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FTX: How to Prevent a Similar Dumpster Fire

4 mins
Updated by Ryan James
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In Brief

  • Many parts of the digital asset industry operate in regulatory gray zones, prompting lawmakers and regulators to take action.
  • The US Securities and Exchange Commission (SEC) could address the cryptocurrency landscape by classifying most cryptocurrencies as securities, giving them access to regulatory protocols and common laws.
  • The Commodity Futures Trading Commission has established some rules for crypto derivatives, but these only apply to swaps and futures, not commodities.
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Hindsight is 20/20 yet the red lights were obvious. Sam Bankman-Fried’s FTX crypto club for crypto bros was an ill-managed Medusa of companies replete with issues – pooling customer funds alongside its own.

There were little or no administration institutions in place and minimal financial statements were released. However, there were numerous famous figures—loads of well-known personalities. In that regard, FTX had the marketing part nailed.

Yes, we’re looking at you Tom Brady.

This didn’t age well- Source: YouTube

With SBF now facing 30 years in prison on multiple federal charges including wire fraud and money laundering. People are wondering how this could have happened and what steps should be taken to prevent it from recurring.

The revelation of the FTX dumpster fire (which amounts to a good old-fashioned Ponzi scheme) has highlighted the fact that many parts of the digital asset industry have been running blind in hazy regulatory zones. Prompting lawmakers and regulators to call for much-needed regulation.

Protecting Customer Assets

Many cryptocurrency companies have failed due to their failure to protect their customers’ assets. FTX, for instance, lent customer funds to its sister company. The hedge fund Alameda Research (conveniently run by SBF’s supposed girlfriend, Caroline Ellison) – which is technically illegal.

Yet, the Securities and Exchange Commission has a rule in place to protect customers’ assets. However, this doesn’t apply to crypto customer accounts as the industry resists registering with the SEC, arguing that tokens do not qualify as securities.

Gary Gensler, SEC Chair and friend of SBF, has a different opinion. So did his predecessor during the Trump administration, Jay Clayton. Both of them recognize the litmus test from the Supreme Court’s ruling in 1946 that states an asset will be prosecuted by the SEC when people finance a firm with the goal to gain more money from the endeavors of its leadership. In other words, nearly all tokens are securities according to the SEC.

According to James Cox, a Duke University law professor specializing in securities law, Congress could significantly address the cryptocurrency landscape by simply classifying most cryptocurrencies as securities. He states that doing so would give the defined assets access to off-the-rack regulatory protocols, as well as common laws surrounding those rules.

The Commodity Futures Trading Commission has established some rules for crypto derivatives. However, their regulation only applies to swaps and futures — not commodities.

Keep ‘em Separated

Some crypto projects have supplied a wide array of offerings and services that have muddled the rules, adversely impacting customers. Crypto exchanges being the most glaring illustration. These platforms execute various functions, such as market making, trading, custodianship, and securities lending. 

Gensler and his ilk maintain that this system is swarming with contradictions. In stark contrast, typical finance companies that render diverse services usually register their individual business branches under the governing bodies responsible. This must also be practiced in crypto, according to experts.

Open the Books

Exposure to hazards is fundamental to financial direction in US markets. However, these disclosures are mainly non-existent in crypto. Knowledge on dozens of non-US divisions of FTX is almost completely lacking. It is known more about FTX US, the American unit, but determining what still exists is difficult since it was a private company that was privately owned.

Current SEC rules for issuers and financial advisors would decrease the anonymity of crypto, but Congress may have to reinforce them. “I need more knowledge about what created the tokens,” says Reyes from Southern Methodist University, so as to figure out if code writers can control token prices.

Truth in Advertising 

Crypto firms like FTX have thrived by drawing in many individuals through their flashy ads featuring celebrities such as Tampa Bay quarterback Tom Brady and comedian Larry David. This year, crypto businesses aired promotional content during the highly-viewed Super Bowl, which amassed more than 112 million viewers.

The SEC already has regulations forbidding anyone from publicizing securities without divulging how much, if any, payment was received. Notable people such as Kim Kardashian have been fined for

Self-governance Doesn’t Work

One of FTX’s major failings was its complete absence of corporate governance. John Ray III, who is now leading FTX (and also filled a similar role with Enron post-collapse). Warned the Delaware court handling the firm’s insolvency proceedings not to rely on any of their financial statements. Ray also mentioned that most FTX entities had never held board meetings. They were however allegedly very good at stealing investor funds.

Erica Williams, who chairs the SEC’s public accounting board, warned recently that any US government agency cannot legally inspect the audits of private crypto firms such as FTX. In other words, she is suggesting that investors should be wary and ask more questions when dealing with cryptocurrency projects and trading platforms. In effect, the SEC is promoting a buyer-beware program.

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