Expert: FTX fiasco means the crypto industry is about to face consequences in Washington, D.C.

On November 11, when Veterans Day was celebrated across the United States, Sam Bankman-Fried (SBF) announced that FTX, one of the world's largest cryptocurrency exchanges by trading volume, filed for bankruptcy. Lawmakers and pundits were quick to seize on the swift breakup of FTX, calling for more regulation of the crypto industry. White House press secretary Karine Jean-Pierre said: "Recent news further underscores these concerns [about consumer harm] and highlights why prudential regulation of cryptocurrencies is indeed needed."

It is unclear exactly what happened to FTX. Reports that $1 billion to $2 billion in client funds have gone unaccounted for are deeply disturbing. Widespread signs of consumer harm and corporate misconduct will only increase the likelihood that Congress will act to regulate the cryptocurrency industry. As Congress seeks to reform the regulatory environment for cryptocurrencies, it is important that lawmakers provide regulatory transparency without hindering positive innovation.

It is still unclear exactly what happened to FTX. Reports that $1 billion to $2 billion in client funds have gone 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 seeks to overhaul the regulatory environment surrounding cryptocurrencies, it is important that lawmakers provide regulatory transparency without hindering positive innovation.

FTX event sorting

SBF was once the golden boy of the crypto world. He started his career in traditional proprietary trading at Jane Street and left Wall Street in November 2017 to found Alameda Research, a quantitative trading firm focused on cryptocurrencies. Three months later, he became famous as the first person to arbitrage the difference between bitcoin prices in Japan and the United States, and he and his team are said to be making $25 million a day. Just over a year later, he founded FTX. Just look at the now-deleted profile of SBF that Sequoia Capital (which invested $214 million in FTX) praised to see that many consider him a financial guru.

SBF eventually left Alameda to focus on FTX while retaining a substantial stake in the fund. FTX has rapidly grown into one of the largest cryptocurrency exchanges in the world, with revenue growing over 1,000% between 2020 and 2021. In January, FTX was valued at $32 billion. But on Nov. 2, leaked documents revealed that Alameda Research held a large amount of FTX tokens. Four days later, Changpeng Zhao (CZ), CEO of rival Binance, tweeted that Binance would liquidate approximately $2.1 billion worth of FTT. CZ’s statement, combined with concerns about illiquidity, led to a typical bank run on FTX.

Faced with a liquidity crisis, FTX and Binance reached an acquisition agreement. However, Binance withdrew from the deal “as a result of the company’s due diligence.” Over the next 48 hours, SBF dropped the "good assets" guarantee, asked investors for $8 billion to save his company, and offered an apology.

On November 11, SBF announced that FTX, FTX.US, Alameda Research and about 130 other affiliated companies had filed for bankruptcy protection.

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 bankruptcy cases, with legal experts claiming that many clients may never get their money back. After SBF left, FTX appointed John J. Ray III, who had managed the liquidation of Enron after its collapse, to oversee the bankruptcy process.

Fallout spreads to Washington, D.C.

Over the past few years, in Washington, cryptocurrency regulation has largely been considered a “nonpartisan” issue, with few issues crossing political lines as much as it does. Lawmakers, regulators and the industry generally acknowledge that cryptocurrencies and blockchain technology do not fit within existing regulatory structures, leaving much of the industry in a regulatory gray area, leading many to complain about regulation through enforcement. These complaints have led lawmakers to push for new legislation aimed at clarifying the rules of the road for cryptocurrencies.

While a number of smaller pieces of legislation have been proposed, two major bills seek to provide transparency to the crypto industry. The Responsible Financial Innovation Act proposed by Lummis-Gillibrand delineates the jurisdiction of the Securities and Exchange Commission (SEC) and the Commodity and Futures Trading Commission (CFTC) over digital assets, allows exchanges to register with the CFTC, and regulates stablecoins. Providers come up with new requirements. The Digital Commodities Consumer Protection Act (DCCPA) would grant the CFTC exclusive jurisdiction over digital commodity transactions, require exchanges to register with the CFTC, create new disclosure requirements for digital commodity brokers, and more.

The DCCPA was sponsored by the chairmen and chairmen of the House and Senate Agriculture Committees, which have jurisdiction over commodity markets, with only minor differences between the House and Senate versions of the bill.

With Congress in recess, 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 has only increased the likelihood of legislative action against cryptocurrencies.

In addition to comments from the White House and federal regulators, lawmakers have not backed down on FTX. Senator Sherrod Brown, D-Ohio, said the SBF should be subpoenaed to testify before the Senate and urged regulators to "crack down" on the industry. Senator Elizabeth Warren (D-Massachusetts), historically critical of cryptocurrencies, said the industry was mostly "smoke and mirrors" before calling for more regulation.

Other members of Congress made more subtle comments about FTX. “Oversight is one of the most critical functions of Congress, and for FTX’s clients and for the American people, we must get to the bottom of this matter. We must hold bad actors accountable so responsible actors can use technology to build a more An inclusive financial system," said Rep. Patrick McHenry of North Carolina. Senators Debbie Stabenow of Michigan and John Boozman of Arizona, the original sponsors of DCCPA in the Senate, pointed to the FTX debacle as evidence that Congress should pass its bill.

The crypto industry has also rallied around the FTX incident to push for more regulatory transparency. Coinbase CEO Brian Armstrong published an article on the day FTX filed for bankruptcy, calling for proper regulation of the exchange. "It's also important to understand why this happened, and what changes we need to make if we want to prevent something like this from happening again," Armstrong wrote. "Now, the United States faces a choice: be the first to provide clear, regulation of business development, or risk losing the key drivers of innovation and economic equality."

future outlook

Congress is likely to act to regulate cryptocurrencies within the next year. The FTX debacle made it all but a foregone conclusion.

As lawmakers weigh how to prevent the next FTX, it is critical that they avoid the pitfalls of panic-driven policy. As many have already pointed out, FTX’s misconduct and subsequent collapse are not unique to the crypto industry. Experts were quick to compare it to Enron and Lehman Brothers. As has happened since these events, Congress should first investigate FTX and then enact legislation to increase transparency and close the loopholes that allow FTX to function as it does.

So far, Congress and federal regulators have been unable or unwilling to provide clear regulation for the crypto industry. But we've also seen examples where poorly drafted legislation has created more confusion than transparency. An example is the vague definition of a broker in the US Infrastructure Investment and Jobs Act, which has not yet been amended.

As lawmakers iteratively draft legislation targeting cryptocurrencies, it is critical that any proposal be strictly focused on a particular issue in a particular context. 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 on which they operate.

Hopefully the U.S. Congress can avoid a moral panic and use the current momentum to enact legislation that would provide regulatory transparency for crypto applications without hindering innovation. American consumers and innovators should expect that.