FTX fiasco means consequences to come for cryptocurrencies in Washington DC

On Nov. 11, as the rest of the country celebrated 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 cryptocurrency industry. “The most recent news further underscores these concerns [about consumer harm] and highlights why prudent regulation of cryptocurrencies is indeed needed,” said Karine Jean-Pierre, White House press secretary.

It is unclear what exactly happened to FTX. Reports that between $1 and $2 billion of client funds are unaccounted for are deeply troubling. Widespread consumer harms and indications of corporate impropriety only increase the likelihood that Congress will take action to regulate the cryptocurrency industry. As Congress looks to overhaul the regulatory environment related to cryptocurrencies, it is important for lawmakers to provide regulatory clarity without impeding positive innovation.

Anatomy of a collapse

Sam Bankman-Fried was once the golden boy of the cryptocurrency world. Kicking off his career in traditional proprietary trading on Jane Street, Bankman-Fried left Wall Street and founded a cryptocurrency-focused quantitative trading firm called Alameda Research in November 2017. Three months later, he rose to fame as the first to profit significant difference in the price of Bitcoin in Japan and the United States, earning him and his team $25 million a day. A little over a year later, he founded FTX. One has only to read the now-deleted laudatory profile of Bankman-Fried of Sequoia Capital (who has invested $214 million in FTX) to see how many believed him to be a financial expert.

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 cryptocurrency exchanges in the world as revenues grew more than 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 amount of FTX (FTT) tokens. Four days later, Changpeng “CZ” Zhao, CEO of rival exchange Binance, tweeted that his company would liquidate about $2.1 billion in FTT. CZ’s statements coupled with fears of illiquidity led to a classic run on FTX.

Facing a liquidity crunch, FTX and Binance have agreed on an acquisition. But, “as a result of corporate due diligence,” Binance withdrew from the deal. Over the next 48 hours, Bankman-Fried quashed 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 crash on consumers is devastating. Court documents show FTX Group may have “over a million creditors in these Chapter 11 cases” and legal experts have said many customers may never get their money back. After Bankman-Fried’s exit, FTX appointed John J. Ray III—the attorney who handled the liquidation of Enron Corp. after his disappearance—to oversee the bankruptcy proceedings.

Fallout in Washington, DC

In recent years in Washington, cryptocurrency regulation has been widely viewed as a “pre-partisan” issue that crosses policy lines in ways 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 complained is the regulation through application. These grievances have led lawmakers to push for new legislation that aims to clarify the rules of the road for cryptocurrencies.

While there are numerous small pieces of legislation that have been proposed, there are two major bills that seek to provide clarity for the cryptocurrency industry. The Lummis-Gillibrand Responsible Financial Innovation Act outlines digital asset jurisdiction 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 requirements for stablecoins, including other things. The Digital Commodities Consumer Protection Act (DCCPA) would grant the CFTC exclusive jurisdiction over digital commodity exchanges, require exchanges to register with the CFTC, and create new disclosure requirements for digital commodity brokers, among other things.

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

The DCCPA is sponsored by the chairman and ranking 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 shutting down, it’s unlikely any of these bills will pass 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 cryptocurrencies.

Beyond comments from the White House and federal regulators, lawmakers have pulled no punches when it comes to FTX. Ohio Democratic Senator Sherrod Brown said Bankman-Fried should be called to testify before the Senate and urged regulators to “crash down” on the industry. Democratic Massachusetts Senator Elizabeth Warren, a historical critic of cryptocurrencies, 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. “Overseas is one of the most critical functions of Congress and we must go through with it for FTX’s customers and for the American people. It is essential to hold bad players accountable so responsible players can leverage 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, have pointed to the collapse of the FTX as evidence why Congress should pass the bill.

The industry has also rallied around FTX to push for greater regulatory clarity. Coinbase CEO Brian Armstrong wrote an op-ed the day FTX filed for bankruptcy, calling for reasonable regulation of the exchanges. “It’s also important to be clear about why this happened and what needs to change if we are to prevent something like this from happening again,” Armstong wrote. “Now, the United States has a choice: take the lead by providing clear, business-driven regulation, or risk losing a key driver of innovation and economic equality.”

Going forward

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

As lawmakers consider how to prevent the next FTX, it’s imperative to avoid the pitfalls of panic-driven politics. As many have already pointed out, FTX’s irregularity and subsequent collapse is not unique to cryptocurrencies. Experts were quick to draw comparisons with Enron and Lehman Brothers. As happened in the aftermath of those incidents, Congress should first investigate FTX and then produce legislation that increases transparency and closes the loopholes that allowed FTX to operate the way it did.

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

So far, Congress and federal regulators have been unable or unwilling to provide clear rules for the cryptocurrency industry. But we have also seen cases where poorly drafted legislation has created more confusion than clarity. The impractically vague definition of a broker in the Infrastructure Investment and Jobs Act is a case and a point and has yet to be resolved.

As lawmakers draft and reformulate legislation targeting cryptocurrencies, it is essential that any proposal is tightly tailored to address specific problems in a specific context. For example, custody and non-custody portfolio services operate differently and should be regulated differently. Most importantly, lawmakers must not confuse applications and the protocols they run on.

Hopefully, Congress will avoid moral panic and use the current momentum to produce legislation that provides regulatory clarity for cryptographic applications without hindering innovation. American customers and innovators should expect no less.

Luke Hogg is policy officer at the non-profit Lincoln Network, where she focuses on the intersection of emerging technologies and public policy.

Opinions expressed are those of the author alone and do not necessarily reflect the views of Cointelegraph. This article is for general informational purposes only and is not intended to be and should not be relied upon as investment or legal advice.

Leave a Reply

%d bloggers like this: