Following FTX’s swift, stunning collapse in November, crypto industry participants, lawmakers and regulators alike have all been mulling the same questions: Why were regulators blindsided by FTX’s implosion and, more importantly, how can the next crypto crisis be prevented?
In a speech at Duke University on Wednesday, Commodity Futures Trading Commission (CFTC) Commissioner Kristin Johnson formally called on Congress to modify several pieces of proposed digital asset legislation to expand the U.S. agency’s authority to conduct due diligence on any firm – foreign or domestic – seeking to purchase a minimum 10% share of the equity interest in a CFTC-registered market participant.
“Specifically drawing from the example of LedgerX, I am advocating for regulation that formalizes the obligation to separate customer property, ensure financial resource requirements … and introduce effective governance and risk management controls,” Johnson said.
Johnson’s remarks echoed CFTC officials’ brewing frustration in recent months over the agency’s limitations and calls for more authority.
In December, Rostin Behnam, CFTC chairman , told lawmakers in December that his agency did not have enough authority to properly oversee FTX, which was based in the Bahamas. Instead, the CFTC only had insight into LedgerX – one of the few FTX-owned companies that has remained solvent throughout the collapse and subsequent bankruptcy process.
Behnam and Johnson have used the example of FTX to demand expanded authority for their agency to oversee the crypto industry – something they’ve repeatedly argued could prevent the next FTX from happening.
LedgerX was a CFTC-regulated entity prior to being purchased by West Realm Shires (the legal name for FTX US) in 2021. Johnson noted that less than two years after being brought under the FTX umbrella, ”market participants find themselves navigating the dark and troubling waters of FTX’s bankruptcy.”
LedgerX is currently being auctioned off as part of the FTX bankruptcy proceedings. Preliminary bids for the company were due on Wednesday, and the sale is expected to be finalized by March.
Johnson argued in her speech that the current regulatory requirements around such acquisitions are minimal – and not enough to prevent future collapses. The CFTC must simply be notified of any transfer of equity ownership and is not otherwise involved in a sale.
Instead, she proposed that the CFTC initiate a notice and comment process for proposed acquisitions to give the agency “greater visibility into the financial health, corporate governance and risk management” of any business that wants to buy into a CFTC-regulated entity.
“In times of crisis, with expanding access to retail market participants, and with increasingly diverse markets, relying on other regulatory frameworks such as anti-trust legislation, may prove too limited in scope to prevent crypto-crises,” Johnson added.
‘A new cautionary tale’
Johnson didn’t hesitate when discussing corporate failures that led to FTX’s implosion, saying the collapsed Bahamian exchange was the latest example in a string of “cautionary tales woven together by a set of common threads.”
“An almost 30-year-old CEO launches an international crypto exchange. Within a few years, the founder and the exchange achieve crypto-celebrity status. At its peak, the exchange captures significant market share,” Johnson said.
Such meteoric rises, Johnson added, are often followed by an all-too-common ending: “Like lightning striking, in an instant the exchange suspends trades, shutters the windows for withdrawals, silences traffic on its website and files for bankruptcy protection, leaving customers infuriated, investors stunned, and creditors scrambling in a footrace to the courthouse.”
After the initial chaos, the arduous, lengthy process of cleaning up the mess of a crypto crisis remains, Johnson said.
“We are years if not decades from untangling the Gordian knot of conflicts of interest, an absolute failure of corporate governance, absence of effective internal controls, and transactions with affiliated entities,” she said.
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