FTX Collapse Was Old Tricks Powered by New Technology

The collapse of FTX has spurred calls for greater oversight of the crypto industry.

But the appropriate regulatory tools and methods may already exist, hidden in plain sight as traditional banking controls that just need to be tweaked toward the crypto industry.

The demise of the popular exchange, which was at one point the world’s third largest by volume traded, “calls into question the promise of the industry,”  U.S. Sens. Elizabeth Warren, D-Mass., and Dick Durbin, D-Ill., said in a letter sent last week to the former and current CEOs of the crypto exchange, Sam Bankman-Fried (SBF) and John J. Ray III respectively.

As FTX investor Ontario Teachers’ Pension Fund said in a statement, “Naturally, not all of the investments in this early-stage asset class perform to expectations.” But where is the line between “performance expectations” and outright scam?

As reported by PYMNTS earlier, FTX, together with its affiliates, owes their 50 largest creditors $3.1 billion, and the group of companies counts over a million creditors in total.

PYMNTS CEO Karen Webster recently sat down with Hanna Halaburda, associate professor at NYU Stern School of Business, to talk more about the implications of FTX’s collapse and the power of existing market regulations, saying that crypto industry detractors are wrongly using the company’s demise as a stand-in to paint the whole cryptocurrency market as a scam.

“In this case, it wasn’t a crypto failure. It was a very old-fashioned fraud… The exchange failed due to stealing and lying. And we already have laws against that,” Halaburda said. “Talking about FTX, it really doesn’t matter whether they were dealing in crypto and tulips bulbs, or pieces of gold. They were just mismanaging what they were the trusted custodians of.”

It is becoming increasingly clear as more information continues to come to light that FTX’s exchange and the reasons behind its failure hold little resemblance to the blockchain-based innovations of Web3’s emergent computing fabric and the promise of its applications, both of which are grounded in applied math, computer science and cutting-edge statistics.

Rather, she said, the structural issues of the FTX collapse are not too dissimilar to those taken advantage of by bad actors in traditional financial markets, where intermediaries define the investment landscape and are its driving force.

The risks that need to be addressed are likewise similar to those inherent within traditional finance.

Halaburda said it is important to unpack whether there is, “anything special about crypto where [retail investors] get roped in more [than with other investment opportunities]… I do think that making a bigger deal of voluntarily complying with regulation can go a long way.”

When other innovative payment and online currency platforms were coming of age, such as PayPal, there weren’t calls for separate regulations. Instead, it was decided that internet-based payment processors like PayPal needed to comply with existing payment and transfer regulations, a decision that, depending on the applicable regulations, required applying for various operating licenses. PayPal went ahead and got those licenses in all 50 states, making sure that they were operating in full compliance within all the marketplaces they wished to do business.

However, for as long as there have been rules and regulations, there have been insider shortcuts to get around them. Technology moves fasters than regulators do, and bad actors rarely act in good faith.

“The idea that to get around U.S. regulations these actors set up separate subsidiaries, [they] say they’re compliant with those regulations, but they were connected to something else that wasn’t, and then it becomes much more of a rolling ball. How do you separate those markets and how do you enforce those regulations? And U.S. banking regulations are generally enforced quite strongly outside the U.S. when U.S. customers are being served,” said Halaburda.

What is required for appropriate consumer protection regulations in today’s global economy is better education for consumers around the pitfalls and benefits of the various traditional and emergent financial marketplaces, and an expanded toolkit for regulatory and enforcement bodies that empowers them to protect U.S. consumers and investors, no matter where in the world they — or their money — are.

“People believed FTX was trustworthy because it was big, which made them assume other people believed it was trustworthy… People could have gone to exchanges that they knew were compliant with regulations, like Coinbase, instead they go to exchanges that they almost know aren’t compliant, because people believe in this larger trust,” Halaburda said. “[The importance of regulations] is there’s a lot of people out there, on the street telling you wonderful stories and why you should part with your $20 bill and why they need it.”

By dealing with cryptocurrency platforms like FTX on the terms in which their failures have affected consumers — which in FTX’s case is primarily as a centralized finance intermediary committing fraud — governments and legislators can draw upon a variety of traditional precedents to safely shepherd this still-nascent industry, and the consumers that continue to trust it, into the future.