FTX Collapse May Prompt Big Regulatory Crackdown – Lawyer

Editorial Staff 18 November 2022

FTX Collapse May Prompt Big Regulatory Crackdown – Lawyer

As ripples spread from the meltdown of the crypto exchange, a lawyer argues that if the business is found guilty of widespread fraud or failed to stop it, this will boost demands for the whole sector to be more heavily regulated. Swiss bank Julius Baer also said the saga highlighted significant corporate governance failings.

(Updated with Julius Baer reactions.)

The cryptocurrency industry could be hit by a wave of new regulations if it turns out that embattled FTX, which has filed for bankruptcy in the US, is found guilty of widespread fraud or failed to stop it, a lawyer argues.

Reports (Coindesk, 17 November) cited court filings made by the firm’s Bahamian liquidators late yesterday that there were signs that “serious fraud and mismanagement” occurred at FTX.

The implications of such findings, if substantiated, are enormous for the cryptos space, Nicola McKinney, partner at Quillon Law, said in a statement. 

"News that FTX's liquidators have pointed to signs of serious fraud at the exchange is a major and potentially concerning development in the FTX saga. If it emerges that FTX defrauded customers on a major scale, or that there were internal failings which failed to prevent external fraud this will no doubt have drastic regulatory consequences for the entire cryptocurrency industry," McKinney said. 

"The digital assets and decentralised finance industry is already facing calls for regulation from governments and from non-governmental organisations such as the IMF and UN. Should it transpire that FTX committed or failed to prevent fraud, the scope and extent of those failings is likely to take some time to emerge, including the number of potential victims, but it is likely to increase the support for new regulatory regimes to be imposed,” she said. 

Dramatic falls in the prices of “stable-coins” and other crypto entities this year have already prompted regulators around the world to scrutinise the sector. The demise of FTX and the massive losses of its founder, Sam Bankman-Fried, have made front-page news, giving the digital assets space ugly publicity.

Earlier this week news articles alleged that the balance sheet of Alameda, a crypto hedge fund owned by Bankman-Fried, held billions of dollars’ worth of FTX’s own cryptocurrency, FTT, which was used as collateral in further loans. Such an arrangement would mean that a fall in the value of FTT would hurt both businesses. Crucially, FTT had no value beyond FTX’s longstanding promise to buy any tokens at $22, prompting fears that the whole institution had no basis. Matters took a turn for the worse when rival cryptocurrency exchange, Binance said it was pulling out of its deal to purchase FTX Trading. Binance said it had significant concerns about FTX.

"Cryptocurrency is an asset class that has been heavily affected by investment frauds and Ponzi schemes in recent years, however these allegations against FTX are of particular relevance given that the exchange was the third largest in the world at its peak. A clearer picture will no doubt emerge, however the liquidators' findings pose a serious cause for concern for investors, regulators and the wider cryptocurrency market,” McKinney said.

FTX, which operated in The Bahamas through a subsidiary called FTX Digital Markets, declared bankruptcy in the US after media reports said there was a crossover with sister trading firm Alameda Research's financials. This blurring panicked investors, prompting large outflows.

“The Joint Provisional Liquidators’ findings to date indicate that serious fraud and mismanagement may have been committed” with respect to the group, the document filed in the US Bankruptcy Court of the Southern District of New York was quoted by Coindesk as saying. The documents were filed on behalf of Brian Simms, Kevin Cambridge, and Peter Greaves, who have been put in charge of winding up the company’s affairs in the Bahamas.

The saga is also an important moment for The Bahamas, which has been keen to present itself as a compliant regime. Earlier this year, policymakers in the Caribbean jurisdiction lauded 2020 legislation that regulates digital assets. The “DARE” (Digital Assets and Registered Exchanges Act), 2020, has enabled The Bahamas to attain the number one world ranking on Solidus Labs’ recent Global Crypto Index ranking for digital assets regulations that both protect consumers and encourage innovation.

“While the collapse of FTX continues to send shockwaves through the digital asset world, leading to suspensions of withdrawals by lending platforms, crypto markets do not seem to be very surprised,” Carsten Menke, head of next generation research, Julius Baer, said in a note on 18 November. 

“Bitcoin and Ethereum remained very much rangebound during the past few days. That said, amid mounting contagion and shattered confidence, any kind of recovery becomes much less likely. The wounds of this crypto crisis will need much more time to heal, and the long-term potential of digital assets has firmly moved out of focus,” Menke continued. 

“The collapse of FTX continues to send shockwaves through the digital asset world, which is not very surprising, given its reach as one of the world’s largest crypto exchanges and platforms. During the past few days, we have heard about closely related companies and platforms that have run into problem as well.

“Reports have emerged that BlockFi, a crypto lending platform which suspended withdrawals earlier this week, could file for bankruptcy due to significant exposure to FTX. Meanwhile, Genesis Global Capital, another crypto lending platform, also suspended withdrawals, citing ‘unprecedented market turmoil’ after already being affected by the collapse of Three Arrows Capital in June. The parent company of Genesis Global Capital itself is a member of the Digital Currency Group, which is a conglomerate of crypto companies and platforms and thus raised fears of further contagion.

“That said, it does not seem that crypto markets are very surprised by the news. Bitcoin and Ethereum, the two leading coins, remained more or less rangebound since the FTX collapse, as the total market capitalisation of the asset class hovers around the $830 billion level. Some see parallels between the collapse of FTX and the collapse of Lehman Brothers in 2009. We agree, as there are the same kind of interlinkages between market participants as during the Great Financial Crisis. 

“Furthermore, we are also witnessing significant shortcomings in terms of risk management and corporate governance. While today’s phase of the crypto crisis shows clear similarities to the Great Financial Crisis, which culminated in the collapse of Lehman Brothers, initially there were parallels to the dot-com bubble as well, such as the fear of missing out, a high degree of exuberance, and excessive valuations,” he added.

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