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FTX failure may strengthen case for more robust crypto regulation

SEC's Gensler says FTX favored 'light touch' proposals

Senate Agriculture Chair Debbie Stabenow, D-Mich., has proposed cryptocurrency legislation that SEC Chair Gary Gensler suggested was 'too light touch' for the industry.
Senate Agriculture Chair Debbie Stabenow, D-Mich., has proposed cryptocurrency legislation that SEC Chair Gary Gensler suggested was 'too light touch' for the industry. (Bill Clark/CQ Roll Call file photo)

The spectacular collapse of major cryptocurrency exchange FTX is prompting calls for stronger regulation in Congress, where some bipartisan proposals are being characterized as too industry friendly.

FTX, where users could buy and sell cryptocurrency, had grown rapidly into a prominent fixture, with a quirky CEO familiar to lawmakers on Capitol Hill. NFL quarterback Tom Brady promoted the exchange in Super Bowl ads as the “safe and easy” way to get into crypto as a skeptical Larry David humorously played the foil. 

The skepticism turned out to be warranted. On Friday, after a tumultuous week, FTX filed for bankruptcy and embattled CEO Sam Bankman-Fried resigned.

Amid the turmoil, members of Congress particularly attuned to crypto called for better protections to prevent runs on crypto companies like this and others.

Sen. Cynthia Lummis, R-Wyo., called the FTX collapse the “clearest example yet of why we need clear rules of the road for digital asset exchanges in the United States.” 

“Market manipulation, lending activity and whether customer funds and assets were appropriately safeguarded are just a few of the many issues my colleagues and I need to consider in the coming days,” Lummis said in a statement. 

House Financial Services ranking member Patrick T. McHenry, R-N.C., said the events showed congressional action is necessary.

“It’s imperative that Congress establish a framework that ensures Americans have adequate protections while also allowing innovation to thrive here in the U.S.,” he said in a statement. 

Lummis is one of several lawmakers with a legislative proposal that aims to create rules for crypto spot trading, the kind in which cash is exchanged for crypto on FTX and other exchanges. Congress has acknowledged that there is not an overarching and centralized regulatory framework in the U.S., while Securities and Exchange Commission Chair Gary Gensler has called for crypto platforms to be registered and regulated like exchanges.

However, not everyone thinks the bills proposed will protect against the kind of failures by FTX and other financial technology firms this year.

Gensler criticized legislation introduced this year by Senate Agriculture Chairwoman Debbie Stabenow, D-Mich., and ranking member John Boozman, R-Ark., that aims to better regulate cryptocurrency by giving the Commodity Futures Trading Commission authority over some of the largest digital commodities, including bitcoin.

Gensler said in an address to the Healthy Markets Association on Wednesday that the legislation was promoted by “the same folks that failed in the last day or two,” referring to FTX and Bankman-Fried, who had encouraged passage of the bill. “And you sort of wonder why,” Gensler said. “Because it was too light touch.” 

Other lawmakers say the SEC should share some of the blame.

“Congress’ failure to pass legislation creating regulatory guardrails for crypto trading, combined with the complete hostility and lack of transparency by @SEC.gov, has generated a debilitating amount of legal uncertainty,” Senate Banking ranking member Patrick J. Toomey, R-Pa., tweeted.

A pullout and a plummet

Crypto news site CoinDesk reported last week that Alameda Research, a trading firm founded by Bankman-Fried, was more financially bound to FTX than previously disclosed, after the site reviewed a private financial document. The report contradicted earlier assurances by Bankman-Fried that there were strict barriers between Alameda and FTX.

Customers began to pull out their money. In lockstep, FTX’s proprietary cryptocurrency, known as FTT, which had been valued at about $22 on Nov. 7, plummeted to about $1.50 as of Monday. 

Bitcoin fell sharply as well over the past week, a drop attributed to the FTX turmoil.

What prompted the run at FTX?

The CEO of Binance, the world’s largest crypto exchange and a rival to FTX that had once been a supporter, tweeted that Binance planned to sell FTT tokens it obtained in compensation for a previous buyout of its FTX stake, over concerns about FTX’s liabilities. 

Binance then offered to buy FTX, but it soon backed out of the deal, saying “as a result of corporate due diligence, as well as the latest news reports regarding mishandled customer funds and alleged US agency investigations, we have decided that we will not pursue the potential acquisition.”

FTX, headquartered in the Bahamas, is being investigated by the Royal Bahamas Police Force, the agency said in a statement. There are multiple reports of U.S. investigations as well. 

Lee Reiners, policy director at the Duke Financial Economics Center in North Carolina, said the situation at FTX was an example of a “classic run.”

“I think I was as surprised as anyone,” Reiners said. “The perception out there was that FTX was on pretty solid financial footing.”

Bankman-Fried is a well-known crypto figure in Washington and has given testimony on Capitol Hill. He had tweeted in the past that he was optimistic about crypto-friendly legislation. 

Bankman-Fried testified at a House Agriculture Committee hearing in May over the company’s proposal to clear crypto trades without a traditional intermediary, which would have needed approval from the CFTC. But he had also sought government approval for a separate business initiative that would have allowed crypto transactions without the protection of an intermediary.

The exchange applied in December 2021 to amend its clearinghouse license to allow cash-settled digital asset products using margin to be traded on the platform, which would have been the first of its kind. On Monday, the CFTC announced that an FTX affiliate had withdrawn this request.

House Agriculture Chairman David Scott, D-Ga., had said at the time that the proposal could be a threat to derivatives markets. 

The reputation of Bankman-Fried is now badly tarnished.

“Sam has lost his luster,” Reiners said. “He has sort of become a darling in D.C. and he played the D.C. game very well.” Any regulatory or policy proposal that Bankman-Fried and FTX were pushing may get a skeptical eye, he said.

As for lawmakers’ hope for progress on crypto rules, many are skeptical.

Ryan Selkis, founder of Messari Inc., a crypto research group, tweeted to his 280,000 followers that the Stabenow-Boozman bill is “dead this year.”

Better Markets CEO Dennis Kelleher, a government watchdog and consumer-focused group, said in a statement that there had been warnings. “The crypto carnage, volatility, and wealth destruction over the last twelve months were red flags of the threats posed to customer protection and systemic stability by cryptocurrency investments generally,” he said.

Robert Weissman, president of consumer advocacy group Public Citizen, said the CFTC and the SEC should scrutinize the aftermath of FTX “to ensure as little additional damage is inflicted on real people as possible.” 

“At this moment, Congress needs to take heed and ensure it doesn’t let a failing, scam-based industry lobby its way to a legislative bailout,” Weissman said in a statement. 

Bart Naylor, financial policy advocate at Public Citizen, was even more blunt.

“FTX will be one of the tombstones in a vast crypto graveyard,” he said in a statement. “Unfortunately too many of the victims were vulnerable people lured by the promise of finally being admitted to the promised land of capitalist opportunity.”

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