crypto, said the industry was mostly “smoke and mirrors” before calling for more regulation.

Other members of Congress have been more nuanced in their comments on FTX. “Oversight is one of the most critical responsibilities of Congress and we must get to the bottom of it for FTX customers and the American people. It’s important that we hold bad actors accountable so responsible actors can use 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 DCCPA’s original Senate sponsors, pointed to the collapse of the FTX as evidence why Congress should pass their legislation.

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

Go forward

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

As lawmakers weigh how to prevent the next FTX, it’s crucial that they avoid the pitfalls of panic-driven politics. As many have pointed out, the impropriety and subsequent collapse of FTX isn’t just down to crypto. Experts were quick to draw comparisons to Enron and Lehman Brothers. As happened after these incidents, Congress should first investigate FTX and then enact legislation that would increase transparency and close the loopholes that allowed FTX to operate the way it did.

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

So far, congressional and federal regulators have been unable or unwilling to issue clear regulations for the crypto industry. But we have also seen cases where poorly worded legislation has created more confusion than clarity. The impractically vague broker definition in the Infrastructure Investment and Employment Act is a case and point and has yet to be addressed.

As lawmakers draft and revise crypto-centric legislation, it’s important that each proposal is narrowly tailored to address specific issues in a specific context. For example, custodial and non-custodial wallet services work differently and should be regulated differently. More importantly, lawmakers must not confuse applications and the protocols they run on.

Hopefully, Congress will avoid a moral panic and use the current momentum to enact 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 technology and public policy.

The opinions expressed are solely those of the author and do not necessarily reflect the views of Cointelegraph. This article is for general informational purposes and should not be construed as legal or investment advice.

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