Disclaimer: This article was written the first part of December 2022. Given the rapid pace at which new pieces of information are being uncovered on the FTX case, there is a potential impact on the views expressed due to different angles and perspectives about this case.
Editor’s note: Since the writing of this article, FTX co-founder and CEO, Sam Bankman-Fried has been arrested and indicted on eight counts of conspiracy to commit wire, securities, commodities fraud, money laundering and conspiracy to defraud U.S. campaign finance regulations.
The FTX story indeed unravels like a proper telenovela, where each and every day brings its share of new twists to the plot.
The latest twist is the series of video interviews Sam Bankman-Fried gave to several large media and during which, to summarize, he essentially explains that he had no idea of what was going on within his own company nor, consequently, of its extent. This seems completely surrealistic coming from the founder and CEO of FTX, who dealt with billions of dollars in customers' assets and the co-founder of Alameda Research, the other company which seems to be mainly responsible for the mismanagement of these funds.
In the last few weeks since the FTX news broke, I have kept receiving messages from connections, essentially stating how awful and destructive this situation was and would be for the whole crypto industry.
The media and my LinkedIn feed (and I bet yours too!) has allowed us all to receive feedback, takeaway and theories from almost everyone. The feedback and comments range from crypto experts, investment bankers to lawyers.
I am not a crypto expert and my take on the matter is slightly unorthodox—at least until now. I believe the FTX crash is actually good news for the crypto ecosystem. This article will outline my thoughts on why.
Events That Occurred
On October 11, 2022, FTX, one of the largest crypto exchanges globally, went bankrupt, potentially dragging up to 100,000 creditors in its fall.
Little by little we are discovering the extent of the chaos created by Sam Bankman-Fried, who, a few weeks ago, was still considered the "white knight of cryptos."
For several months, doubt has been spreading on the solvency of FTX, doubt validated by Changpeng Zhaopar (also known as “CZ”), the boss of the world's leading crypto exchange platform (Binance), whose opinion holds weight. FTX customers want their assets back, but they are no longer with FTX.
In addition, we learned that some of the FTX customers’ assets have been used by another company created by Bankman-Fried’s Alameda Research. The other portion was siphoned off by a hack the day after the bankruptcy.
The Enron’s Analogy
Given the scale of the disaster, the deep roots of FTX in the crypto ecosystem, and the implications in terms of governance, many have rightly referred to the similarity of this situation to the infamous Enron affair in the early 2000s.
Nevertheless, I would argue that although the FTX case is certainly a textbook case in terms of everything an organization should not do when it comes to proper governance, it is slightly different than Enron.
Indeed, Enron was a listed energy-trading and utility company and had to abide by strict and well-defined requirements with regard to accounting, financial reporting and many other elements.
Consequently, the requirements for Enron’s audits (both from a regulatory and internal perspective) were rather clear, and ultimately, so were the reasons for the auditors' failure, i.e., an accumulation of negligence and deception at different levels (the Securities Exchange Commission, credit rating agencies and investment banks).
But in FTX’s case, the issue is slightly deeper. There are no clear and consistent regulatory requirements for virtual asset service providers (VASPs) in the U.S. when it comes to the companies' reserves or the safeguarding of the client's funds, and that is why, in my opinion, the Markets in Crypto-Assets (MiCA) is a much welcome piece of regulation for the E.U.1
Hypothetically speaking, would MiCA have been able to mitigate an FTX case? Again, in hypotheticals, the answer would be yes for the following reasons outlined next in the article.
MiCA foresees the harmonization and strengthening of the rules on registration and authorization to operate for VASPs.
This notably means deeper and more formal (fit and proper) checks on their ultimate beneficial ownerships, more substantial capital requirements, and the need for a solid risk management framework, particularly for anti-money laundering/counter-terrorist financing (AML/CTF) to be in place.
Capital Reserves, Safeguarding of Funds and Insolvency
MiCA also provides for several proper prerequisites when it comes to VASPs’ capital reserves, safeguarding of funds and insolvency.
This aims at making sure these entities are not out of control with their clients' funds, and when and how these funds are being safeguarded.
This also provides certain levels of guarantee as to the level of liquidity that needs to be secured by the VASPs regarding their clients’ funds, which is something that certainly was disregarded in the FTX case.
Finally, MiCA contains numerous provisions aimed at ensuring consumer protection.
These make it de facto much more difficult to deceive or even defraud customers and, even if this were to happen, the penalties would be more severe.
Even with MiCA, Europe is not immune to seeing similar FTX scandals happening on European soil; however, we can have some level of confidence that MiCA should reduce the risk of occurrence and, if or when this happens. Moreover, MiCA also provides a more structured framework in terms of sanctions and penalties for the concerned companies and a more solid layer of protection for consumers and their funds.
Now let us all bear in mind that MiCA is not there yet. Meanwhile, although the first layer of protection (at least from an AML/CTF point of view) already applies rather consistently through the Sixth AML Directive across the EU, an FTX-like drama could well be uncovered on this side of the Atlantic. For example, the recent case of two Estonian citizens arrested for a $575 million cryptocurrency fraud and money laundering scheme reminds us of this.
FTX has been (and will remain) an eye-opening event to the fact that crypto is certainly a fascinating ecosystem in terms of innovations and opportunities but remains highly unstructured and unregulated for now. Therefore, one must remember that one still ventures into it at one's own risk.
With a little hindsight, this event will push the industry's stakeholders to be more disciplined in terms of internal controls and governance, considering that dramas like FTX can simply undermine user confidence sustainably.
- Kanishka Singh, “Two Estonian citizens arrested in $575 mln cryptocurrency fraud, money laundering scheme,” Reuters, November 21, 2022, https://www.reuters.com/legal/two-estonian-citizens-arrested-575-mln-cryptocurrency-fraud-money-maundering-2022-11-21/