Following FTX's collapse, regulators face public ire

Key points: 

• Some reports suggest that eight members of Congress, five of whom received donations from FTX, attempted to block the SEC from investigating FTX.
• The inability of regulators and policymakers to issue clear crypto regulations is a key reason why investors are heading to offshore exchanges.
• In the face of a cryptocurrency debacle, U.S. regulators must erect fences to protect investors while allowing homegrown innovation to flourish.
• Regulation must lead to a mandate that prohibits the mixing of client and exchange assets

2022 is drawing to a close, and 2022 could go down in history as one of the most eventful years in the crypto industry, thanks to a long winter that wiped out more than 70% of market capitalization and a massive crash of crypto companies. This is mainly due to internal mismanagement and an unproven decision-making process.

Through all the ups and downs, one thing remains clear: Retail customers have lost a lot of money due to a lack of regulation.

Despite multiple promises by U.S. lawmakers this year to bring cryptocurrencies under regulation, after every major cryptocurrency event like Terra and FTX we see a new round of regulatory discussions without concrete action.

The role of regulators has come under scrutiny following the collapse of FTX due to the close ties between former CEO Sam Bankman Fried and policymakers. Some reports suggest that eight members of Congress, five of whom received donations from FTX, attempted to block the SEC from investigating FTX.

Coinbase CEO Brian Armstrong is unhappy with regulators' failure to stem further contagion, claiming that enforcement actions against U.S. companies are pointless for breaches by offshore crypto exchanges.

Armstrong also accused the SEC of failing to issue timely regulations and moving nearly 95% of trading activity to offshore exchanges.

Jim Preissler, co-founder of decentralized exchange service provider SOMA.finance, explained that most people don’t fully understand the role of regulators such as the SEC.

He said: “The SEC sets rules and guidelines. For example, the SEC has been repeatedly clear that other than perhaps Bitcoin, they see every other crypto offering as a potential security. Violators then face potential enforcement, and in extreme cases, they can bring in the DOJ for criminal cases. Right now, the SEC has a huge backlog of violators to potentially go after. They are still doing the precedent-setting types of cases — initial coin offerings, Influencers, exchanges, lending products, etc:”

“This will set the groundwork for future enforcement. As the SEC ramps, we could see the cases coming even faster and more furious.”

As Armstrong pointed out, the inability of regulators and policymakers to issue clear crypto regulations is a key reason why investors are heading to offshore exchanges.

Preissler noted that regulation already exists in the U.S. — exchanges must have a state money transmitter license, a bank license to offer cryptocurrencies, or if they offer blockchain, be registered with the SEC for an Alternative Trading System (ATS).

He added that any further regulations could add to or possibly replace existing regulations. “Without one or both of those categories in the U.S., an exchange would be in violation of existing regulations..”

Former SEC attorney Patrick Daugherty told, “the SEC and the CFTC [Commodity Futures Trading Commission] have jurisdiction over token sales by or through non-U.S. platforms and exchanges to U.S. persons. Although the details vary depending upon the particular platform or exchange, many U.S. persons are customers of non-U.S. platforms and exchanges, giving the U.S. agencies jurisdiction over them"

When asked why the SEC failed to take timely action against offshore exchanges, Doherty suggested a congressional hearing, saying:

“These are questions that need to be asked by House and Senate committee members in their oversight capacity. There is no effective private redress against the SEC in a case like this. That’s what Congressional oversight is for.”

The CFTC and SEC have come under increased scrutiny following the collapse of cryptocurrency exchange FTX as the exchange pushed the CFTC to become the top regulator of the cryptocurrency market. Republican lawmakers accused the SEC chairman of coordinating with FTX "to gain a regulatory monopoly."

U.S. regulators need to take better safety precautions

The regulatory process is time-consuming due to the number of parties involved, and all legislation must pass Congress before it can be implemented. However, regulators such as the SEC can use injunctions to develop strategies to protect investors. One such case can be seen in the ongoing case between the agency and Ripple executives. In this lawsuit, the SEC is using legal means to enforce the law, even though there is no clarity on which crypto assets are considered securities and which can be considered assets.

David Kemmerer, CEO of crypto tax solutions provider CoinLedger, called for government-to-government cooperation with tax havens to ensure mutual respect for relevant laws. It is also important to note that only authorized traders are allowed on offshore exchanges.

He also said regulators should promote safe and efficient markets so U.S. regulators can keep investors from flocking to offshore exchanges, saying:

“There should also be equity investments from local firms to support innovative and cutting-edge technology. Additional funding to protect investors from offshore exchanges, like subsidized loans, should also be opened up by the regulators. Equally, there should be fewer political interferences and favorable taxation.”

In the face of a cryptocurrency debacle, U.S. regulators must erect fences to protect investors while allowing homegrown innovation to flourish.

Richard Mico, chief legal officer of crypto channel solutions provider Banxa, told that there is still a long way to go to establish comprehensive crypto regulation, but regulators can develop and clarify clear guidelines so that good players can enter and continue to innovate regions within the United States while holding bad actors accountable. He says:

“Regulation by way of enforcement should not be the leading way to supervise the industry. In the absence of a robust and uniform regulatory framework, proactive industry engagement and the creation of fit-for-purpose signposts and guidance is critical.”

Mico also proposed cracking down on advertisers and promoters, saying: “although legally based in the Bahamas, the meltdown of FTX.US hurt American citizens investing on the platform. Cracking down on crypto influencer campaigns that lack appropriate disclaimers and/or disclosures (e.g. conflict of interest) is one way that the SEC can protect consumers.”

U.S. regulators have a regular relationship with cryptocurrencies. Since the FTX debacle, there have been strong calls for greater regulation. Richard Gardner, CEO of crypto infrastructure provider Modulus, believes that regulation must lead to a mandate that prohibits the mixing of client and exchange assets. He cited the EU's MiCA regulation as an example:

“It becomes much easier to make a strong argument that competent investors will see a real reduction in risk by utilizing exchanges that are overseen by United States and/or EU regulators. Beyond offshore exchanges, the risk extends to DeFi projects which are borderless by design. Not only is there a question of oversight, but there are security concerns, given that the vast majority of assets hacked in 2021 came from defi projects.”

He added that the failure of regulators has definitely done damage to the cryptocurrency industry. However, the responsible parties for the FTX debacle are the exchange and its CEO, Sam Bankman-Fried. "It's easy and convenient to put the blame on regulators, but what SBF has done is absolutely ruthless. Regulators have certainly learned from recent events, and in a perfect world, that would mean the incoming Congress acted quickly," Gardner said.

The collapse of FTX left regulators in trouble for failing to protect investors from losses should another multibillion-dollar company fail. Going forward, it will be interesting to see how regulators and lawmakers address issues of jurisdiction, and oversight to make the crypto ecosystem more resilient.