Massive FTX failure sparks fresh calls for new crypto rules

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Massive FTX failure sparks fresh calls for new crypto rules

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The stunning fall of major cryptocurrency exchange FTX is prompting fresh calls among both longtime skeptics and some industry heads for tougher government oversight of the volatile and less-regulated world of digital currencies.

With the demise of FTX threatening to leave scores of customers empty-handed and torpedo crypto’s chances of gaining mainstream acceptance, some of the industry’s major players are mounting an effort to regain public trust by signaling increased openness to transparency and government regulation.

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“Regulators, rightfully, will scrutinize this industry much, much harder, which is probably a good thing to be honest,” Changpeng Zhao, the CEO of Binance (the biggest crypto exchange in the world), said on Nov. 11, the day FTX declared Chapter 11 bankruptcy.

“Short-term, it’s very painful for retail investors,” Zhao said, per CNN. “We feel that pain. But longer-term, this is another wakeup call to say, ‘Look, we are in a new industry. There are a lot of risks and we need to learn how to deal with these risks.’”

Meanwhile, several other crypto exchanges announced that they would be voluntarily releasing audits from third parties in the wake of the FTX disaster.

The attempt by Zhao and others within the crypto sphere to show support for oversight comes as some in the industry draw comparisons between FTX’s downfall and the implosion of investment banking giant Lehman Brothers during the 2008 financial crisis. That underscores concern among crypto’s biggest believers about the ripple effects that FTX’s failure could have on the viability of the industry as a whole. Already, the value of popular cryptocurrencies has taken a hit.

“The fall of FTX could be the moment that really kicks off the broader decline — maybe even demise — of cryptocurrency,” James Royal, a senior investing reporter at Bankrate, told CNBC.

It also suggests that FTX’s collapse, among other things, could at least somewhat shift attitudes both within and outside the industry toward regulation, increasing the likelihood of stricter rules in the years to come — and permanently reshaping the crypto landscape as a result.

“FTX was fine until it wasn’t,” Mark Hays, a senior policy analyst at Americans for Financial Reform, said in a statement. “This is yet another example of digital asset firms learning the hard lessons of the past one hundred years of financial crises and regulatory reforms. If the digital asset industry has a real future, they must meet at least the minimum safeguards which exist for traditional financial institutions so as to prevent or mitigate such fiascos.”

“Pretending that the industry can dictate its own standards only puts consumers, investors, and financial markets at more risk,” Hays added.

Sen. Elizabeth Warren (D-MA), a fierce crypto critic, said the “implosion of FTX must be a wake up call for Congress and financial regulators to hold this industry and its executives accountable.”

“Too much of the crypto industry is smoke and mirrors,” she tweeted. “It’s time for stronger rules and stronger enforcement to protect ordinary people.”

Crypto platforms, like traditional financial institutions, are already subject to some oversight from the Securities and Exchange Commission, the Treasury Department, and other government bodies. The White House also released a new regulatory framework in September.

Nevertheless, the crypto world has been rocked by instability this year that has evaporated trillions in market value, erasing some everyday investors’ savings and retirement funds. In the spring, digital currency markets crashed as the value of popular cryptocurrencies such as Bitcoin and Ethereum plunged.

And as cryptocurrency activity has spiked in recent years, so has crime, with the number of illicit cryptocurrency transactions jumping from $7.8 billion in 2020 to $14 billion last year, according to one report.

“Even after a decade of efforts aimed at figuring out how to regulate cryptocurrencies effectively, the United States and other countries continue to struggle to enforce their own regulations due to the inconsistency of international regulations and the ease with which criminals can create new cryptocurrency wallets and accounts when theirs are targeted by law enforcement,” Josephine Wolff, an associate professor of cybersecurity policy at Tufts University, wrote in a blog post for the Brookings Institution last month.

FTX’s meltdown happened in the course of a week. Amid concerns about the firm’s financial health (in part sparked by Zhao, who tweeted on the morning of Nov. 6 that Binance was liquidating its remaining FTX token holdings “[d]ue to recent revelations”), customers began frantically withdrawing their assets from FTX.

Sam Bankman-Fried, the exchange’s 30-year-old founder and until recently its CEO, told staff that there were approximately $6 billion in withdrawals in the days that followed — which was far higher than normal and sparked a liquidity crisis, Reuters reported. More recently, Bankman-Fried told Vox that he needed to raise $8 billion to repay account holders.

Bankman-Fried has now lost the vast majority of his billion-dollar empire, and both he and FTX reportedly face investigations from the SEC, the Department of Justice, and other authorities.

“Part of the reason FTX was able to do what it did was because it operates in the Bahamas, a tiny island country with very little regulatory oversight and ability to oversee financial services businesses,” Brian Armstrong, the CEO of Coinbase, another online exchange platform, wrote in a Nov. 11 op-ed for CNBC.

“Instead of putting in place clear guidelines for crypto, U.S. regulators have focused on regulation by enforcement — going after U.S.-based companies for not following the rules without actually establishing what those rules are,” he added.

“All of this helps explain why more heavy-handed regulation would just make the problem of crypto companies and crypto users going overseas worse,” Armstrong said. “Instead, we need smarter regulation that protects consumers and makes the U.S. a more attractive place for crypto companies to operate.”

Zhao has previously backed some form of added regulation, provided it doesn’t prevent the industry from expanding.

“Over-regulation or poorly designed regulation will kill the industry in the local market, and hence make the local market miss out on the next FinTech evolution,” Zhao wrote in a blog post earlier this year. “But good regulation that has been carefully designed and tailored will allow the industry to grow faster, not slower.”

But there is reason to doubt how serious cryptocurrency executives are about embracing regulation.

Exchanges such as Binance and Coinbase have themselves been the subject of investigations into their compliance with anti-money laundering rules. Last month, Reuters also reported that Zhao had approved a plan to avoid scrutiny from regulators.

Consumer advocacy groups such as Americans for Financial Reform and crypto critics in Congress have also accused the industry of spending millions on lobbying and campaign contributions to friendly lawmakers to ensure that if new regulatory legislation does pass, it is too weak to truly keep the industry in check.

“Regulators should be on high alert should they need to intervene if these problems in the crypto markets grow larger,” Hays said of the FTX debacle. “However, policymakers shouldn’t rush to offer half-baked solutions.”

He cited a bill introduced by Sens. Debbie Stabenow (D-MI) and John Boozman (R-AR) that would bring some new oversight to digital assets.

“We’re concerned that the bill, which was heavily influenced by crypto industry lobbying, could actually usher in a weak regulatory framework for digital assets that would fail to adequately protect consumers and investors and might instead legitimize questionable crypto business practices and models not unlike what we’ve seen today,” Hays said.

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In any case, the recent implosion of FTX and its aftershocks are likely to send lawmakers back to the drawing board for now, Politico reported, delaying movement on the bill or any others as the dust settles.

“D.C. is not a very forgiving town and people tend to have long memories,” Gabriella Kusz, the CEO of the Global Digital Asset and Cryptocurrency Association, told Protocol. “Integrity is very hard to build and very easy to lose.”

© 2022 Washington Examiner

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