FTX collapse calls for immediate crypto regulations

Another day, another cryptocurrency news story. But this time, it’s not just a story, it’s the collapse of one of the world’s largest crypto exchanges – FTX.

Failure of corporate governance, lack of effective controls, policies, and compliance gaps have led to its fall. The volatile crypto market has dipped again and shed light on another poorly managed crypto project and unstable ecosystem.

On 11^th November 2022, Sam Bankman-Fried, the founder of FTX, filed for bankruptcy protection in the US. It is estimated that FTX could owe money to more than a million people and has left many with significant losses.

The FTX collapse evidently calls for regulations to prevent customers from being victims of this loosely unregulated market. If crypto were to be regulated effectively, investors would be protected and may not suffer such losses from collapses.

What caused the FTX collapse?

Whilst investigations into the collapse are still ongoing, this is what we know so far:

• Binance stated that it was selling its holdings of FTT (a share in FTX) because it participated in risky loans.  
• As a direct domino effect, there was a surge of customer withdrawals that halted trading.
• Customers sent money to Alameda as the exchange did not have the ability to accept wire transfers – however, the funds were never transferred and Almeda kept hold of, traded with and frequently lost, $8 billion of FTX customer funds.

To clean up the FTX mess, John J. Ray III has been appointed as the Chief Restructuring Officer and CEO of FTX to oversee its bankruptcy proceedings.

In the bankruptcy filing, John J. Ray commented “never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information.” He also said that “nearly every situation in which I have been involved has been characterised by defects of some sort in internal controls, regulatory compliance, human resources and systems integrity,” and “compromised systems integrity and faulty regulatory oversight abroad.” All of which could have led to the fall of FTX.

Should crypto be regulated with existing US laws?

In the aftermath of the FTX fall, Sheila Bair, former Head of the Federal Deposit Insurance Corporation, stated that US regulators must act now with current laws to protect investors rather than wait for new regulations to be implemented.

“The regulators need to swallow hard and get an agreement and then start implementing, using the authorities they have now…set a framework, publicly announce it, implement it through rule changes and policy announcements. But get on with it because more and more people are getting hurt.”

Federal regulation of cryptocurrency trading hasn’t been confirmed, but a desire to regulate the industry has. The Securities and Exchange Commission (SEC) is looking to stop the registration of misleading crypto asset offerings such as the Ducat and Locke tokens. This is to protect investors from misleading promotions.

However, there have not been any updates in relation to the FTX bankruptcy from regulators so far.

How have other nations reacted to the FTX bankruptcy?

Although crypto has been included in the amended Financial Services and Markets Bill (FSMB), currently crypto exchanges can only be held accountable on anti-money laundering grounds – the FTX collapse calls for faster regulations to hit the crypto market.

The Deputy Governor of the Bank of England, Sir Jon Cunliffe, labelled the collapse as “probably the largest – and certainly the most spectacular – failure to date in the crypto ecosystem.” He warned that the collapse threatens the stability of the wider financial system. Whilst the crypto world is not “interconnected enough with mainstream finance…its links with mainstream finance have been developing rapidly.”

“We should not wait until it is large and connected to develop the regulatory frameworks necessary to prevent a crypto shock that could have a much greater destabilising impact.”

The UK needs to ensure that “innovation can take place but within a framework in which risks are properly managed and which safeguards the sustainability of such innovation.”

The FTX collapse provides “a compelling demonstration of why that matters,” he adds. There were fundamental issues around FTX’s “corporate structure, governance, internal controls and record keeping,” and regulation imposes these much-needed requirements. Regulatory bodies’ supervision ensures that regulatory obligations are implemented.

Crypto exchanges such as FTX bundle products and functions all within one firm. Whereas conventionally, these functions would be separated into different entities or overseen with tight controls.

CUBE comment

Following the collapse of FTX, there will most likely be increased regulatory scrutiny in the crypto industry. The events have cemented that regulatory compliance and oversight are important in preventing the downfall of a firm – compliance should never be an afterthought and always be something that is covered within a company’s policies.

CUBE’s Automated Regulatory Intelligence (ARI) can provide tailored regulatory planning to manage changes and reduce risks through gaining access to regulations that matter most to your business, all in one place. Build an inventory of obligations using CUBE’s AI-based machine reading and regulatory classification to build out your compliance frameworks in a matter of seconds.

For the UK, the FCA has even warned that FTX may have provided services without authorisation and customers are unlikely to get their money back.