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What the fall of FTX taught us about crypto regulations

The lessons learned from FTX's downfall: understanding the implications of crypto regulations.

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The recent fall of FTX comes with devastating consequences to many, cooling the conditions of an already chilly crypto winter. While the loss of consumer funds and the drop in crypto prices across the board are detrimental to many in the new-age financial system, it’s the anticipation of regulators’ reactions that are adding to the hysteria. 

After taking a deep dive into exactly what happened at FTX, we take a look at the response from regulators and what this is likely to mean for the greater crypto industry in terms of regulations.

The FTX death spiral and its effects on the crypto financial system

The history

To understand the full demise of FTX, one needs to understand its history. In 2019, when FTX launched, Binance was a prominent investor and partner. CEOs, Sam Bankman-Fried (FTX) and Changpeng Zhao (Binance) had a mutually beneficial strategic partnership and amicable relationship.

This soured as FTX grew in size and they became the two top centralized entities in the crypto ecosystem, and ultimately largest competitors. In 2021, both exchanges accounted for roughly 30% of trading volume on crypto exchanges, accounting for over $27.5 trillion. 

The breakup

That same year, things reached a pinnacle point in their relationship and FTX bought Binance out of the partnership, paying $2.1 billion, much of that with FTT, the platform’s native token. Fast forward to November 2022: Changpeng Zhao (CZ) tweeted that he would be liquidating the FTT crypto assets as a result of Sam Bankman-Fried speaking ill of Binance to regulators and other “recent revelations”. 

The allegations

It is believed these revelations were that FTX’s sister trading company, Alameda Research, was in financial trouble, an allegation made by Coindesk and Mike Burgersburg, the man who accurately predicted the Celsius crash. At this point, we should mention that Alameda and FTX’s combined FTT holdings account for 75% of the entire supply. 

With Binance announcing that they were going to sell their crypto assets, accounting for 7.4% of the entire FTT supply, shockwaves were sent through the industry. 

The consequences

In a matter of hours, the FTT price dropped 83%, trading at $18.72 before dropping to $3.14. In a desperate attempt to stabilize the market, Alameda offered to buy Binance’s FTT supply, to no avail. 

At the same time, investors rushed to pull their funds from the exchange, estimated to be roughly $6 billion worth of net withdrawals. In light of the recent Terra LUNA crash and subsequent demise of Celsius and Voyager, investors were taking no risks. 

The next twist in this unfortunate story is that FTX froze all withdrawals on the platform and announced that it was going into a “strategic transaction” with Binance, with Binance set to buy its biggest competitor. The acquisition was rumored to be worth $1.

This all came crashing down several hours later when CZ announced to his Twitter following that after reviewing the books they would no longer be moving forward with this plan. 

Within 24 hours, the broader crypto assets market started to feel the effects. Bitcoin was down 16%, Ethereum down 24% and Solana, widely backed by Sam Bankman-Fried, down 43%. 

On November 10, Sam Bankman-Fried announced that Alameda Research would be “winding down trading” and issued an apology to his Twitter following. FTX was in the process of sourcing funding for liquidity purposes, with the platform estimated to need around $10 billion in order to honor customers' crypto assets withdrawal requests.

What was really going on at FTX?

This story boils down to CZ tweeting that he would sell his FTT in light of allegations, which created mass FUD and subsequently led to the demise of its biggest competitor. How did a company, considered a heavyweight in the financial markets, worth $30 billion a few months prior, and making 8 figures in revenue a day, suddenly become insolvent?

Industry insiders believe that the relationship between FTX and Alameda was a bit more reprehensible than it appeared on the surface. Based on leaked insights into Alameda’s financials, it is speculated that Alameda used a significant portion of its FTT holdings as collateral to borrow funds from FTX (these funds being customer funds).

While illegal, this also poses a high risk that could see the collapse of both platforms, and consumer funds along with them. If this is proven to be true, jail time could ensue. 

In an internal email circulated to the Binance team, CZ stated that this was not part of a greater plan, nor is it a win for Binance as the greater crypto economy will be affected. From investor trust to crypto prices dropping to the hawk-eyed regulators eagerly watching from the sidelines, the demise of FTX is in no one’s favor. 

Ultimately, the same catalyst that saw the fall of Celsius has been observed here, FTX used its own token as collateral. Let this be a warning sign for any future trading platforms, and a prominent note for those working on crypto regulation.

What this means for the regulation of crypto exchanges

Before any regulators could even whisper a word, big platforms like Binance, KuCoin, OKX and more are believed to be in plans to implement Proof of Reserves accountability. This involves an independent audit of funds by a third party, made available to the public.

The Commodity Futures Trading Commission (CFTC), Securities and Exchange Commission (SEC) and the Department of Justice (DOJ), three of the biggest financial regulators in the U.S. have begun (or are continuing, in some cases) investigations into FTX. It is believed that the Texas Securities Board started investigating the exchange and CEO in October. 

In the wake of the aftermath, the White House is also calling for stronger crypto oversights and Californian regulators have announced that they are launching an investigation into FTX, asking customers affected by the virtual currency calamity to come forward. 

Insiders are faulting U.S. regulators for not having more clear guidelines in place, saying that their “stringent-yet-unclear” frameworks have driven big exchanges overseas where there is even less of a regulatory landscape and taxes often go unpaid. With the proper legal framework in place, perhaps situations like these could be avoided, and instead of fleeing, people would trust in U.S. regulatory standards. 

Regulators need to find a balance between creating and implementing legal frameworks that both support the innovation and development of the crypto space but at the same time keep avaricious CEOs in line and all centralized operations above board. 

Regulations put in place to hinder money laundering have been successful, with little consequence to the trader. There is no reason why regulations implemented to stop such happenings in the crypto world could not have the same success.

The latest crisis in the cryptocurrency space is likely to push regulators to amplify their work on building legal frameworks for platforms managing digital assets to adhere to, not just in the U.S., but globally. 

What this means for crypto assets and the crypto industry

While Bitcoin, Ethereum, Solana and most other cryptocurrencies are recovering from lows of yesterday, there is a somber feeling in the crypto space knowing that to the week a year ago Bitcoin and Ethereum reached their current all-time highs.

Crypto trading is known to have its risks, and the responsibility to stay within the green lines falls on the individual trader. While many investors embrace the “hodl” approach (hold the investment for long periods of time), it is of the utmost importance to stay in the know about what is happening in the market and to thoroughly, very thoroughly, vet the coin they are looking to invest in. 

Another, perhaps most important, precaution to take is to work only with crypto platforms that are regulated by government-endorsed financial bodies. Just because you are working with decentralized digital currencies doesn’t mean that you should throw caution to the wind and leave your funds unprotected.


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