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The FTX Crypto Scandal: "Same old-school fraud, just with new technology"

24 April 2023
Shockwaves were felt across the entire crypto industry after the spectacular collapse of FTX, one of the largest cryptocurrency exchanges in the world. As a result, will we see the introduction of an effective regulatory framework for cryptoassets?

The collapse of FTX

On 13 December 2022, the founder and former CEO of FTX, Sam Bankman-Fried (SBF), once known as the "King of Crypto" was arrested by the US Securities and Exchange Commission (SEC) on 8 counts of fraud, money laundering and violation of campaign finance laws. The SEC accused SBF of knowingly devising a scheme to misappropriate customer deposits through siphoning off the FTX investments into his sister company, Alameda Research LLC, and then attempting to conceal the movement of funds. 

FTX's current CEO, John Ray III, has told Congress that FTX had unacceptable management practices and that he has never seen "such an utter failure of corporate controls at every level of an organization”. This is no understatement given that Ray managed the Enron accounting scandal in 2001. 

SBF has entered not guilty pleas to all charges against him. However, former CEO of Alameda Research, Caroline Ellison, as well as co-founders of FTX, Gary Wang and Nishad Singh, have pleaded guilty to fraud charges arising from the collapse as part of cooperation agreements with US prosecutors. The three are assisting the Department of Justice with its investigation into the collapse of FTX and are expected to testify against SBF at his trial.

What does the collapse of FTX and subsequent arrest of SBF mean for the crypto industry?

This case has been described as one of the largest frauds the US has ever seen, with the fallout already being noted by global financial markets and consumers worldwide. 

The anonymity of cryptocurrency has meant that it can be favoured for criminal activity. With that arises the need to introduce regulation of cryptoassets. 

The EU has already drafted its first major regulatory framework for cryptoassets, the Markets in Crypto Assets (MiCA), expected to be implemented in 2024 and regulatory initiatives in the UK are now coming thick and fast. 

The long awaited HM Treasury consultation on the shape and scope of regulations in the crypto sector was announced on 1 February 2023, with a published Consultation Paper titled "Future financial services regulatory regime for cryptoassets: Consultation and call for evidence" (CP). 

The CP proposes extensive new rules and regulations covering activities in cryptoassets. If introduced, they will result in wide-ranging change and potential safeguards for cryptocurrency consumers in the UK. Those cryptoasset activities and entities proposed in the scope of the UK's future regulatory framework include issuance, disclosure, trading venues and lending (the latter is not covered by MiCA). 

The CP also touches on algorithmic stablecoins and non-fungible tokens- assets that the cryptoasset industry acknowledges are potentially difficult to regulate due to a lack of back up assets for the cryptoassets and their debatable underlying value.

The Treasury currently proposes that the suggested new rules and regulations covered in the CP will be inserted into the Financial Services and Markets Act 2000 (FSMA). As FSMA already provides a well-established regulatory framework, the Treasury decided it would be best not to introduce a separate piece of legislation (as the EU has done with MiCA), since this could potentially create a confusing regulatory overlap for market participants between traditional financial services activities and cryptoasset activities.

The proposals mean that crypto firms intending to carry out cryptoasset regulated activities in the UK,regardless of whether the firm is domiciled outside of the UK, will have to undergo a rigorous process to obtain FCA authorisation. This includes crypto firms that are already registered with the FCA for AML / CTF purposes, "because businesses will need to be assessed against a wider range of measures than they have been as part of the Money Laundering Regulations registration process." 

In time, the FCA envisages an introduction of a single authorisation process "in order to give businesses and consumers a streamlined process and regulatory clarity. This would also support supervisory and enforcement processes as there may be complexities arising from an enforcement case involving multiple parties, some of whom are Money Laundering Regulations registered and some of whom are FSMA-authorised."  

The Treasury's consultation closes on 30 April, and following a response from market participants, the FCA will propose detailed rules that will be reflected in FSMA and across the FCA's rulebook. 

It is clear that now is the time for the UK to introduce comprehensive fit for purpose regulations, to ensure consumer protection in light of the alleged use of crypto exchanges to conceal wide-scale fraud and money laundering. 

Market commentators and business leaders have said that investors need to tread with care in the interim and only time will tell whether any legislative changes and implemented regulatory oversight will prove effective. 

If you have any questions relating to this article or would like advice in this area, please contact one of the authors below.

Further Reading