Blog Post

Lessons of the FTX Collapse

Bretton Woods Committee  | Mon, Feb 6, 2023

by Anthony Elson


The collapse of FTX in many ways is an example of the problems associated with a weakly regulated financial enterprise, as much as it is a demonstration of the problems associated with crypto finance in its current state. 

As a financial enterprise, the bankruptcy of FTX shows the major failings that can arise in an organization with an exceptionally weak governance structure as regards internal financial controls, record-keeping and the oversight of an independent board of directors. There also appear to have been shortcomings in the scope and scrutiny of its outside auditors.

As a crypto finance institution, the problems just cited were compounded by the general lack of an appropriate regulatory framework for digital finance, at both the domestic and international levels. Some commentators have argued that establishing a specific regulatory regime and federal licensing procedure for digital financial firms would give too much legitimacy to what in many cases are purely speculative operations without any redeeming economic or social value. However, this indictment is too vast for the growing and diversified field of crypto finance and ignores the fact that investors will continue to have an interest in certain crypto finance operations, while traditional financial firms will continue to take an interest in potential  investment opportunities they see in the field of crypto finance. 

The FTX experience should not be taken as an indictment of digital finance, in general. Stablecoins offer the prospect of more efficient payments arrangements, both domestically and globally, and could operate as an adjunct to money market funds, if appropriately regulated. The benefits of stablecoins for payments and transfers have already been demonstrated by the establishment of certain corporate, “permissioned” stablecoin arrangements, such as JP Morgan’s JPM Coin. Decentralized finance (DeFi) raises the possibility of improvements in banking operations, both in terms of their inclusiveness and cost, if established within a sound regulatory framework. Central bank digital currencies (CBDCs) are likely to improve the efficiency, speed and safety of global payments systems.

In the design of an appropriate regulatory framework for crypto finance, transparency and disclosure requirements must be given primary emphasis as a basic protection for potential users and investors. In addition, the principle of “same activity, same risk, same rules” should be pursued as to whether crypto finance firms are dealing with assets that are judged to be securities, commodities or bank-like instruments. In the United States, efforts to apply the regulatory principle just stated to crypto asset operations have not yet been successful because of the lack of Congressional action and the highly fragmented nature of the government’s regulatory structure. By contrast, the EU is creating a comprehensive regulatory framework for crypto assets under its Markets in Crypto Assets (MiCA) regime to replace a patchwork of different national schemes that now exist.

Given the global reach of most crypto finance operations, it is essential that efforts are made to establish similar standards in the regulatory regimes across countries in order to allow for closer coordination and cooperation in the supervision of these operations and to prevent regulatory arbitrage, which was a factor in FTX operations. The FTX experience also shows that, at the very least, specific global standards are needed for data management and disclosure, governance arrangements, custody services and reserve management practices of crypto asset providers, centralized exchanges and stablecoins. 

The international challenge of regulating and supervising crypto finance operations requires the continued guidance and oversight of the Financial Stability Board (FSB). In October 2022, the FSB issued guidelines for the regulation, supervision and oversight of crypto asset and stablecoin activities that it intends to finalize later this year in the light of comments it has recently received (see FSB Consultative Document).

Other elements of the international financial architecture need to continue to promote the establishment of a framework for the orderly and sound development of digital finance. The IMF, for example, can play a key role in analyzing digital finance operations on a global basis in its semi-annual Global Financial Stability Reports and in providing guidance on the globally consistent regulation of these operations at the country level in its periodic Fintech Notes. Efforts could also be made to include assessments of digital finance regulatory frameworks in member countries in the IMF’s periodic Financial Sector Assessment Program (FSAP) reports with the World Bank. 

Without the development of sound national legal regimes based on globally consistent regulatory principles, crypto finance will develop in ways that are increasingly detrimental to financial stability, with little benefit to investors and consumers. 

Mr. Elson is a former senior staff member of the IMF and the author of a number of books on economic and financial globalization, including most recently “The Global Currency Power of the US Dollar – Problems and Prospects” (2021).

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