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The Effect of FTX’s Collapse on Regulators

FTX_Collapse_Regulatory_Response

The collapse of FTX has had a snowballing effect, which is estimated to have affected over one million holders and investors, with losses in the billions (USD). In order to maintain a level of trust with their clients, more and more crypto market players have made public their official financial statements proving their assets at least match their liabilities to customers.

Regulators, however, now face scrutiny and are demanded to impose more stringent regulations protecting investors specifically, enhance the visibility into entities’ activities, and avoid conflict of interest. Coinbase’s CEO stated that those “who care about the future of crypto want to create sensible regulation for centralised exchanges and custodians in the U.S. and other regions”, adding that “regulators need to establish clear rules that bring crypto back on-shore, encourage innovation, and protect consumers.” 

Unsurprisingly, regulators agree that a stricter regulatory framework for cryptocurrencies is needed. Although such changes cannot be made overnight, some authorities have made public their intentions to apply changes in the upcoming years.

The International Organization of Securities Commissions

The IOSCO’s chair, Jean-Paul Servais, stated in an interview that:

  • The entity’s focus in 2023 will be to improve the regulatory framework for crypto-assets, as well as targeting ‘conglomerate’ platforms such as FTX.
  • Creating new regulations for crypto platform, focusing on conflicts of interest, can have its start in existing ones for fiat.
  • Crypto ‘conglomerates’ provide a multitude of services and products to the public, with no authority to oppose such practices, which creates conflict of interest.

“For investor protection reasons, there is a need to provide additional clarity to these crypto markets through targeted guidance in applying IOSCO’s principles to crypto assets,” Servais said.

  • The Markets in Crypto-assets (MiCA) guidance, recently issued by the EU and which focuses on the supervision of crypto operators, is the starting point of developing a global framework
  • The IOSCO intends to publish “consultations report on these matters in the first half of 2023”.

The IOSCO is the global securities watchdog, whose function is to develop, implement and promote adherence to internationally recognised standards for securities regulation. It works closely with G20 countries and the Financial Stability Board to improve the global regulatory framework in their area of expertise.

US Department of the Treasury

Janet L. Yellen, Secretary of the Treasury, stated that recent events triggered by FTX’s situation “demonstrate the need for more effective oversight of cryptocurrency markets.”

The reports issued in response to the President’s Executive Order on Digital Assets identified risks which recently materialised, such as“comingling of customer assets, lack of transparency, and conflicts of interest”.

The Secretary advises that “where existing regulations apply, they must be enforced rigorously so that the same protections and principles apply to crypto assets and services. The federal government, including Congress, also needs to move quickly to fill the regulatory gaps the Biden Administration has identified.  In terms of financial stability, spillovers from the events in crypto markets have been limited, but a recent report by the Financial Stability Oversight Council, which Treasury chairs, warned that further interconnections of the traditional financial system and crypto markets could raise broader financial stability concerns.” 

During a White House briefing, Press Secretary Karine Jean-Pierre stated that FTX’s case “highlights why prudent regulation of cryptocurrencies is indeed needed.” 

Bank of England – Speech by Deputy Governor Sir Jon Cunliffe

Sir Jon Cunliffe, referred to the current state of events as “probably the largest – and certainly the most spectacular – failure to date in the crypto ecosystem”, noting that greater regulation of the crypto-assets and crypto market players is necessary.

It seems that regulators agree upon risks that need to be addressed:  transparency of crypto entities’ activities, protection of investors and financial stability. However, the deputy governor highlights that although the crypto world is not “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.” This does not mean though that ”we should [..]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.”

An interesting aspect raised in his speech concerns the sector’s inability to grow should more cases like FTX unfold. “[T]he very instability and riskiness of the world of unregulated crypto finance, most recently demonstrated by FTX, will in the end ensure that the sector cannot grow.”

A suggested starting point to better regulate the crypto world is“existing regulatory frameworks – for investment products, for exchanges, for payments systems and other financial functions – and the level of assurance we require that the relevant risks have been managed.”

Cunliffe advises that regulators should keep an open approach in this development in order to properly assess if the same level of assurance can be obtained as in traditional finance. “But we should also be firm that where it cannot, we are not prepared to see innovation at the cost of higher risk”, he mentions. These are the principals of the Financial Services and Markets Bill, currently in Parliament. One of its objectives is to “extend the current Bank of England and FCA regulatory regimes for e-money and payment systems to cover the use ‘stablecoins’ for payments.”

A consultation session will be open in 2023 to discuss matters such as:

  • Extending the Bill to cover “investor protection, market integrity and other regulatory frameworks that cover the promotion and trading of financial products to activities and entities involving crypto assets.”
  • The “regulatory framework that will apply to such systemic payment systems and the services, like wallets, that accompany them”.
  • Regulatory safeguards that are needed“for a non-bank systemic stablecoin to ensure that the coin issuance is fully backed with high quality and liquid assets (which could include central bank reserves), alongside loss absorbing capital as necessary, to compensate coinholders in the event that the stablecoin fails”.

BaFin

Mark Branson, President of the German Federal Financial Supervisory Authority (BaFin) commented, during an interview, on the threat cryptocurrencies pose to financial stability, an opinion which echoes England’s Central Bank’s views: currently they do not.

 “Overall, banks’ interest in offering crypto-asset trading to their customers still seems, to me, to be limited.”

“[…] certain crypto-assets based on blockchain technology carry significant risks, especially if they are seen as an investment. At present, they do not pose a threat to financial stability. However, developments could move that way, should momentum return to market growth and interconnections with the traditional financial system intensify even further.”

BaFin’s President seems to be in favour of crypto-assets usage hinting at a need to improve their regulatory framework: ”[…]not all crypto business models are serious. Waves of innovation, as we know, also bring with them freeloaders and crooks.”

“In principle, blockchain technology is promising. Let’s hope that we move from “promising” to “effective and scalable”.

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