What does the future hold for the cryptoasset market? More
regulation is one certainty, and on that, nearly everyone seems to
agree, writes Andrew Pimlott
The collapse of crypto exchange FTX in November 2022 sent shock
waves through the digital asset world. Anyone who had deposits in,
lent to, or bought shares in the exchange stands to lose
everything. It went from a valuation of $32bn in October to $1 when it filed for bankruptcy on November
11, 2022.
Anyone holding FTX Tokens (FTT), FTX’s cryptocurrency, also suffered.
They saw its value plunge from $26.26 on November 1, 2022, to $2.18
on November 12, 2022, to around $1.30 at the end of November.
Eleven years ago, I was seconded to New York to work on the
collapse of MF Global (brokerage). MF Global and FTX have some
similarities, both dipped into customers’ funds to fill a
financial black hole. The fallout from MF Global was huge. Lots of
people lost everything and many businesses filed for bankruptcy.
The fallout from FTX will follow a similar path. The wider crypto
market has been damaged too. Before FTX went bankrupt, global
cryptocurrency market capitalization stood at $0.95 trillion,
already a huge drop from $3 trillion in November 2021, according to
Binance, the world’s biggest crypto
exchange. Now it has slipped even further to $0.84 trillion.
Meanwhile, New Jersey-based crypto lender BlockFi, which had “significant”
exposure to FTX, has become the latest casualty of the fallout from
the debacle, filing for bankruptcy on November 28, 2022.
Investors, investment managers, exchanges, and others in the
crypto ecosystem are now sifting through the wreckage, trying to
figure out what went wrong with what was the world’s second or
third-biggest crypto exchange. Most are putting a brave face on
events, still convinced that the market as a whole offers great
potential. FTX’s creditors may even get something back if the
company’s bankruptcy lawyers recover some of the assets. BitGo, the custodian company given the job of
tracking down the assets, says it has recovered $740m so far.
Crypto-philes are also encouraged by the resilience of Bitcoin,
the biggest cryptocurrency by market capitalization, where 1
bitcoin at the end of November of 2022 was worth $16,422. Yet that
is some distance below the $20,483 it was trading at just before
FTX crashed, and dramatically lower than its $59,249 value exactly
a year earlier.
Less impressed with the current situation and the future of
crypto in general, are investors in traditional asset classes. They
may not have lost any money, as the incident did not spill over
into the wider financial markets, but they are in the same
crypto-sceptic camp as financial regulators and governments.
Officialdom is not only worried about consumers piling into
cryptoassets and losing their money, it is concerned about the
potential impact on financial stability if things carry on as they
are.
That is why the U.S. House Financial Services Committee, for
example, will hold a bipartisan hearing on December 16th into
FTX’s collapse and the broader consequences for the digital
asset ecosystem. The hearing will be live streamed on https://financialservices.house.gov/live/ and
will capture the world’s attention as the committee says it
expects to hear from the people concerned including Sam
Bankman-Fried, the exchange’s former chief executive.
The demise of FTX – what happened?
FTX, based in the Bahamas, was used by investors and speculators
to trade cryptocurrencies for other cryptocurrencies and fiat
currencies. But concern about its stability surfaced when an article in Coindesk, a cryptocurrency news
site, highlighted the inappropriate relationship between FTX and
Almeda Research, a partner firm. The story prompted rival exchange
Binance to announce it would sell its holdings of
FTT, and FTT’s value fell. Other holders of FTT began to
sell off their deposits held with FTX, creating a run on the
exchange which it could not cope with. Binance stepped in to say it
would acquire FTX to ensure depositors could withdraw their funds,
but a day later withdrew from the acquisition because of doubts
about FTX’s finances.
The situation quickly worsened. On November 10th, the Securities Commission of the Bahamas froze
FTX’s assets and applied to the Supreme Court of The
Bahamas for the appointment of a provisional liquidator. The next day FTX and its related companies applied
for bankruptcy in the US state of Delaware. Bankman-Fried
resigned as chief executive and was replaced by John J Ray III, the lawyer, and insolvency
professional who oversaw the liquidation of Enron 20 years ago.
Secretary of the Treasury Janet Yellen was quick to
make a statement, expressing the U.S. government’s
concerns. “The recent failure of a major cryptocurrency
exchange and the unfortunate impact that has resulted for holders
and investors of crypto assets demonstrate the need for more
effective oversight of cryptocurrency markets,” she said on
November 16, 2022.
She added that for the past year the Treasury Department had
been working with the President’s office and financial
regulators to identify risks in crypto markets. Some of the risks
identified – including commingling of customer assets, lack
of transparency, and conflicts of interest – “were at
the center of the crypto market stresses” observed in the past
week, she said.
Existing regulations applying to cryptoassets “must be
enforced rigorously”, she said, the government “needs to
move quickly to fill the regulatory gaps” and action must be
taken to prevent “spillovers from the events in crypto
markets” threatening financial stability in the wider
market.
Legal and political reactions
Although FTX was based in the Bahamas, the liquidators there agreed to consolidate
proceedings in the US. A lawyer at law firm Sullivan &
Cromwell acting for FTX in its bankruptcy case told the U.S.
Bankruptcy Court for the District of Delaware that Sam
Bankman-Fried ran the exchange as his “personal fiefdom”.
He spent “substantial amounts of money” on items
unrelated to the business before it imploded, said James Bromley on the first day of the
hearing in late November 2022.
“We have witnessed one of the most abrupt and difficult
collapses in the history of corporate America,” said Bromley,
whose team is winding down the company and trying to unravel its
web of assets to repay creditors.
The next significant public discussion on the case is likely to
be the US House Financial Services Committee’s
bipartisan hearing on December 16. The committee says it
“expects to hear from the companies and individuals involved,
including Sam Bankman-Fried, Alameda Research, Binance, FTX, and
related entities, among others”.
Committee chairwoman Congresswoman Maxine Waters, a democrat
representing part of California, said “the fall of FTX has
posed tremendous harm to over one million users, many of whom were
everyday people who invested their hard-earned savings into the FTX
cryptocurrency exchange, only to watch it all disappear within a
matter of seconds”.
“This event is just one out of many examples of
cryptocurrency platforms that have collapsed in the past year
[which is why] we need legislative action to ensure that digital
assets entities cannot operate in the shadows outside of robust
federal oversight and clear rules of the road.”
Industry reaction
Although crypto investors and other industry players have been
hit hard by the scandal, they are battling on grim-faced. They
might be secretly worried, but outwardly they are confident about
the future. The first session of a cryptoassets inquiry held by the
UK Parliament’s Treasury Committee on
November 14, 2022 featured evidence from several leading figures in
the crypto sector including Ian Taylor, Executive Director at
CryptoUK; Daniel Trinder, Vice President Government Affairs, Europe
and MENA at Binance; and Tim Grant, Head of Europe, Middle East,
and Africa at Galaxy Digital.
Committee Chairman Harriett Baldwin MP got straight to the point
with her first question: “With the collapse in so many
different cryptoassets in 2022, and the news last week, which we
will drill into in greater detail as we go through, would you say
that cryptoassets are the tulip bulbs of the 21st
century?”
Binance’s Daniel Trinder was the first to respond to the
comparison with the Dutch tulip bulb market bubble-and-burst of the
1600s. “I would not say that they are tulip bulbs,”
replied. “The key failure last week, plus the ones earlier in
May, are largely down to issues relating to failures around
governance, risk management, excessive leverage, and if we believe
the reports, inappropriate use of clients’ assets. These are
traditional failures that have plagued traditional finance. I do
not think that there is anything inherent around the failures that
I am aware of around crypto or the technology per se at this
moment.”
Tim Grant of Galaxy Digital – an investment company
specializing in cryptoassets and blockchain technology company
– was just as forthright in his convictions about the
potential of the crypto market. “It would be wrong to throw
the baby out with the bathwater and say that all cryptoassets are
purely speculative, do not have some economic value, and do not
have some element of value creation built into them.”
Ian Taylor of CryptoUK, the self-regulatory trade association
for the country’s cryptoasset industry, accepted that it
“is a highly risky and volatile asset class [but] we always
advise people who want to invest to do their homework and perhaps
be prepared to lose 100% of their investment”. He went on to
say that if the market were regulated more closely, “some of
these events may not have taken place”. What this shows, he
added, “is that we need some regulation around these central
actors, such as audits and proofs of reserves on assets and
liabilities”.
One of the main criticisms leveled at the market by crypto-phobe
investors and regulators is that it is under-regulated. Yet, as Ian
Taylor’s comments show, many crypto-philes are asking for more
regulation to put their industry on a sounder footing.
More regulation is certainly the UK authorities’ intention. City Minister
Andrew Griffiths has proposed an amendment to the financial services
and markets bill which would widen the scope of crytpoasset
regulation. The U.S. government and regulators have similar
intentions, as illustrated by Secretary of the Treasury Janet
Yellen’s comments mentioned earlier. So does the European Union
– its Regulation on Markets in Crypto-Assets (MiCA)
will into force in 2024, giving financial regulators powers over
companies providing cryptoasset services such as trading, lending,
and custody.
Financial firms do not usually welcome, never mind request,
greater regulatory and legislative intervention, but this time it
is different. Crypto firms realize that if the rules and laws
governing their activities are not tightened up they may not have a
future.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
Credit: Source link
