November 16, 2022
In the wake of the collapse of FTX, we can expect to see a far-reaching regulatory response. Just this week, U.S. Treasury Secretary Janet Yellen explained to Bloomberg that the collapse of FTX is further evidence that the market for digital assets requires “very careful regulation." Yellen continued, "In other regulated exchanges, you would have segregation of customer assets…the notion you could use the deposits of customers of an exchange and lend them to a separate enterprise that you control to do leveraged, risky investments — that wouldn’t be something that’s allowed.”
Secretary Yellen pointed out that the crypto sector is not yet large enough or “deeply integrated with our banking sector and, at this point, doesn’t pose broader threats to financial stability.” This point echoed Secretary Yellen's statements after the collapse of stablecoin Terra, explaining at a congressional hearing, "I can’t say [stablecoins] have reached a scale where they’re financial stability concerns. I wouldn’t characterize it as a real threat to financial stability, but they're growing very rapidly and present the same kind of risks we’ve known for centuries from bank runs.”
However, Yellen and many of her colleagues across the executive branch have been calling for a comprehensive plan for digital assets. At a hearing on May 10th, 2022, in the wake of the Terra collapse, Yellen said, "I think that simply illustrates that this is a rapidly growing product, and that there are risks to financial stability, and we need a framework that's appropriate.” She later said legislation to address crypto regulation would be "appropriate" this year.
The reality is that if the FTX collapse had happened three years ago — similarly to what happened with the launch of stablecoin project Libra — regulators would be scrambling to understand and implement crypto regulation. However, in the last few years, we have seen regulators and policy makers across the globe move to develop legal frameworks for crypto, and we are thus likely to see an increased focus in light of what has happened with FTX. Regulators have already highlighted the need for consumer protection, combatting scams and fraud, and the need for responsible governance. Here are some examples:
🇺🇸 United States: In the September White House Framework for Digital Assets, one of the key tenets is the drive to foster financial stability. The framework explains that "Digital assets and the mainstream financial system are becoming increasingly intertwined, creating channels for turmoil to have spillover effects." While the framework highlights the collapse of stablecoin Terra, it also speaks to the FTX saga. The framework also underlines the "responsibility of executive branch agencies to identify, track, and analyze emerging strategic risks that relate to digital asset markets."
🇸🇬 Singapore: In October, the Monetary Authority of Singapore (MAS) proposed measures to address some of the issues which have since been highlighted by FTX. Specifically, the measures would require service providers to provide relevant risk disclosures to enable retail consumers to make informed decisions regarding crypto trading and "will be required to implement proper segregation of customers’ assets, mitigate any potential conflicts of interest which arise from the multiple roles they perform, and establish processes for complaints handling."
The MAS’s proposals — for which the comment period closes in December 2022— are arguably the most directly relevant to risks posed by FTX to consumers. For example, MAS dedicates several pages to a section entitled, “Segregation of Customers’ Assets and Risk Management Controls,” in which the regulator proposes that businesses should ensure that customers’ assets are segregated from the Digital Payment Token Service Provider’s (DPTSP) — what MAS calls a VASP or CASP — own assets, and held for the benefit of the customer. MAS explains, “The recent failure of several firms in the DPT industry underscores the importance of DPTSPs having effective and robust arrangements in place for the identification and segregation of customers’ assets. In addition to minimising the risk of loss or misuse of customers’ assets during the ordinary course of business, these arrangements facilitate the return of customers’ assets in the event of the DPTSP’s insolvency.” MAS also focuses much of its proposal on ensuring that customers are properly informed of the “arrangements and risks involved in having their assets held by DPTSPs.”
🇪🇺 Europe: The EU's Market in Crypto Assets (MiCA) legislation is an attempt to mitigate some of the FTX-style risks, by requiring crypto firms to “ensure internal risk management mechanisms," according to a recent tweet from European Parliament economics committee member Stefan Berger. But what does that mean? For example, MiCA requires stablecoin issuers and crypto asset service providers (CASPs) to undergo a licensing process that, depending on the entity involved, includes maintenance of reserves, a comprehensive set of conduct and organizational rules such as robust governance and internal control arrangements, and conflict of interest, liquidity management and risk management policies.
This is just a sample of the high volume of guidance being released by regulators around crypto-assets. We are seeing similar guidance and proposals in the U.K., UAE, and across the globe. Beyond the regulatory focus on the need for good governance and other controls, we are seeing a focus on consumer protection, advertising and promotion, and identifying fraud and scams. For example, in January, the U.K.’s HM Treasury put forth a plan to regulate crypto advertising and its response to its consultation on financial promotions to cryptoassets. That same month, MAS set forth guidelines prohibiting crypto businesses from advertising in public areas including on buses, ATMs, public websites, and in broadcast and print media. Additionally, in March, Ireland’s central bank issued a warning for consumers on crypto advertising and social media influencers. The Central Bank of Ireland said that cryptocurrencies were “highly risky and speculative” for retail investors and warned people to be mindful of “the risks of misleading advertisements, particularly on social media, where influencers are being paid to advertise crypto assets.” In August, Dubai’s Virtual Assets Regulatory Authority (VARA) issued similar regulations on crypto promotion.
While many jurisdictions have provided white papers, proposals and guidance, FTX is likely to accelerate the discussions around creating comprehensive frameworks. The key for policy makers will be to strike the balance between ensuring good governance and consumer protection while not stifling innovation.
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