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After the FTX exchange failed in November 2022, this article delves into the subsequent timeframe, which became infamous as one of the most memorable crypto winters in the realm of digital currencies.
After the fall of FTX exchange, that time in crypto history is referred to as particularly bleak.
The collapse of FTX and its more than 130 affiliated companies triggered a domino effect of bankruptcies and job losses among Web3 businesses, leading to one of the longest cryptocurrency slumps. During this period, Bitcoin’s (BTC) price reached a low of $16,000.
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After the bankruptcy resulted in a significant $8.9 billion loss for crypto investors, regulatory bodies felt compelled to respond by creating more robust frameworks focusing on transparency within the crypto exchange and service provider sectors to prioritize investor protection.
US regulatory authorities imposed record-breaking penalties on Binance, even without proven user fund misuse. They similarly penalized lesser exchanges in a cautious move to forestall any possible collapses similar to FTX.
How did FTX collapse?
Approximately 18 months ago, the once high-profile cryptocurrency exchange FTX experienced a dramatic downfall, leaving a significant impact on the international crypto market and erasing around forty billion dollars in value within just a few short days.
Essentially, FTX crumbled due to the mishandling of user funds, causing approximately $10 billion in trading losses for Alameda Research. Alameda Research, a quantitative trading firm, utilized FTX customers’ funds that were transferred without authorization by Bankman-Fried to cover its own trading deficits, now known as the “Alameda gap.”
During that dismal month, Alameda incurred losses totaling over half a million dollars each day before acquiring Gary Wang’s quantitative trading protocol, as detailed in Michael Lewis’ biography on Bankman-Fried.
In November 2022, it came to light that a significant portion of Alameda’s account balances consisted of FTX’s FTT tokens, leading to the unraveling of the user fund misappropriation.
The surprising announcement triggered a significant sell-off, resulting in a dramatic drop in the price of FTT tokens. This event brought forth concerns about FTX and Alameda Research’s financial stability, ultimately leading to an influx of customer withdrawal requests totaling approximately $6 billion within a three-day span. Unfortunately, FTX was unable to process these withdrawals promptly and had to temporarily halt them.
On November 11, 2022, FTX initiated bankruptcy proceedings. On December 12, 2022, Bankman-Fried was taken into custody in the Bahamas following accusations of criminal misconduct from US authorities. He was subsequently transported to the United States in January 2023. On March 28, 2024, Bankman-Fried was given a 25-year prison sentence by a federal court.
The regulatory crackdown after the FTX collapse
When FTX exchange crumbled, the US Securities and Exchange Commission (SEC) grew more vigilant and intensified investigations into other crypto exchanges to prevent future collapses similar to FTX’s from occurring.
In June 2023, the Securities and Exchange Commission (SEC) filed lawsuits against Coinbase and Binance Exchange, accusing them of securities law violations. The SEC specifically claimed that Binance and its founder, Changpeng Zhao, mishandled and misused billions of dollars from user accounts.
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Although there is no proof that Binance took funds from users improperly, they were accused and agreed to pay a massive fine of $4.3 billion for allegedly breaking Anti-Money Laundering regulations.
In relation to the Coinbase lawsuit, the SEC asserted that the platform functions without registration as an exchange, broker, and clearing agency, thus breaking securities laws. The SEC accused Coinbase of listing and dealing with 13 tokens deemed securities, as stated in the complaint submitted in June 2023.
Coinbase attempted to end the legal dispute by asking a judge to reject the SEC’s jurisdiction over crypto trading platforms. However, this request was denied on March 27, giving the SEC the green light to move forward with their lawsuit against Coinbase.
Instead of creating new rules specifically for blockchain technology, the initial regulatory approach primarily relied on pursuing prosecutions and enforcing existing laws, as stated by Ashar Burney, the legal representative of TDeFi, in an interview with CryptoMoon.
“This approach reflects a broader trend where regulators address fraudulent activities within the crypto space through existing legal frameworks, emphasizing enforcement against criminal behavior rather than introducing new regulations specific to blockchain technologies.”
Burney stated that the main cause of FTX’s downfall was not insufficient regulations, but rather instances of criminal deceit instead.
How the regulatory landscape evolved post-FTX
After the failure of FTX, cryptocurrency exchanges are making greater efforts to be transparent, with Binance, the biggest exchange, taking the lead.
By November 2022’s end, Binance introduced its Proof-of-Reserves (PoR) system. This feature displays the actual assets Binance holds for users. The external audit is meant to assure users that Binance has sufficient reserves to cover withdrawal requests. According to the PoR page, Binance’s main assets were overcollateralized by at least 102% as of April 12th.
Other major cryptocurrency exchanges, such as Coinbase, OKX, Crypto.com, Kraken, and Bybit, have responded to Binance’s call for transparency by implementing similar practices.
Although FTX underwent extensive financial audits using the latest PoR (Proof of Reserves) systems, it’s essential for investors to carry out their own due diligence as these checks didn’t prevent the occurrence of fraud, as per TDeFi’s legal representative, Burney, in a conversation with CryptoMoon.
“SBF’s firm underwent multiple audits by reputable auditing firms, demonstrating the complexity of identifying fraudulent behavior even with established compliance measures. Overall, investors’ safety is not significantly different, especially considering that the crypto industry experiences lower fraud rates compared to traditional fintech and investment sectors.”
Governments around the world have adopted a more cooperative stance towards regulating the emerging crypto market in addition to the initiatives taken by crypto exchanges for transparency, as stated by James Wo, the founder and CEO of DFG, in an interview with CryptoMoon.
“Although countries have different stances with some being more crypto-friendly than others, they all work towards the same goal of providing a framework that prevents Anti Money Laundering (AML) with ample Know Your Client (KYC) processes in countries that do not outright ban it.”
Starting in May 2023, the European Council introduced a complete set of regulations specifically designed for the crypto market. Named the Markets in Crypto Assets (MiCA) framework, its primary goal is to safeguard investors by enforcing stricter disclosure requirements and anti-money laundering measures.
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Due to the passing of the MiCA bill by the end of 2024, crypto exchanges will be subject to regulation and overseen as authorized entities, according to Vyara Savova, senior policy advisor at the European Crypto Initiative.
“2024 is the year of MiCA, and the whole EU will now have a comprehensive legal framework for crypto-assets, crypto-asset services, and crypto-asset service providers (also known as CASPs). Crypto exchanges are a type of CASP under MiCA and will become fully regulated in December 2024. “
According to Savova, MiCA (Markets in Crypto-Assets) is a major advancement for global financial regulation and protection of investors. However, its effectiveness hinges on how each member state implements it within their respective countries.
“An important aspect that is often overlooked is the role of member state laws in applying this regulation, as these laws will create the supervisory framework in the respective country.”
In an attempt to establish themselves as leading centers for cryptocurrency innovation, Hong Kong and Dubai have implemented regulations that are favorable to the industry. A significant step forward was taken in January 2024, when regulatory approval was granted for the launch of Bitcoin spot exchange-traded funds (ETFs).
Bitcoin ETFs signal an innovation-friendly approach, but investors are not necessarily safer
Following long regulatory fights, the SEC in the US gave its approval to Bitcoin ETFs with a management fee of ten basis points on January 10. This means traditional investors can now easily invest in Bitcoin by purchasing shares of these ETFs through publicly traded funds.
According to Wo from DFG, the green light given to the ETFs is a promising indication of forward-thinking regulation towards innovations in the US, as expressed in an interview with CryptoMoon.
“Despite the lawsuits to multiple crypto exchanges, the SEC previously approved the Bitcoin ETF with the Ethereum ETF being filed. This is a signal that governments are more in favor of regulation than outright banning, as seen in many other countries regulators which provide tight regulations for the approval of licenses to operate crypto-related businesses.“
Other countries have been encouraged to take similar actions following the U.S.’s approval of an ETF. The Securities and Futures Commission (SFC) of Hong Kong may grant approval to the first four Bitcoin ETF applications by April 15, with reports suggesting that the regulatory process has been expedited for these initial ETF proposals.
Although there have been major regulatory advances worldwide, such as the introduction of Exchange-Traded Funds (ETFs) and stricter rules for cryptocurrency exchanges, investors still face a risk of another FTX-type collapse, as stated by DFG’s Wohlsen.
“Although regulation and compliance have stepped up in regulated entities, it does not mean it will not happen again even if we can expect better risk management from these entities. Overall, self-custody will still be the safest as you are in control of your own funds as long as you take sufficient risk mitigations of not clicking on phishing or scam links that may drain your wallet.”
Looking ahead to 2024 and beyond
After the FTX failure, there was increased cooperation among international regulatory bodies to prevent future major crypto exchange collapses. Major economic powers have implemented fresh regulations for crypto exchanges, and Europe introduced the first extensive regulatory framework for the crypto sector, serving as a model for other regulatory entities.
The European MiCA (Markets in Crypto-Assets) framework is currently under development. A significant portion of the legislation remains to be finalized, specifically concerning marketing and communication guidelines for crypto exchanges. These regulations could potentially influence crypto service providers operating within Europe, as mentioned by Savova, the senior policy lead at the European Crypto Initiative, during an interview with CryptoMoon.
“What will develop throughout 2024 is the CASP and, therefore, exchanges’ marketing communications and what will be allowed. It’s a very impactful topic that emerged in France and is now being discussed at the EU level through the Retail Investment Strategy.”
The consultation period for MiCA’s reverse solicitation guidelines, which is the second package, will conclude on April 29. The results of this consultation have significant impact on how MiCA will be implemented in its final form come December, as stated by Savova.
“[This will determine] how exchanges and other CASPs from countries outside of the EU might provide services to EU citizens without a license and how these services should be marketed in Europe. The outcomes of this consultation will be critical for MiCA’s implementation in December.”
Based on what Burney from TDeFi mentioned, crypto service providers may face increased regulatory oversight with more detailed reporting and adherence to regulations. This could result in a more developed and trustworthy sector within the cryptocurrency market.
“These developments reflect a shift towards a more mature regulatory framework aimed at balancing innovation with regulatory oversight. However, obtaining a license in the US may not entirely prevent exchanges from operating globally and serving US customers, highlighting the challenges of regulating a decentralized and global industry.”
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2024-04-19 19:10