Analyzing the FTX scandal from a compliance perspective

December 1, 2022
Cryptocurrency

FTX, a digital currency exchange, is a platform where people could buy and sell digital assets like Bitcoin, Dogecoin and Ether. Owing to its low trading fees and aggressive market strategies, FTX grew bigger by the minute from 2019. In 2021, when a lot of crypto firms were going out of business, FTX was left without a scratch.

However, CoinDesk published Alameda Research’s balance sheet in early October of 2022 which led to a transparent picture of FTX. Apparently, Sam Bankman-Fried, Former CEO of FTX, had owned Alameda Research, which had its own tokens called FTT. FTTs were given to customers as perks for their loyalty but if the prices for these tokens were to fall, Alameda would quickly go into insolvency. The leaked balance sheet therefore led competitors of FTX to sell all the FTTs they owned, leading to a crash in the price of FTTs. Consequently, FTX took the hit as both FTX and Alameda were connected and funds  moved from FTX to Alameda.

Sam Bankman-Fried might have thought that Alameda had enough collateral to cover those moves but the fall in FTT prices led to an utter disaster. FTX’s current CEO John Ray has been quoted as saying, “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.” He has in fact called FTX’s poor management and financial opacity “unprecedented.”

Gatenox CEO, Pawel Kuskowski invited top practitioners of corporate compliance, Carol Van Cleef and Art Middlemiss, to talk about this major failure in compliance by FTX and other imperative issues such as anti-money laundering, KYC (Know Your Customers), sanctions, market abuse, manipulation and even fraud in this video.

Carol Van Cleef, an attorney and consultant, has been embedded in the crypto industry since 2012 and has also contributed to the digital currency system to be prosecuted by the US Government. Art Middlemiss, a lawyer in New York, handles fraud issues as a prosecutor and handled one of the first prosecutions in Zimbabwe related to cryptocurrency. He was formerly a banking compliance officer, addressing crucial issues such as money laundering, sanctions and anti-corruption practices.

When asked about the setup of FTX in the Bahamas from a regulatory perspective, Art mentioned that anyone who invests their money somewhere would expect their money to be safe in that regime. The probable reason why FTX was setup in Bahamas and not in the US was because it had a better regulatory regime. US was either too unpredictable or too harsh. What happened with FTX has been a “horrible public relations disaster” for Bahamas in terms of the reception of their regulatory environment. There is a strong chance that Bahamas will act strongly to protect their reputation. Carol adds that the people of Bahamas have worked very hard to put up a regime which protects the regulatory background that provides a backbone to the crypto system.

Pawel clarifies that although the US regime can be unreliable to some extent, there are well established exchanges like Coinbase in the US. Thus, from a typical compliance perspective, there are some questions that must be answered. What would the recovery be like? Would it be the US courts trying in the Bahamas or would the local courts try to recover the funds?

Art answers that because of such multijurisdictional cases of fraud, there is likely to be a myriad of litigation across borders over a simple question: where did my money go? He also adds that if a seller is located in the US, one thing that is being sold to the customers is transparency. US exchanges are generally safe, regulated and have worked with the government in order to meet compliance requirements e.g Gemini. This is in contrast to other exchanges who might be cheaper to operate because they are based elsewhere, but the FTX scenario illustrates the risks of operating elsewhere.

According to Carol, the Bahamian entity did not back their transaction one for one whereas the US entity did, so funds held in the US entity were safe. US Money Transmitter licenses meant that there was not a chance to be the same kind of run on the bank that was seen in respect with the parent company, FTX.

Pawel claims that in traditional finance, companies are expected to segregate client money to fund any other activities of the company. However, nothing similar exists in the crypto space. Apparently, although the concept of segregating client money existed, it was not implemented or enforced in the Bahamian regime.

In the US, there is some level of comfort for customers because they can at least expect their money to be in safe hands. Whereas in a different regime, if something goes wrong, the customers are placed in a different level of risk. For example, in 1933, US was establishing rules on how to sell securities and the importance of transparency I.e. providing people with all the information required to make an informed investment decision. Art states that one of the questions that a prosecutor may ask in this situation of FTX to Sam Bankman Fried is whether it would make any difference to him if, in terms of buying a token, he knew somebody was going to take that token and artificially increase its price by keeping a big chunk of those tokens away from the market. Art adds that a probable answer to this is yes, which is perhaps a good indication of fraud going on in the market.

As Carol states here, crypto has been celebrated for its transparency and there is a great likelihood of finding information using a blockchain analytics tool that can show what could have been done to prevent the fire that has been sparked. Although the harm has been done, this information can be used as a prevention tool in the future in order to stop the same from happening again and conduct surveillance.

Art also says that when people are entrusting their money to an entity, people should ask “What do I know about that entity?” and “Is my money safe there?” but unfortunately they don’t ask this everyday. The hallmark of fraud is that if something looks to be too good to be true, most of the time, it is.

Analyzing the FTX scandal from a compliance perspective

December 1, 2022

FTX, a digital currency exchange, is a platform where people could buy and sell digital assets like Bitcoin, Dogecoin and Ether. Owing to its low trading fees and aggressive market strategies, FTX grew bigger by the minute from 2019. In 2021, when a lot of crypto firms were going out of business, FTX was left without a scratch.

However, CoinDesk published Alameda Research’s balance sheet in early October of 2022 which led to a transparent picture of FTX. Apparently, Sam Bankman-Fried, Former CEO of FTX, had owned Alameda Research, which had its own tokens called FTT. FTTs were given to customers as perks for their loyalty but if the prices for these tokens were to fall, Alameda would quickly go into insolvency. The leaked balance sheet therefore led competitors of FTX to sell all the FTTs they owned, leading to a crash in the price of FTTs. Consequently, FTX took the hit as both FTX and Alameda were connected and funds  moved from FTX to Alameda.

Sam Bankman-Fried might have thought that Alameda had enough collateral to cover those moves but the fall in FTT prices led to an utter disaster. FTX’s current CEO John Ray has been quoted as saying, “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.” He has in fact called FTX’s poor management and financial opacity “unprecedented.”

Gatenox CEO, Pawel Kuskowski invited top practitioners of corporate compliance, Carol Van Cleef and Art Middlemiss, to talk about this major failure in compliance by FTX and other imperative issues such as anti-money laundering, KYC (Know Your Customers), sanctions, market abuse, manipulation and even fraud in this video.

Carol Van Cleef, an attorney and consultant, has been embedded in the crypto industry since 2012 and has also contributed to the digital currency system to be prosecuted by the US Government. Art Middlemiss, a lawyer in New York, handles fraud issues as a prosecutor and handled one of the first prosecutions in Zimbabwe related to cryptocurrency. He was formerly a banking compliance officer, addressing crucial issues such as money laundering, sanctions and anti-corruption practices.

When asked about the setup of FTX in the Bahamas from a regulatory perspective, Art mentioned that anyone who invests their money somewhere would expect their money to be safe in that regime. The probable reason why FTX was setup in Bahamas and not in the US was because it had a better regulatory regime. US was either too unpredictable or too harsh. What happened with FTX has been a “horrible public relations disaster” for Bahamas in terms of the reception of their regulatory environment. There is a strong chance that Bahamas will act strongly to protect their reputation. Carol adds that the people of Bahamas have worked very hard to put up a regime which protects the regulatory background that provides a backbone to the crypto system.

Pawel clarifies that although the US regime can be unreliable to some extent, there are well established exchanges like Coinbase in the US. Thus, from a typical compliance perspective, there are some questions that must be answered. What would the recovery be like? Would it be the US courts trying in the Bahamas or would the local courts try to recover the funds?

Art answers that because of such multijurisdictional cases of fraud, there is likely to be a myriad of litigation across borders over a simple question: where did my money go? He also adds that if a seller is located in the US, one thing that is being sold to the customers is transparency. US exchanges are generally safe, regulated and have worked with the government in order to meet compliance requirements e.g Gemini. This is in contrast to other exchanges who might be cheaper to operate because they are based elsewhere, but the FTX scenario illustrates the risks of operating elsewhere.

According to Carol, the Bahamian entity did not back their transaction one for one whereas the US entity did, so funds held in the US entity were safe. US Money Transmitter licenses meant that there was not a chance to be the same kind of run on the bank that was seen in respect with the parent company, FTX.

Pawel claims that in traditional finance, companies are expected to segregate client money to fund any other activities of the company. However, nothing similar exists in the crypto space. Apparently, although the concept of segregating client money existed, it was not implemented or enforced in the Bahamian regime.

In the US, there is some level of comfort for customers because they can at least expect their money to be in safe hands. Whereas in a different regime, if something goes wrong, the customers are placed in a different level of risk. For example, in 1933, US was establishing rules on how to sell securities and the importance of transparency I.e. providing people with all the information required to make an informed investment decision. Art states that one of the questions that a prosecutor may ask in this situation of FTX to Sam Bankman Fried is whether it would make any difference to him if, in terms of buying a token, he knew somebody was going to take that token and artificially increase its price by keeping a big chunk of those tokens away from the market. Art adds that a probable answer to this is yes, which is perhaps a good indication of fraud going on in the market.

As Carol states here, crypto has been celebrated for its transparency and there is a great likelihood of finding information using a blockchain analytics tool that can show what could have been done to prevent the fire that has been sparked. Although the harm has been done, this information can be used as a prevention tool in the future in order to stop the same from happening again and conduct surveillance.

Art also says that when people are entrusting their money to an entity, people should ask “What do I know about that entity?” and “Is my money safe there?” but unfortunately they don’t ask this everyday. The hallmark of fraud is that if something looks to be too good to be true, most of the time, it is.

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