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Will the collapse of FTX lead to better regulation of cryptocurrencies?

Will the collapse of FTX lead to better regulation of cryptocurrencies?

On Tuesday, November 22, the first hearing on the bankruptcy case of the FTX cryptocurrency exchange took place. One of the lawyers representing the company, James Bromley, was forthright. “You are witnessing what is probably one of the most dramatic and severe collapses in the history of corporate America,” he said in a Delaware courtroom. He described FTX as a “personal fiefdom” of its co-founder and former chief executive Sam Bankman-Freed, and said that a significant portion of FTX’s assets had been “stolen or missing.” The comments come five days after John J. Ray III, FTX’s new CEO, filed a filing in Delaware federal bankruptcy court in which he echoed the same sentiment. “Never in my career have I seen such a complete failure of corporate control and such a complete lack of reliable financial information as here,” Ray wrote in a statement. “From compromised systems integrity and misguided regulatory oversight across borders to the concentration of control in the hands of a very small group of inexperienced, inexperienced and potentially compromised individuals, this situation is unprecedented.” (“I wish I had been more careful,” Bankman-Fried wrote in a letter to former employees on the day of the hearing, apologizing for the collapse of FTX. “I deeply regret my mistake.” However, the former CEO argued that if he didn’t succumb to pressure to file for bankruptcy, he could have saved the company.)

The valuation carries a lot of weight, coming from Ray, who over the course of his 40+ year career presided over some of the most high-profile corporate bankruptcies in recent history. He oversaw the liquidation of energy trading firm Enron after its collapse in 2001 and oversaw the bankruptcies of Canadian telecommunications company Nortel and subprime mortgage provider Residential Capital. His report is a scathing indictment of FTX executives, including Bankman-Fried, but it can also be seen as an indictment of the security measures that are supposed to keep markets safe for ordinary people. It will take months, if not years, to fully understand what went wrong at FTX and related companies and why. But two things could emerge from the FTX crisis that could turn a tragic situation into a learning opportunity, and could also reduce the likelihood of similar corporate failures in the future. First, in the future, investors may be more wary of potential crypto investments, as well as the aggressive marketing and false promises that often accompany them. Secondly, the regulation of digital assets may finally become clearer and more stringent. “Whenever your business fails, as the facts emerge, lessons are usually learned that can inform other companies in the industry, as well as the general public, about what the risks are and how similar risks can be avoided in the future.” . Deborah Meshulam, partner at DLA Piper and former SEC official, said. “We are at the very beginning of the journey.”

The crypto industry and its US regulators have been in a cold war for several years now. Dozens of new digital currencies and companies have been launched, and agencies in charge of overseeing the markets have struggled to keep up. More than thirteen years after Bitcoin was first released, there is still no centralized regime to regulate the industry. “The state of regulation in the US is multifaceted,” Meshulam told me diplomatically. “You do have a number of different regulatory regimes that deal with different aspects of digital asset activity. And you have them at the federal level and at the state level.”

Digital assets consist primarily of coins, tokens, and currencies such as bitcoin and ether, which are created using cryptography technology and whose transactions are recorded on the blockchain, a decentralized e-ledger that is theoretically transparent to everyone – sort of like a giant table in the sky. Many cryptocurrencies are traded on specialized platforms such as FTX. The best-known of the regulators that oversee cryptocurrencies and other digital assets is the SEC, which has taken the stance that most digital assets are offered as securities, making them subject to U.S. securities law and generally requiring them to be registered with the SEC. before selling to the public. However, instead of publishing a list of attributes that the SEC believes result in an asset being classified as a security, the agency’s opinion has been communicated through multiple channels in a less than accurate manner, at least according to some in the crypto industry. And every time something is not clearly defined, it provides an opportunity for various market participants to claim that the rules do not apply to them.

One way the SEC communicates its interpretation of existing rules to the public is by taking enforcement action, usually by suing companies or individuals and charging them with conducting an “unregistered securities offering” or committing fraud. The agency has filed a number of allegations against crypto firms in recent years, including against Kik Interactive, which the agency accused in 2019 of violating securities laws by issuing unregistered tokens. (The agency won the case and Kik had to pay a $5 million fine.) one hundred and seventy-one original buyers worldwide to raise money. (In the settlement, the company agreed to return $1.2 billion to investors and pay a civil penalty of $18.5 million.) A high-profile case involving similar allegations against Ripple Labs, which issued a token called XRP, has yet to be solved. (“Like a hammer that wants everything to be a nail, the SEC keeps everything in a fog to be able to claim that every cryptocurrency is a security,” wrote Stu Alderothy, Ripple’s general counsel this summer.) If the SEC loses the Ripple case, this will be a major setback in his efforts to establish that most tokens are securities that he should keep an eye on.

The Commodity Futures Trading Commission, which regulates derivatives markets, also has certain powers over digital assets, which it classifies as “commodities” rather than securities. In the crypto industry, the CFTC has so far been seen as more lenient than the SEC, and many in the industry would prefer to have power over business consolidated under the CFTC. The Responsible Financial Innovation Act was introduced to Congress last June and proposes to clarify and streamline the division of responsibilities between the two agencies. Senator Cynthia Lummis, a Wyoming Republican who co-sponsored the bill with Senator Kirsten Gillibrand, a New York Democrat, recently tweeted that the FTX collapse would not have happened if their bill had already been passed.

According to the bankruptcy court filing, FTX consisted of four business groups: a division comprising FTX US, a US-registered exchange where US residents could trade digital assets and tokens; Alameda Research LLC is essentially a cryptocurrency-focused hedge fund; a group of venture investment companies; and another group based around FTX.com, a cryptocurrency exchange based outside of the US. They were all controlled by Bankman-Fried, with small minority interests owned by FTX co-founder Zixiao (Gary) Wang and former CTO Nishad. Singh.

As more details emerge about the Bankman-Freed empire and how it was run, the argument for stricter regulatory and legislative action may gain more support. There was no proper “monitoring of payment” of FTX expenses, Ray wrote in the lawsuit, noting that FTX employees “submitted payment requests via an online ‘chat’ platform where a disparate group of executives approved payments by responding with personalized emojis. “There was no centralized control over the company’s cash. FTX Group corporate funds were used to purchase real estate in the Bahamas, where the company was headquartered, for employees and consultants. Reuters reported that FTX, Bankman-Fried’s parents and company executives bought $121 million in real estate, mostly “luxury beachfront homes.” (FTX, Bankman-Fried and company executives did not respond to Reuters requests for comment. A spokesman for Bankman-Fried’s parents said they were trying to reclaim FTX’s property prior to filing for bankruptcy. Separately, James Bromley, an FTX Attorney, said Tuesday the company spent $300 million in the Bahamas, buying homes and vacation properties for their executives.)

According to Ray, the FTX Group did not maintain appropriate ledgers and records or security controls for its digital assets. Bankman-Fried used an automatic deletion app to communicate with employees and encouraged them to do the same. Those in charge of the bankruptcy were unable to find out who even worked for the company due to its “obscure records and lines of responsibility”. Ray also said that the company’s available financial statements – the company was unable to find reports for two of its four business groups – should not be trusted; one of the accounting firms that have worked on them is called Prager Metis, and its website describes it as “the first CPA firm to officially open its Metaverse headquarters on the Decentraland metaverse platform.” (In a statement to Bloomberg Tax, Prager Metis defended its financial statements by saying they were “fairly reported.”) To add another dark comedy to the situation, Ray says that at least $372 million in “unauthorized transfers” of FTX digital assets and another three hundred million dollars of unauthorized minting of an FTX-issued token called FTT occurred on the day the bankruptcy filing was filed, suggesting that other crypto market participants were ready to take advantage of the FTX mess. In response, the company hired forensic analysts, investigators and cybersecurity experts to try to identify those responsible for the potential theft of assets, as well as investigate what could be a “very substantial transfer” of FTX ownership in the days leading up to the bankruptcy. FTX is estimated to owe nearly $3.1 billion to the top 50 creditors, including clients who lost money in their accounts. But the real numbers could be even higher. According to Ray, “Debtors has discovered and protected only a subset of FTX Group’s digital assets that they hope to recover.” ♦

Written by khirou

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