Regulators face public ire after FTX collapse, experts call for coordination

2022 is nearing an end and might go down as one of the most eventful years for the crypto industry owing to the prolonged winter that had wiped more than 70% of the market cap from the top and the barrage of crypto firms imploding. This was mainly due to internal mismanagement and unchecked decision-making process.

Among all the ups and downs, one thing has remained clear — retail customers have lost a significant amount of money due to a lack of regulatory oversight.

While lawmakers in the United States promised to bring crypto under regulatory purview many times this year, after every major crypto fallout like Terra and FTX, we see another round of regulatory discussions without any concrete action.

The role of regulators has been heavily scrutinized in the wake of FTX’s collapse due to the close ties between former CEO Sam Bankman Fried and policymakers. Some reports indicate that eight congresspeople, five of whom received donations from FTX, tried to stop the Securities and Exchange Commission from investigating FTX.

Breaking: 8 Congress Members tried to stop the SEC from inquiring into FTX by questioning the SEC's authority to inquire about Crypto5 of those 8 members also received campaign donations from FTX, ranging from $2,900 to $11,600

— Nancy Pelosi Stock Tracker ♟ (@PelosiTracker_) November 25, 2022

Coinbase CEO Brian Armstrong was not very pleased with regulators’ failure to avoid another contagion and claimed that enforcement action against U.S.-based companies for the irregularities committed by an offshore crypto exchange makes no sense.

Armstrong also blamed the SEC for failing to come up with timely regulations, driving out nearly 95% of the trading activities to offshore exchanges.

https://t.co/0HxlRiI6Sy was an offshore exchange not regulated by the SEC.The problem is that the SEC failed to create regulatory clarity here in the US, so many American investors (and 95% of trading activity) went offshore.Punishing US companies for this makes no sense.

— Brian Armstrong (@brian_armstrong) November 10, 2022

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

He told Cointelegraph, “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 noted by Armstrong, the inability of regulators and policymakers to come up with clear crypto regulations has been a primary driver behind investors going to offshore exchanges.

Preissler noted that regulation already exists in the United States — exchanges need to have either a state-level money transfer license, a banking license to offer cryptocurrencies or a registration as an alternative trading system (ATS) with the SEC if they are offering blockchain-based securities.

He added that any further regulation could be on top of existing ones or potentially supplant them. However, “without one or both of those categories in the U.S., an exchange would be in violation of existing regulations.”

Patrick Daugherty, a former SEC lawyer, told Cointelegraph that “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 about why SEC failed to take any timely actions against off-shore exchanges, Daugherty recommended a congressional hearing and explained:

“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 faced greater scrutiny in the wake of the collapse of the FTX crypto exchange as the exchange was lobbying for making the CFTC the chief oversight committee for the crypto market. Republican lawmakers have accused the SEC chair of coordinating with FTX “to obtain a regulatory monopoly.”

U.S. regulators must put better safeguards in place

The process of regulations is time-consuming due to the number of parties involved and all legislation must pass through Congress before being implemented. However, regulators like the SEC can use court injunctions to develop pwolicies that protect their investors. Such an instance is seen in the ongoing case between the agency and Ripple executives. In this lawsuit, the SEC is using legal means to enforce the laws despite the lack of clear regulations around which crypto assets qualify as securities and which ones can be deemed as an asset.

David Kemmerer, CEO of crypto tax solution provider CoinLedger, called for inter-governmental collaborations with the tax havens to ensure that relevant laws are mutually respected. Also important, offshore exchanges must only use authorized dealers.

He also said regulators should promote safe and efficient marketplaces, so U.S. regulators can avoid the exodus of investors to offshore exchanges, telling Cointelegraph:

“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 light of the crypto meltdown, U.S. regulators must put guardrails in place to safeguard investors while still enabling domestic innovation to flourish.

Richard Mico, chief legal officer at crypto on-ramp solution provider Banxa, told Cointelegraph that establishing comprehensive crypto regulation is a long road, but there are obvious guidelines that prudential regulators can lay out and clarify to allow good actors in the space to continue innovating within the U.S. while holding bad actors accountable. He told Cointelegraph:

“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 suggested 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.”

American regulators have had an on-again, off-again relationship with crypto. Since the FTX debacle, there is now a strong call for increased regulation. Richard Gardner, CEO of crypto infrastructure provider Modulus, believes that regulation must bring a mandate prohibiting the co-mingling of client assets and exchange assets. He cited the example of the European Union’s MiCA regulations, telling Cointelegraph:

“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 to act surely has been a detriment to the cryptocurrency industry. However, the liable party in the FTX debacle is the exchange and its CEO, Sam Bankman-Fried. “It is easy and convenient to pass the buck to regulators, but what SBF has done is absolutely unconscionable. Regulators have certainly learned their own lesson from recent events, and, in a perfect world, that will mean swift action from the incoming Congress,” Gardner said.

The collapse of FTX has put regulatory bodies in the hot seat over their failure to protect investors from losing money in the collapse of yet another billion-dollar firm. Looking ahead, it will be interesting to see how regulators and lawmakers alike tackle questions of jurisdiction, purview and oversight in an effort to make the crypto ecosystem more stable.