On November 11, as the rest of the country was celebrating Veterans Day, Sam Bankman-Fried announced that FTX — one of the world’s largest cryptocurrency exchanges by volume — had filed for bankruptcy. Legislators and pundits were quick to seize on FTX’s rapid demise to call for increased regulation of the crypto industry. “The most recent news further underscores these concerns. [about consumer harm] and highlights why sensible regulation of cryptocurrencies is really needed,” said White House Press Secretary Karine Jean-Pierre.
It remains unclear what exactly happened on FTX. Reports that between $1 and $2 billion of client funds have gone missing are deeply troubling. The widespread harm to consumers and signs of corporate wrongdoing only increase the likelihood that Congress will take action to regulate the crypto industry. As Congress seeks to overhaul the regulatory environment for cryptocurrencies, it is important that lawmakers ensure regulatory clarity without inhibiting positive innovation.
Anatomy of a collapse
Sam Bankman-Fried was once the golden boy of the crypto world. After starting his career in traditional private trading on Jane Street, Bankman-Fried left Wall Street to found Alameda Research, a cryptocurrency-focused quantitative trading firm, in November 2017. Three months later, he rose to fame by becoming the first to make significant profits from arbitrage. bitcoin price difference between Japan and the US, allegedly earning him and his team $25 million a day. A little over a year later, he founded FTX. One need only read the laudatory, now deleted profile of Sequoia Capital’s Bankman-Fried (which invested $214 million in FTX) to see how many people considered him a financial genius.
Bankman-Fried eventually left Alameda to focus on FTX while maintaining a significant stake in the fund. FTX has quickly grown into one of the largest crypto exchanges in the world as revenues grew by over 1000% between 2020 and 2021. In January, FTX was valued at $32 billion. But on Nov. 2, leaked documents revealed that Alameda Research owns a large amount of FTX tokens (FTT). Four days later, Changpeng “CZ” Zhao — CEO of rival exchange Binance — tweeted that his company was liquidating about $2.1 billion in FTT. CZ’s statements, combined with concerns about illiquidity, resulted in a classic foray into FTX banks.
As part of Binance’s withdrawal from FTX capital, Binance received approximately $2.1 billion in cash (BUSD and FTT) last year. Due to recent revelations that have come to light, we have decided to eliminate all remaining FTTs from our books. 1/4
— CZ Binance (@cz_binance) November 6, 2022
Faced with a liquidity crunch, FTX and Binance agreed to the acquisition. But “as a result of corporate due diligence,” Binance pulled out of the deal. Over the next 48 hours, Bankman-Fried removed assurances that “the assets are fine,” asked investors for $8 billion to save his company, and issued an apology.
1) I’m sorry. It is most important.
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 about 130 other affiliated companies have filed for Chapter 11 bankruptcy.
1) Hello everyone:
Today I filed with FTX, FTX US, and Alameda for a US Chapter 11 Voluntary Hearing.
— SBF (@SBF_FTX) November 11, 2022
The impact of the FTX crash on consumers is devastating. Court documents show that the FTX Group may have “more than a million creditors in these Chapter 11 cases” and legal experts say many clients may never get their money back. Following the departure of Bankman-Fried, FTX appointed John J. Ray III, the lawyer who led the liquidation of Enron Corp. after her death, to oversee the bankruptcy proceedings.
Fallout in Washington DC
Over the past few years in Washington, cryptocurrency regulation has been largely considered a “pre-partisan” issue that cuts across political lines in a way that few issues can. Legislators, regulators and industry representatives are widely acknowledging that crypto and blockchain technologies do not fit into existing regulatory structures, leaving much of the industry in a regulatory gray area and leading to what many see as regulation through enforcement. These complaints have prompted lawmakers to push for new legislation aimed at clarifying the rules of conduct for cryptocurrencies.
While many smaller pieces of legislation have been proposed, there are two major pieces of legislation that aim to bring clarity to the crypto industry. The Lummis-Gillibrand Responsible Financial Innovation Act delimits jurisdiction over digital assets between the Securities and Exchange Commission (SEC) and the Commodity and Futures Trading Commission (CFTC), allows exchanges to register with the CFTC, and sets new requirements for stablecoin providers, among other things. . The Digital Goods Consumer Protection Act (DCCPA) will give the CFTC exclusive jurisdiction over digital goods trading, require exchanges to register with the CFTC and, among other things, establish new disclosure requirements for digital goods brokers.
Related: Senator Lummis: My proposal with Senator Gillibrand gives the SEC the power to protect consumers
The DCCPA is sponsored by the chairman and senior member 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 adjourned, it is unlikely that any of these bills will be passed before the end of the year. But lawmakers have made clear their intention to revisit the issue next year, and the collapse of FTX has only increased the likelihood of legislative action on cryptocurrency.
In addition to comments from the White House and federal regulators, FTX has not been hit by lawmakers. Ohio Democratic Senator Sherrod Brown said Bankman-Fried should be called to testify in the Senate and urged regulators to “crush” the industry. Massachusetts Democratic Senator Elizabeth Warren, who has historically been a critic of crypto, said the industry has basically been “smoke and mirror” before calling for increased regulation.
The collapse of FTX should be a wake-up call to Congress and financial regulators to hold the industry and its leaders to account.
Too much of the crypto industry is smoke and mirrors. It’s time for stricter rules and tougher enforcement to protect ordinary people.
— Elizabeth Warren (@SenWarren) November 11, 2022
Other members of Congress spoke at greater length in their comments on FTX. “Oversight is one of the most important functions of Congress and we need to get to the bottom of this for FTX clients and the American people. It is critical that we hold bad actors accountable so that responsible players can use technology to create a more inclusive financial system,” said Rep. Patrick McHenry of North Carolina. Senators Debbie Stabenow of Michigan and John Boozeman of Arizona, who are the original sponsors of the DCCPA in the Senate, cited the collapse of FTX as evidence why Congress should pass their bill.
The industry has also rallied around FTX to achieve greater regulatory clarity. Coinbase CEO Brian Armstrong wrote an op-ed on the day FTX filed for bankruptcy, calling for prudent 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 this from happening again,” Armstong wrote. “The US now has a choice: take the lead with clear, business-oriented regulation, or risk losing a key driver of innovation and economic equality.”
It is likely that Congress will take action to regulate cryptocurrencies next year. The collapse of FTX makes this almost true.
As lawmakers ponder how to prevent the next FTX, it is imperative that they avoid the pitfalls of panic policy. As many have pointed out, FTX’s misconduct and subsequent crash is not unique to crypto. Experts were quick to draw comparisons with Enron and Lehman Brothers. As happened after these incidents, Congress must first investigate FTX and then pass legislation that would increase transparency and close the loopholes that allowed FTX to operate the way it did.
Related: Will SBF be penalized for mismanaging FTX? Do not count on it
Until now, Congress and federal regulators have been unable or unwilling to provide clear rules for the crypto industry. But we have also seen instances where badly drafted law created more confusion than clarity. The impracticable vague definition of a broker in the Infrastructure Investment and Jobs Act exists and has yet to be corrected.
As legislators develop and revise cryptocurrency-focused legislation, it is important that any proposal be narrowly tailored to address specific issues in a particular context. For example, custodial and non-custodial wallet services operate differently and should be regulated differently. More importantly, legislators should not confuse applications with the protocols they operate on.
Let’s hope Congress avoids a moral panic and seizes the current momentum to develop legislation that provides regulatory clarity for cryptographic applications without hindering innovation. American buyers and innovators should expect nothing less.
Luke Hogg is a policy manager at the non-profit Lincoln Network, where he focuses on the intersection of new technologies and public policy.
The opinions expressed are solely those of the author and do not necessarily reflect the views of . This article is for general informational purposes and is not intended and should not be taken as legal or investment advice.