Bullish sentiment should not obscure the lessons to be learned from FTX
As crypto markets continue to be in the midst of a bull market, combined with the most institutional adoption to date, there are multiple reasons for investors and advocates to be optimistic. One of the more surprising headlines that is at least a partial result of resurgent prices, new innovation, and greater adoption was the news that recently was released connected to the bankruptcy of FTX. Even as Bankman-Fried sits in prison, beginning his lengthy sentence, and the regulatory landscape (and regulators) struggle to move past the failures and embarrassment that this collapse and associated crimes caused, a positive story emerged. In May 2024 it was announced that the bankruptcy estate managing the recovery and eventual winding down of FTX has been able to recover enough funds to repay investors in full, with some estimates ranging as high as a 140% recovery.
Setting aside some comments stating that this absolves Bankman-Fried and his former colleagues of criminal activity – of which Bankman-Fried was found guilty in court and some former colleagues are still awaiting sentencing for – there are several important lessons that all interested parties in the crypto space should be aware of moving forward. The facts remain that criminal charges were brought against these individuals and that while sentences can always be reduced in the future these charges, and crimes, exist.
Rising Prices Lift All Boats
Any investor that has studied the history of markets for any assets has heard some version of the phrase from Warren Buffet that savvy investors are only revealed during bear markets; this is the case with FTX as well. The positive headlines regarding the ability of the bankruptcy estate to pay back investors tends to overshadow one important point; these repayment ratios and metrics are based on the prices of crypto at November 2022. The 2024 bull market has greatly increased the price of all cryptoassets, including those that were held on the balance sheet of FTX, leading to much higher levels of available assets. When combined with the cash recoveries that were possible via clawbacks and real estate sales, the picture of the repayment process becomes clearer.
The fact that FTX, on paper, has the ability to make investors whole 18 months after filing for bankruptcy should not obscure the fact that this is an incomplete presentation of the facts. Illiquidity is fine, and portfolio managers deal with that risk/reward trade-off on a daily basis, but that is no excuse for the commingling of funds, wire fraud, and other financial crimes committed at FTX.
Repayment Plans Expose The Need For Faster Liquidation
For an asset class that can move as quickly as cryptoassets can, and do, the recovery updates from the bankruptcy estate of FTX are another example of the need for more investor education regarding legal differences in different markets. It is encouraging and worth noting that established legal practices have seemingly worked as intended during this process, but that is not a reason to stop seeking improvement. Contrasting with the United States, the customers of FTX Japan were able to regain access to funds long before U.S. investors received this recent news.
This also raises interesting differences that crypto investors should keep in mind. At FTX Japan the crypto held by investors were segregated and present in each individual customer account. Contrasting this to the situation faced by U.S. investors, where crypto funds were not segregated (and in some cases were missing), highlights the importance of understanding the nuances and differences between various markets.
Questions that have been raised regarding the FTX bankruptcy and eventual liquidation include, but are not limited to issues around crypto rehypothecation, private key management, succession planning for key personnel at crypto exchanges, and exactly how much disclosure and transparency should be required of crypto broker dealers.
Given the rapid acceleration of cryptoassets and blockchain-based applications it is inevitable that legal, as well as financial reporting, complications will arise. Although it remains true that all cryptoassets, including bitcoin, are financial instruments it should be evident that the rapid development of institutional products alongside individual investor interest, indicates that at least some crypto-specific frameworks and rules are necessary.
Regulatory Guardrails Are Needed
In May 2024, in a rare show of bipartisan agreement, the U.S. Congress (both chambers) voted to repeal the controversial SAB 121 that had been issued by the SEC. In addition to these votes serving as another rebuke to Chairperson Gensler and his campaign to regulate all cryptoassets are equity securities, this illustrated a fact that crypto advocates and investors have known for year; clear and concise regulatory frameworks are necessary. Bitcoin ETFs have drawn tens of billions of inflows since inception, and TradFi institutions continue to develop and deploy blockchain and crypto native assets, but the regulatory environment in the U.S. remains murky.
Protecting investors, as well as maintaining liquid and transparent markets should be a key priority of both U.S. regulatory and policymakers, but this should not stand in the way of much-need innovation. Especially since stablecoins, and the implications tokenized transactions, seem to be attracting the attention and investment of TradFi institutions, policymakers would be well advised to conduct productive conversations on these topics versus scoring political points.
FTX continues to cast a long shadow over the crypto space, but also provides crypto advocates, investors, and policymakers an opportunity to learn – and implement – important lessons.
