On Nov. 11, while the rest of the U.S. was celebrating Veterans Day, Sam Bankman-Fried announced that FTX — one of the world’s largest cryptocurrency exchanges by volume — had filed for bankruptcy. Lawmakers and pundits were quick to seize on the swift breakup of FTX, calling for more regulation of the crypto industry. “Recent news further underscores these concerns [about consumer harm] And underscores why there is a real need for prudential regulation of cryptocurrencies,” White House Press Secretary Karine Jean-Pierre said.
It is unclear exactly what happened to FTX. Reports of $1 billion to $2 billion in client funds unaccounted for are deeply disturbing. Signs of widespread consumer harm and corporate misconduct will only increase the likelihood that Congress will act to regulate the crypto industry. As Congress sets its sights on overhauling the regulatory environment for cryptocurrencies, lawmakers must provide regulatory transparency without hindering active innovation.
Anatomy of a breakdown
Sam Bankman-Fried was once the golden boy of the crypto world. Bankman-Fried began his career in traditional proprietary trading on Jane Street, left Wall Street and founded a cryptocurrency-focused quantitative trading firm called Alameda Research in November 2017. Three months later, he rose to fame by becoming the first person to profit by arbitrage the difference in bitcoin prices in Japan and the United States, with him and his team allegedly earning $25 million a day. Just over a year later, he founded FTX.Just read the acclaimed, now-deleted profile of Bankman-Fried from Sequoia Capital (which has invested $214 million in FTX) to see how many Believe He is a financial expert.
Bankman-Fried eventually left Alameda to focus on FTX while retaining a substantial stake in the fund. With revenue growth of more than 1000% from 2020 to 2021, FTX has rapidly grown into one of the largest cryptocurrency exchanges in the world. In January, FTX was valued at $32 billion. However, on Nov. 2, leaked documents indicated that Alameda Research held a large amount of FTX tokens (FTT). Four days later, Changpeng Zhao “CZ,” CEO of rival exchange Binance, tweeted that his company would be liquidating approximately $2.1 billion worth of FTT. CZ’s statement, combined with concerns about illiquidity, resulted in a typical bank run on FTX.
As part of Binance’s exit from its FTX stake last year, Binance received approximately $2.1 billion in equivalent cash (BUSD and FTT). As a result of recent revelations, we have decided to liquidate all remaining FTT on our books. 1/4
— CZ Binance (@cz_binance) November 6, 2022
Faced with a liquidity crisis, FTX and Binance agree to an acquisition. However, Binance withdrew from the deal “as a result of corporate due diligence.” Over the next 48 hours, Bankman-Fried dropped the “asset integrity” guarantee, demanded $8 billion from investors to save his company, and apologized.
1) Sorry. This is the most important thing.
I screwed up and should have done better.
— SBF (@SBF_FTX) November 10, 2022
On November 11, Bankman-Fried announced that FTX, FTX.US, Alameda Research and approximately 130 other affiliates had filed for Chapter 11 bankruptcy protection.
1) Hello everyone:
Today I filed the FTX, FTX US and Alameda voluntary Chapter 11 procedures in the US.
— SBF (@SBF_FTX) November 11, 2022
The impact of FTX’s debacle on consumers has been devastating. Court documents show that FTX Group may have “more than 1 million creditors in these Chapter 11 cases,” with legal experts asserting that many customers may never get their money back. Following Bankman-Fried’s departure, FTX appointed John J. Ray III (the attorney in charge of the liquidation of Enron after its collapse) to oversee the bankruptcy process.
Fallout in Washington, D.C.
Over the past few years, in Washington, cryptocurrency regulation has largely been considered an “ex-partisan” issue, emerging in a way that few issues can cross political lines. Legislators, regulators, and the industry generally acknowledge that crypto and blockchain technology doesn’t quite fit into existing regulatory structures, leaving much of the industry in a regulatory gray area and leading many to complain about regulation through law enforcement. The complaints have prompted lawmakers to push for new legislation aimed at clarifying the rules of the road for cryptocurrencies.
While many smaller pieces of legislation have been proposed, there are two major bills aimed at providing clarity to the crypto industry. The Lummis-Gillibrand Responsible Financial Innovation Act establishes jurisdiction over digital assets between the U.S. Securities and Exchange Commission (SEC) and the Commodity and Futures Trading Commission (CFTC), allows exchanges to register with the CFTC, and imposes requirements on stablecoin providers. New requirements, among other things. The Digital Commodity Consumer Protection Act (DCCPA) would grant the CFTC exclusive jurisdiction over digital commodity transactions, force exchanges to register with the CFTC, and create new disclosure requirements for digital commodity brokers, among other things.
related: Senator Lummis: My proposal with Senator Gillibrand empowers the SEC to protect consumers
The DCCPA was sponsored by the chairmen and ranking members of the House and Senate Agriculture Committees, which have jurisdiction over commodity markets, and there are only minor differences between the House and Senate versions of the bill.
With Congress winding down, neither bill is likely to pass before the end of the year. However, lawmakers have made it clear that they intend to revisit the issue next year, and the FTX debacle only increases the likelihood of legislative action against cryptocurrencies.
Aside from comments from the White House and federal regulators, lawmakers also did nothing when it came to FTX. Sen. Sherrod Brown, D-Ohio, said Bankman-Fried should be called to testify before the Senate and urged regulators to “crack down” on the industry. Democratic Sen. Elizabeth Warren of Massachusetts, a historical critic of cryptocurrencies, said the industry was largely “in the dark” before calling for more regulation.
The implosion of FTX must sound the alarm, demanding that Congress and financial regulators hold the industry and its executives accountable.
Too much of the crypto industry is looking in the dark. It’s time for stronger rules and stronger enforcement to protect ordinary people.
– Elizabeth Warren (@SenWarren) November 11, 2022
Other members of Congress made more subtle comments about FTX. “Oversight is one of the most important functions of Congress, and we must get to the bottom of FTX’s customers and the American people. It is critical 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. Senators Debbie Stabenow of Michigan and John Boozman of Arizona, the original Senate sponsors of DCCPA, pointed to the FTX debacle as evidence that Congress should pass its bill.
The industry also rallied around FTX to push for clearer regulation. Coinbase CEO Brian Armstrong wrote an op-ed the day FTX filed for bankruptcy, calling for sensible regulation of the exchange. “It’s also important to understand why this happened — and what needs to change if we want to prevent something like this from happening again,” Armstone wrote. “Now, the United States has a choice: Take the lead in providing clear, business-friendly regulation, or risk losing the key drivers of innovation and economic equality.”
Congress is likely to act to regulate cryptocurrencies within the next year. The collapse of FTX is almost certain.
As lawmakers weigh how to prevent the next FTX, avoiding the trap of panic policies is crucial. As many have already pointed out, FTX’s misconduct and subsequent collapse are not unique to cryptocurrencies. Pundits were quick to compare it to Enron and Lehman Brothers. As happened after these events, Congress should first investigate FTX and then enact legislation to increase transparency and close loopholes that allow FTX to operate as it has in the past.
related: Will SBF face consequences for FTX mismanagement?don’t count on it
To date, Congress and federal regulators have been unable or unwilling to provide clarity to the crypto industry. But we’ve also seen cases of poorly drafted legislation creating more confusion than clarity. The unrealistically ambiguous definition of a broker in the Infrastructure Investment and Employment Act is a case-by-case and a point that has yet to be determined.
As lawmakers draft and redraft legislation targeting cryptocurrencies, any proposal will have to be tightly tuned to address specific issues in specific contexts. For example, custodial and non-custodial wallet services operate differently and should be regulated differently. More importantly, lawmakers must not confuse applications with the protocols they run on.
Hopefully Congress can avoid a moral panic and use the current momentum to enact legislation that will provide regulatory clarity to crypto applications without hindering innovation. American customers and innovators should expect that.
luke hogg is a policy manager at the nonprofit Lincoln Network, where he focuses on the intersection of emerging technologies and public policy.
The views expressed are solely those of the authors and do not necessarily reflect the views of Cointelegraph. This article is for informational purposes only and is not intended and should not be considered legal or investment advice.