FTX Implosion May Be The Catalyst for Fast-Tracking Legislation

Yesterday, Binance, the largest global cryptocurrency exchange, acquired FTX’s global exchange after its founder and CEO Sam Bankman-Fried appeared to have knowingly parked unbacked, illiquid assets on a sister company’s balance sheet – the stuff regulators warn about – which brought FTX to near-insolvency.

As a result, Bankman-Fried did the only thing he could which was to sell FTX to his competitor.

It’s not a good look for crypto and its legislative champions. On the other hand, if you’re rooting for new regulation, this may be what forces Congress’ hand. Guardrails are needed ASAP if consumers are going to be protected and the industry is going to flourish.

The damage

Is the impact from this bigger than the Terra Luna stablecoin debacle in the Spring? Probably.

First, let’s review the “soft” impact…

Sam Bankman-Fried was arguably the most popular industry figure in Washington D.C., appearing multiple times in front of Congressional committees in spite of his global company’s Bahamian address. Now, his name and reputation have taken a devastating hit affecting relationships with the CFTC and Congress especially as it relates to the feedback he was providing on crypto derivatives changes and the Stabenow-Boozman Digital Consumer Commodity Protection Act (DCCPA) coming out of the Senate Ag committee.

Undoubtedly, SBF’s (as Sam Bankman-Fried is colloquially known) actions were damaging to the crypto industry itself which was already dealing with multiple scandals,  hacks and “rugs” making DC power players wonder if crypto is a positive, world-changing innovation or just a fleeting ponzi scheme that allows SEC Chair Gary Gensler to say, “I told you so.”

Moreover, the financial damage wrought by the enormous blunder is still unknown. Are all customer funds safe? Maybe. Seems so. What about FTX’s billions in funds? Likely not. How about FTX’s investors? They’re definitely holding the bag.

One important qualifier in this mess is that FTX.us (the carve out within FTX which deals with US business) will remain independent from the Binance deal meaning Bankman-Fried is still in the game, so to speak – at least for now – until another shoe drops.

Ironically, this event may end up being a catalyst for passing legislation quickly even though some industry observers, such as Messari’s Ryan Selkis, are maudlin about the prospects.

But, Perianne Boring, CEO of industry advocacy organization Chamber of Digital Commerce, emphasized in a statement the importance of legislation yesterday saying: “This FTX-Binance deal highlights the unique global nature of crypto, and it’s important that U.S. policymakers put in place a legal framework that accounts for such unique features of blockchain technology, while also encouraging ongoing innovation and adoption of the crypto ecosystem in a in responsible and sustainable way.”

Congress responds

The response from multiple members of Congress was remarkable given the culminating event took place on the same day as midterm elections in the United States.

Senator Cynthia Lummis (R, WY) said in an election night tweet yesterday:

“I have many questions regarding Binance acquiring FTX, including potential market manipulation, lending activity, and whether customer funds and assets were appropriately safeguarded.”

Conceivably, there could be Congressional hearings to come regarding the Binance/FTX deal on her Senate Banking Committee. She touted the Responsible Financial Innovation Act (RFIA) co-sponsored with Senator Kirsten Gillibrand (D, NY) in her brief statement here.

Republicans from the House Agriculture Committee, led by Ranking Member Rep. Glenn “GT” Thompson (R, PA), took a moment to tout House Ag’s Digital Commodity Exchange Act (DCEA) legislation saying in a tweet yesterday:

“We’re paying close attention to this developing news and are supportive of ongoing efforts to bring oversight & clarity to #crypto markets. @CongressmanGT’s #DCEA is a necessary step forward to bring transparency to crypto exchanges in the United States.”

Not to be left out of the mix, Rep. Patrick McHenry (R, NC) made a statement of his own regarding yesterday’s events and advocated for – you guessed it – legislation:

“For years, I have advocated for Congress to develop a clear regulatory framework for the digital asset ecosystem, including trading platforms. The recent events show the necessity of Congressional action. It’s imperative that Congress establish a framework that ensures Americans have adequate protections while also allowing innovation to thrive here in the U.S. I look forward to learning more from FTX and Binance in the coming days about these events and the steps they will take to protect customers during the transition.”

Another hearing appears possible. Rep. McHenry, who is Ranking Member of House Financial Services, is also leading the charge along with Chairwoman Maxine Waters (D, CA) on a stablecoin bill.

Communications Director Patrick Creamer for the Republicans on the Senate Ag Committee (led by Ranking Member Senator John Boozman (R, AR)) appeared to reference DCCPA’s legislative momentum in a statement sent to the press: “Discussions to address a few remaining concerns with the legislation are ongoing. This development does not change that work on our end.” So, not only slowdown is their no slowdown in legislative momentum, there are only a few “concerns” which need to be worked out. The size and scope of those DCCPA concerns is unknown, but due to vocal industry pushback, it may be around DeFi.

And given all the comments from Congressional Republicans, it seems clear the Republican caucus wants to move forward with regulation.

The wildcard remains Democrats and the Executive Branch where support seems conflicted in spite of high profile Democratic support from Stabenow, Gillibrand and DCCPA co-sponsor Senator Cory Booker (D, NY) as well as  Rep. Darren Soto (R, FL) and Rep. Bill Foster (D, IL) in the House to name several.

The Dems conflict may be best exemplified by the President’s Executive Order which requested input on crypto and blockchain technology across governmental authorities in March. The EO had a tone which initially seemed to provide hope on supporting innovation while protecting consumers. But after delivery of the reports,  the EO seems to be more of an initiative to construct a cautionary tale.

How about DeFi?

There remains a push-pull with regulation: it enables a centralized authority to control and govern but may also prevent the flowering of decentralized entities which some believe offer a better solution when it comes to cryptocurrency and distributing the benefits of blockchain innovation.

Yet, the perception that DeFi or Decentralized Finance subverts governmental authority persists by allowing paths for bad actors to take advantage (i.e. North Korea).  Consequently, this has led to actions such as OFAC’s recent sanctioning of mixer Tornado Cash, for example.

Former CFTC Commissioner Brian Quintenz, who is now an advisor to venture firm a16z, makes the case that DeFi has a potential to be a winner coming out of all this. He tweeted yesterday: “The evil financial trinity of centralization, leverage (collateral), and opacity keep finding ways to blow things up. Until now, regulation was the only solution. DeFi presents a new one.”

DeFi’s argument is that disclosure, transparency and lack of centralization is everything wanted by legislators. It just needs to be embraced rather than inhibited by regulation.

Coinbase CEO Brian Armstrong of Coinbase, a top exchange based in the U.S., echoed the hopes around DeFi but wasn’t sure about a timetable. He tweeted, “Long term, the crypto industry has an opportunity to build a better system with DeFi and self-custodial wallets that don’t rely on trusting 3rd parties. Instead, you can trust in code/math and everything can be publicly auditable on-chain. This is a topic for another day…” Read the entire thread and a blog post on the company’s approach to risk management.

Regulation and the FTX implosion could be important milestones in DeFi’s endgame. Critically, how a government understands and manages its relationship with DeFi is still to be discovered.