March 2023 Issue
The so-called ‘crypto winter’ which began in early 2022 continues to grip the global crypto market. In November 2022, crypto exchange FTX filed for Chapter 11 bankruptcy protection in a swift fall from grace. The company plunged from $32bn in value to bankruptcy in a matter of days, dragging founder and chief executive Sam Bankman-Fried’s $16bn net worth to near zero.
Investors and customers have lost billions, not all of which will be recovered, according to John Ray, the new court-appointed chief executive of FTX. This, in turn, is likely to trigger lengthy, costly legal action. On 16 November 2022 a class-action lawsuit was filed in a Florida federal court, alleging that Mr Bankman-Fried created a fraudulent cryptocurrency scheme designed to take advantage of unsophisticated investors.
Hammer blow
FTX’s downfall is significant. Its collapse was a hammer blow to the already volatile crypto market, which globally lost more than $1.4 trillion in value in 2022, dropping below $1 trillion. FTX was the largest collapse in the relatively short history of cryptocurrencies. The platform was the third-largest exchange by volume, and thus its trials and tribulations may deter existing and potential crypto investors due to concerns about the stability and security of cryptoassets.
“It seems certain that tougher guidance, rules, laws and related enforcement action will be forthcoming for the crypto market. Governments will be keen to prevent another FTX-style collapse.”
In the immediate aftermath of FTX’s Chapter 11 filing, crypto lender BlockFi paused client withdrawals amid rumours that it too had an uncertain future. Meanwhile, Crypto.com saw withdrawals increase in November 2022 and Genesis Global Capital halted customer withdrawals from its crypto lending unit.
Regulatory response
Though moves to increase regulation of the crypto space were already being drawn up in a number of jurisdictions, the pace of change may accelerate following the collapse of FTX and its sister company Alameda Research. The event may be a catalyst for legislative bodies to introduce new laws governing digital tokens and exchanges, and to give regulators more power to scrutinise cryptocurrencies and other cryptoassets.
In the US, Gary Gensler, chair of the US Securities and Exchange Commission (SEC), has suggested that much of the broader crypto industry is “non-compliant” with existing regulations. The US Financial Industry Regulatory Authority (FINRA) has begun collecting information about crypto marketing practices, which could result in new policy. Back in March 2022, president Biden issued an executive order on crypto which required federal agencies to report on the industry.
Janet Yellen, secretary of the treasury, noted that “We have very strong investor and consumer protection laws for most of our financial products and markets that are designed to address these risks”, but, in the wake of FTX’s collapse, also called for “more effective oversight of cryptocurrency markets”.
In Europe, once the European Parliament gives final approval to the European Union’s Markets in Crypto Assets (MiCA) bill, it will take 18 months before the regulation takes effect. But following the collapse of FTX, there are suggestions that timeline may be shortened.
The MiCA regulation has been hailed as one of the first attempts at comprehensive regulation of cryptocurrency markets. The bill is wide-ranging, covering money laundering, the environment, corporate reporting and consumer protection. It would require stablecoin issuers to hold enough reserves to prevent their collapse, and oblige crypto miners to disclose their energy consumption. Furthermore, any exchanges that operate in the EU will have to be monitored by a financial regulator from an EU member state. Although the MiCA bill was supposed to be voted into law in early 2023, it may be delayed until the second half of 2024, however.
In the UK, the government has signalled its intention to make cryptoassets a regulated financial instrument.
Conundrum
Existing laws – many of which were written decades ago – are not well-suited to governing cryptoassets and providing recourse for fraud, money laundering and other illicit activities that may take place in these digital markets.
It seems certain that tougher guidance, rules, laws and related enforcement action will be forthcoming for the crypto market. Governments will be keen to prevent another FTX-style collapse.
But the crypto market is a complex, divisive space. It would be easy for regulators, in the aftermath of such a high-profile bankruptcy as FTX, to ‘overregulate’ the industry. Critics suggest politicians may not fully understand its inner workings and struggle to keep pace with its evolution.
Any new regulations will need to be properly calibrated and effective to capture digital trades and transfers that can take place instantly, from practically anywhere in the world. According to JP Morgan, regulatory efforts are likely to focus on custody and protection of customers’ digital assets, the unbundling of broker, trading, lending, clearing and custody activities, and greater transparency such as reporting of reserves, assets and liabilities. It will not be easy.
Efforts to maintain financial stability and protect investors are set to gather momentum throughout 2023 and beyond. The crypto space must be prepared for the next phase of its development. While stricter regulation post-FTX may be inevitable, if it helps to prevent fraudulent activity, that will ultimately benefit the crypto industry, investors and the wider economy.
© Financier Worldwide
BY
Richard Summerfield