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FTX is a Bahamas-based cryptocurrency exchange that enables trading of futures contracts and other financial instruments that are derived from cryptocurrency. The company is currently under investigation by the US Security and Exchange Commission following its meltdown, which caused billions of customer deposits to evaporate. Some have attributed the FTX crash to poor corporate governance, while others believe it to be an inevitable consequence of an unregulated sector like crypto. This development raises questions about the existing global cryptocurrency laws and concerns as to whether UK businesses might be at risk of succumbing to FTX's fate.
While FTX owes almost £2.6bn to its top creditors, the ramifications of the company's demise extend beyond its immediate stockholders. Due to the FTX meltdown, Nigerian start-up Nestcoin is laying off staff members. According to reports, the disaster caused Nestcoin to lose over £3.3m. Market Tracker data suggests that cryptocurrency-related investments are not uncommon for listed UK companies. In January 2022, GB Group (plc) reported direct benefits from cryptocurrency dealings. Meanwhile, both Draper Esprit plc and Molten Ventures plc invested in Ledger, a cryptocurrency and blockchain security company.
Samuel Bankman-Fried, FTX’s former CEO and founder, was against the company’s decision to file for bankruptcy. In an unconventional Twitter interview with VOX, Bankman-Fried said that ‘withdrawals would be opening up in a month with customers fully whole’, attributing the company’s fall to ‘messy accounting’. Meanwhile, in the bankruptcy court filing declaration, newly appointed CEO John J. Ray declared in support of the petition:
‘Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented’.
The company’s bankruptcy filing revealed inadequate practices of corporate governance. FTX did not hold board meetings, and neither did most of the subsidiaries:
‘Many of the companies in the FTX Group, especially those organised in Antigua and the Bahamas, did not have appropriate corporate governance. I understand that many entities, for example, never had board meetings’.
The report further disclosed that the company had a very bad cash management system and almost no accounting:
‘balances of customer crypto assets deposited were not recorded as assets on the balance sheet and are not presented’.
Basketball fans may be familiar with the Florida team Miami Heat, and the team’s stadium which is sponsored by the company – the FTX arena. However, like the majority of cryptocurrency exchange businesses, FTX is not publicly traded, hence it is exempt from the US Annual Corporate Governance Report requirements. FTX was not authorised to provide financial services in the UK and indeed, in September 2022, the Financial Conduct Authority (FCA) issued a statement to say that ‘the firm is not authorised by [them] and is targeting people in the UK’. The FCA then stressed that individuals will not have access to the Financial Ombudsman Service or be protected by the Financial Services Compensation Scheme so it is unlikely that they will get their money back if things go wrong.
FTX is not the only digital finance company to collapse due to poor governance. German payment processor and financial services provider Wirecard collapsed due to accounting fraud. Unlike FTX, Wirecard was a regulated company listed on the Frankfurt Stock Exchange. In June 2021, another cryptocurrency company, Binance Markets Limited (BML), was banned by the FCA from undertaking any regulated activities without the prior written consent of the FCA.
Commentators have long argued that we are entering a new era of finance, and the FTX scandal indicates that further regulation is required to ensure security in markets as globalised as digital finance. Current crypto regulation in the UK is very limited. The FCA has previously issued warnings about the risk of cryptocurrencies:
‘Cryptoassets are considered very high risk, speculative purchases. If you buy cryptoassets, you should be prepared to lose all your money’.
Despite this, crypto businesses that operate in the UK are regulated, albeit for anti-money laundering purposes only. Cryptoasset businesses must comply with the Money Laundering Regulations and register with the FCA. FTX was not registered by the FCA and therefore, could not be regulated by them. Indeed, the FCA has published a list of UK businesses that appear to be carrying out cryptoasset activity without being registered with them; however, it is unclear to what extent these companies are affected by this list.
In their 2021 Anti-Money Laundering Guidance for the Legal Sector, the Solicitors Regulation Authority (SRA) mentions ‘crypto-asset wallet providers and exchanges’, as well as ‘businesses utilising new or unproven technology’ as sectors that may indicate a higher risk for businesses, placing cryptocurrency under the umbrella term of ‘new technologies’. However, no reference is made to risks within cryptocurrency specifically.
Some banks have taken the matter into their own hands. In 2018, Lloyds, NatWest, and Virgin banned cryptocurrency purchases using credit cards. More recently, Santander and Virgin Money were able to place limits on their customers’ abilities to purchase crypto. Santander imposed a limit of £1,000 per transaction, as well as a further limit of £3,000 in any rolling 30-day period for transfers due to ‘a large increase in UK customers becoming victims of cryptocurrency fraud’.
On 21 November 2022, Bank of England representative Deputy Governor Jon Cunliffe called for greater cryptocurrency regulation. Cunliffe gave three reasons for cryptocurrency regulation. First, he discussed the need to protect consumers/investors:
‘Whether or not one thinks it is sensible to invest or trade in the highly speculative assets that make up most of the activity in the crypto world, investors should be able to do so in transparent, fair and robust marketplaces, with the protections that they would get in conventional finance’.
Secondly, Cunliffe highlighted the need to protect financial stability:
‘While the crypto world, as was demonstrated during last year’s crypto winter and last week’s FTX implosion is not at present large enough or interconnected enough with mainstream finance to threaten the stability of the financial system, its links with mainstream finance have been developing rapidly. We should not wait until it is large and connected to develop the regulatory frameworks necessary to prevent a crypto shock that could have a much greater destabilising impact’.
Lastly, he brought attention to the need to foster innovation:
‘This may appear counter intuitive to those who see regulation as opposed to innovation. But, as I have said before, ‘people do not fly in unsafe aeroplanes’. Innovation may start in unregulated spaces. But it will only be developed and adopted at scale within a framework that manages risks to existing standards.’
The FTX scandal has attracted global media attention. There appears to be a broad consensus that greater regulation of cryptocurrency is required to ensure that this does not happen in the future. Signs point to more and more countries adopting a zero-tolerance policy approach toward cryptocurrency transactions. Several countries in Africa, Asia, the Middle East and South America have instated an outright ban on cryptocurrency transactions, including China, Egypt, Ecuador, Indonesia, Taiwan and Saudi Arabia. In contrast, the EU is due to adopt new legislation – Markets in Crypto-assets (MiCA), set to come into force sometime in 2023. MiCA rules would facilitate internal control mechanisms, segregation of client assets proof of good management, and white paper. Stefan Berger, a member of the European Parliament declared in support of the legislation: ‘The crypto space is not a gambling casino. MiCA is the bulwark against ‘Lehman Brothers moments’ such as the FTX case.’ Whether the UK will take a similar approach remains to be seen.
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