a Case for Better Industry Practices Rather than Regulatory Overreaction
On November 3 2023, Sam Bankman-Fried (“SBF”), former CEO of FTX Trading Ltd., was found guilty on all seven counts of fraud and conspiracy, presented against him in United States District Court for the Southern District of New York, after a month-long trial.
The collapse of FTX, and the subsequent investigations and trials against SBF, have been extensively covered in numerous media outlets, and used variously as justification for views ranging from “all crypto is a scam”, and “extreme regulation is needed”, to the ideas that FTX was a standalone outlier, or that regulation doesn’t work because FTX was able to commit fraud. None of these are reasonable, informed arguments.
Fraud and incompetence, not weak regulation
The CCA believes that much more nuance is needed in discussions around FTX’s collapse, and its implications for the crypto lending industry.
As determined by the SBF convictions, FTX engaged in blatantly fraudulent practices, on top of many extensively documented examples of incompetence that surprised experienced management and financial services professionals when uncovered. The question of legitimacy of the legal actions against SBF and colleagues are beyond reasonable discussion.
What is often overlooked is that FTX was a legitimate, registered, and most importantly, regulated financial services firm in all jurisdictions where it did business. Calls for stricter regulation inevitably followed news of FTX’ collapse. We agree with the assertion that very few, if any, proposed rules would have averted the debacle.
While the fault for the company’s behavior lies squarely with its officers and staff who knowingly committed fraud, regulation is not designed to actively prevent malicious activity. Laws provide rules and guide-rails that market participants must follow, under threat of legal penalty. They thus are a last-ditch disincentive to irresponsible or even criminal actions.
What should be done?
While the CCA welcomes sensible, principles-based regulation that provides clarity to industry participants about their obligations and which levels the playing field for all, regulation should never be part of a panopticon that proactively blocks unacceptable behavior. Lest we forget, the “traditional” credit and finance sector is no stranger to abuses that even strong laws could not prevent; nearly every major banking and accounting scandal in recent history was the result of violations of existing laws.
Importantly, many of FTX’ failures revolved around invalid collateral and asset valuation, particularly of FTT tokens held by Alameda Research – as well as bad accounting and reporting practices. All of these are possible to detect and prevent through technological means built into various lending solutions and platforms; for example, the CCA has in the past called for implementation of mechanisms to allow anonymous but trustworthy validation of collateral across lending transactions.
Regulators, the public, and the broader financial industry should not draw the wrong conclusions from FTX and the wrongs that led to its failure. It is vital that the crypto sector work together to help ensure trust, whether from regulators or customers.
Existing financial laws already forbid the negligence and outright fraud that FTX committed – SBF was convicted of violating such laws. In this, he is no different from convicted financial criminals like Bernie Madoff, Jérome Kerviel, Nick Leeson, Ivan Boesky, and many others.
The beauty of crypto is its ability to pre-empt many forms of wrongdoing through technological means, which traditional financial institutes do not have access to. While FTX did not implement these measures, legitimate crypto firms should do so. This will allow regulators and supervisors to focus on ensuring fair business practices in those parts of the financial sector that struggle to embrace such credibly-neutral technology.
Stock photo credit: Ekaterina Bolovtsova