My Crypto Lawyer
The FTX brouhaha has further highlighted a problem with US regulation: Securities and Exchange Commission (SEC) ambiguity has forced the top crypto exchanges to operate offshore, leaving customers exposed to bent business practices.
Notably, FTX’s American affiliate, FTX.US, resisted the meltdown. All deposits are backed one-to-one with real money, according to CEO Sam Bankman-Fried, unlike its global counterpart, which seems to have operated more similar to a fractional reserve system.
As well, regulations restricted US-based users from buying FTX’s native token FTT, which came under pressure after Binance said it would dump its holdings of the coin, and even moreso once the acquisition fell through.
This ring-fencing by regulators may have encouraged firms like FTX to set up offshore exchanges, effectively leaving customer assets exposed to high-risk unregulated scenarios.
Before it blew up, the flagship FTX platform handled some $2.6 billion in daily trade volume. The US regulated offering was processing just $174 million, now down to $100 million, per Messari.
The same phenomenon happens on Binance, which hails from the Cayman Islands. It’s handling some $18 billion in daily trades, compared to $700 million on Binance.US — a 96% disparity.
Initially based in Hong Kong, FTX moved its headquarters from Hong Kong to the Bahamas in late 2021 because of its friendly crypto framework.
Residents of the US technically can’t use FTX’s main platform, a stipulation of its user policy, loosely enforced by geoblockers avoidable via virtual private networks. The US version offers fewer cryptocurrencies and opportunities for leverage, similar to the divide between Binance’s own platforms.
A page on its website reads: “US users cannot trade on FTX, but residents of the United States can trade on FTX.US.”
SEC chief Gensler says FTX is on trend for crypto
Coinbase CEO Brian Armstrong, in a tweet late Wednesday, butted heads with Sen. Elizabeth Warren, who said FTX’s blowup shows “much of the industry appears to be smoke and mirrors, and called on the SEC for more aggressive enforcement.
Armstrong argued that the enormous amount of offshore trading activity was a direct result from what he sees as lacking SEC clarity on how the industry should operate.
“The problem is that the SEC failed to create regulatory clarity here in the US, so many American investors (and 95% of trading activity) went offshore. Punishing US companies for this makes no sense,” Armstrong tweeted.
Ripple CEO Brad Garlinghouse agreed, pointing out that most crypto trading occurs offshore because companies effectively have no guidance on how to comply in the US.
SEC chief Gary Gensler had his own say about the matter. Speaking at a Healthy Markets Association event on Wednesday, Gensler described the FTX situation as part of a wider trend within the crypto industry.
“It’s really part of a pattern of what we have seen over the past six or eight months,” he said. “Investors get hurt when we don’t rely upon the time-tested public policy guardrails.”
The former investment banker, who worked as a partner at Goldman Sachs, also highlighted the risks from the “commingling” of key intermediary functions where the same firm serves multiple roles.
“We’ve got a lack of disclosure, a lot of leverage, using other people’s money, a lot of interconnected-ness. … The investing public is hoping for a better future,” he added.
FTX is now being investigated by the SEC over its $8 billion hole on its balance sheet.
Regulation by enforcement and a combative, non-productive approach to working with the industry is what’s driven innovative companies offshore, according to Simon Schaber, chief business development officer at DeFi protocol Spool.
“The FTX fallout is a direct result of SEC failure,” Schaber told Blockworks. “It is once again consumers that suffer the most and his former investment banking employers that benefit the most (domestic competition kept at bay) due to the decisions of Chairman Gensler.”
FTX needs emergency funding to make users whole
FTX founder Bankman-Fried reportedly informed investors on Wednesday that the firm would have to file for bankruptcy unless it received a cash injection.
Bankman-Fried had hoped rival CEO Changpeng Zhao, founder of Binance, would be his White Knight and save FTX from its “liquidity crunch,” but the deal fell through as quickly as the rescue was proposed.
“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 of FTX.com,” Binance said.
Bankman-Fried, barely a billionaire after the shocking downfall of FTX, was on an ambitious deal frenzy while chaos played out in crypto markets earlier this year. He sought to rescue beleaguered lenders Celsius, Voyager and BlockFi, but a string of apparent losses eventually led to FTX’s collapse.
He’s now seeking emergency funding from alternative investors, including Apollo Global, to meet FTX’s withdrawal requests and is said to be “exploring all options.”
In a leaked Slack message, Bankman-Fried told employees his first priority is to compensate customers before anyone else. He also claimed FTX has discussed fundraising with Tron founder Justin Sun, and hinted at the possibility that a future deal would combine FTX and its US affiliate.
But it shouldn’t have had to take a liquidity scare, withdrawal freeze and customers finding their holdings locked up on FTX for the SEC to figure out how to better serve investors.
Get the day’s top crypto news and insights delivered to your inbox every evening. Subscribe to Blockworks’ free newsletter now.
GIPHY App Key not set. Please check settings