Wake up call

Did FTX Ruin Crypto?

Read time 3 minutes

WAKE UP CALL – Did FTX Ruin Crypto?

19/01/2023

The fall of FTX has implications that extend far beyond that firm and its colorful personalities.  Regulators who once approached the industry with caution now face increasing calls to take action.  That raises an important question: How will the FTX debacle impact regulation, enforcement, and corporate practices in 2023?

Regulation and Enforcement

The crypto space has long-enjoyed a relatively hands-off approach from regulators. While lawmakers and regulators debated which agency and regulations were best suited to police digital assets, many in the industry operated under the naïve assumption that being based in a friendly jurisdiction would shield them from aggressive U.S. enforcement.

FTX’s decision to set-up shop in the Bahamas will not materially aid them in escaping U.S. criminal and regulatory enforcement

This unbounded optimism came to an abrupt end with the collapse of cryptocurrency platform FTX, which confirmed the fears of many in the public that crypto was a “scam” and has heightened calls for aggressive regulation of digital assets. Regulators and lawmakers who may have once been concerned that new regulations or aggressive enforcement might slow growth and innovation in this space now face pressure to ensure that retail investors do not fall victim to the “next FTX.”

In the United States, we expect the Securities and Exchange Commission (“SEC”) to take a leading role. The industry’s preference that the Commodity Futures Trading Commission (“CFTC”) take primary control will likely be disregarded, and we expect to see increased criminal enforcement, starting with the players at FTX and Alameda Capital.

One key lesson the industry will learn in 2023 is that FTX’s decision to set-up shop in the Bahamas will not materially aid them in escaping U.S. criminal and regulatory enforcement. If you defraud people in the United States, the United States government has the authority to make you pay the price for doing so.

I don’t mean to suggest that an entity’s decision to set up shop in a particular jurisdiction does not have consequences. Certainly, some regulatory requirements are more easily enforced against corporations that are incorporated or headquartered in a particular jurisdiction. That does not mean that bad actors will be able to evade enforcement of serious wrongdoing.

Expect increased self-regulation by industry players and more scrutiny by investors, vendors, and customers

I expect the United States to work in conjunction with regulators in the Bahamas and other nations to investigate and ultimately bring enforcement actions against individuals involved in the FTX debacle. I believe this will lead to increased international cooperation, and ultimately more enforcement worldwide.

The industry has long decried “regulation by enforcement,” but that is what they are going to get in the short-term. Over time, a more robust regulatory regime will be rolled out. Until then, expect increased self-regulation by industry players and more scrutiny by investors, vendors, and customers.

Increased Scrutiny into Books and Records.

Shortly after taking over as CEO of FTX, John Ray III – no stranger to corporate failures, he led Enron through its bankruptcy proceedings – stated in a filing that he had never “seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.” Major corporate decisions, including requests for large disbursements, were made by a disparate group of supervisors through an on-line chat platform and approved via emoji. Former CEO Sam Bankman-Fried encouraged his employees to use applications that were set to auto-delete communications after a short period of time.

In the wake of the FTX debacle, you can expect increased caution from investors, customers, and vendors

Obviously, most players in the crypto space do not conduct their business in this manner. But in the wake of the FTX debacle, you can expect increased caution from investors, customers, and vendors who will now demand documentation and will not take counterparties at their word.  For example, venture capitalists will be wary of investing in crypto firms, and this decrease in confidence in the industry will be met with a corresponding increase in requests for due diligence before investing. Crypto firms should be prepared with financial documentation.

CONCLUSION

The collapse of FTX should serve as a wake-up call for crypto firms that have taken on excessive regulatory risk and lack adequate documentation. It is time to revisit regulatory compliance and corporate controls from top to bottom.

Meet the author

MEET THE AUTHORS

2 Articles

Renato Mariotti

Partner, Chicago