Op-Ed

The FTX fiasco

“With a multibillion-dollar market capitalization, crypto is here to stay. It’s not going anywhere.” – Ritchie Torres

On November 2, 2022, a news article appeared that launched a series of events that, in a matter of days, led to the mercurial meltdown of one of the world’s largest cryptocurrency exchanges. Thus began the downward spiraling demise of FTX Digital Markets and its related companies worldwide.

Since the Bahamian company was placed in liquidation by the Securities Commission of The Bahamas (SCB), there has been a whirlwind of negative press about FTX, its founder, Sam Bankman-Fried, The Bahamas, and the prospects for cryptocurrency, locally and internationally. Some of what was written and reported about the FTX fiasco can best be described as misguided, fallacious misinformation, and disinformation about what transpired with FTX and its related companies.

Therefore, this week, we will consider this: What accounted for FTX’s devastating demise, and what does this failure mean for The Bahamas?


What happened?

Attorney General Ryan Pinder offered one of the more definitive chronological accounts of what contributed to FTX’s demise and its likely impact on The Bahamas in his national address on Sunday, November 27, 2022. In that address, the attorney general provided a chronology of events leading up to the FTX failure and a prognosis about its future specifically and that of digital assets in general.

FTX Digital Markets was incorporated in The Bahamas in July 2021 and registered as a digital asset business under the Digital Assets and Registered Exchanges Act (“the DARE Act”).

In September 2021, the SCB approved an FTX Digital license to operate in The Bahamas. FTX, previously headquartered in Hong Kong, operated globally for more than two years before coming to The Bahamas.

As the attorney general reported, “FTX Digital Markets quickly set about establishing a major presence in The Bahamas, buying properties, hiring and training Bahamian staff, and sponsoring a number of charitable and community ventures.”

Fast forward one year. On November 2, 2022, details of the financial statements of Alameda Research, a trading company that FTX’s founder also owns, were leaked.

Alameda Research’s balance sheet revealed that a significant portion of its assets was held in FTT, a token issued by an FTX entity. The token holders of FTT were extended discounts on trading fees.

Four days after the leaked Alameda Research financial information, Binance, another crypto exchange and a significant rival to FTX, announced that it was liquidating all its substantial holdings in the FTT token. The Binance announcement prompted many FTX investors to withdraw hundreds of millions of dollars in digital assets from FTX, effectively resulting in a liquidity crunch for FTX.

Two days later, on November 8, 2022, Binance announced that it had entered a non-binding agreement to buy FTX. The very next day, November 9, Binance exited the deal with FTX.

The SCB intervenes

In his national address, Attorney General Pinder stated that in “one day, November 10th, 2022, the Securities Commission of The Bahamas, announced that it had taken action to freeze the assets of FTX Digital Markets, had suspended the registration of FTX Digital Markets as a licensee under the Digital Assets and Registered Exchanges Act, also known as the ‘DARE Act’, and applied to the Supreme Court of The Bahamas, pursuant to its regulatory authority under the DARE Act, to place the company into provisional liquidation”.

“Over the course of eight days, market confidence was lost in a company which at one point had a $32 billion valuation. The Securities Commission deserves the highest praise for moving so swiftly and decisively to suspend FTX Digital Markets’ license and appoint provisional liquidators.

“In addition, the Securities Commission recognized that given the nature of digital assets, and the risks associated with hacking and compromise, placing FTX Digital Markets into provisional liquidation was not sufficient to protect the customers and creditors of the company.

“Therefore, pursuant to their authority under the DARE Act, and pursuant to an order of the Supreme Court of The Bahamas, the Securities Commission secured the assets of FTX Digital Markets to be held on behalf of and for the benefit and restitution of clients and creditors of FTX.

“The speed with which the Securities Commission was able to move was remarkable by any standard.

“The commission was the first regulator in the world to take significant steps with respect to the FTX group of companies, which has operations and regulated activities throughout the world.

“This was done for the purpose of protecting the interests of FTX’s customers and creditors, as well as the integrity of the Bahamian financial services industry.

“The Securities Commission was able to move so quickly because of the strength of the legislative framework which was already in place in The Bahamas to regulate digital asset companies like FTX Digital Markets.

“No other jurisdiction in the world moved or could have moved this quickly in circumstances such as these.”

In his address, Pinder took great care to advise his audience that “among the over 100 companies located in dozens of jurisdictions around the world, FTX Digital Markets is the only entity regulated in The Bahamas. Alameda Research is NOT regulated in The Bahamas.”

While it is too early to determine what ultimately contributed to FTX’s rapid demise, early indications suggest that questionable internal management practices and corporate governance largely contributed to the company’s failure. There will be many investigations into the FTX fiasco. In the final analysis, students in business schools worldwide will study FTX to see what they must avoid as future captains of industry.


The Bahamas
government’s role

There are some who, for their purposes, would like to blame The Bahamas government for the FTX fiasco. Any attempt to do so would be ill-advised and without foundation. If anything, the SCB, a government regulator, acted quickly and decisively to thwart a catastrophe from becoming a national crisis.

Pinder observed in his national address, “As a government, we decided right away that what was most important was not to engage with speculation or gossip, but instead to proceed methodically and deliberately, by the exercise of due process and the rule of law.

“We are in the early stages of an active and ongoing investigation. It is a very complex investigation: the structure and reach of FTX’s activities are truly global, as they consist of over 100 companies located in dozens of jurisdictions.

“Digital assets are in use in jurisdictions across the world – in North America, in Central and South America, in Europe, in the Middle East, in Asia, in Africa, in the South Pacific. They are being utilized and traded in countries — whether there is a regulatory framework in place or not.

“The Bahamas decided that we needed to actively engage in this sector for two reasons: first, to take advantage of the strategic opportunity of this new sector; and second, to protect our existing financial services sector from the risks which unregulated activities connected with crypto-currency and other digital assets may bring about such as illicit financing.

“The Bahamas, with significant expertise in international financial services regulation, decided we would not allow this activity in our jurisdiction without the establishment of a robust legal and regulatory framework, reflective of the best practices observed in the industry and in compliance with the recommendations of global standards setters.

“As I said at the outset, there is an active and ongoing investigation of the affairs of FTX Digital Markets, involving both civil and criminal authorities.

“The SCB, Financial Intelligence Unit, and the Financial Crimes Unit of the Royal Bahamas Police Force will continue to investigate the facts and circumstances regarding FTX’s insolvency crisis, and any potential violations of Bahamian law.

“They will hold accountable any responsible companies and individuals, and act in cooperation with other regulatory agencies and law enforcement bodies, both here in The Bahamas, and in other countries affected.

“Any attempt to lay the entirety of this debacle at the feet of The Bahamas, because FTX is headquartered here, would be a gross oversimplification of reality.

“And it is deeply misguided to conclude that reluctance to communicate the details of an active investigation means that nothing is happening; in fact, the government’s discretion stems from how seriously we take our commitment to the rule of law and the 

independence of the securities regulator.

“We have been shocked at the ignorance of those who assert that FTX came to The Bahamas because they did not want to submit to regulatory scrutiny; in fact, the world is full of countries in which there is no legislative or regulatory authority over crypto, but The Bahamas is not one of them.”


Teachable moment

Although it is still early days, the FTX collapse represents a teachable moment for stakeholders in the digital assets arena. Unless we accept that there are teachable moments that can be derived from the FTX debacle, we will miss a golden opportunity to demonstrate to the world that we are serious about regulating companies operating in this industry. Several lessons can already be learned from this event.

First, we should not panic and should not believe that the FTX demise is a precursor to the ultimate death of the digital assets industry, either in The Bahamas or elsewhere. We will survive this moment.

Second, more robust regulation protocols are urgently needed. This must begin with the initial application process, through to the establishment of the company participating in this arena. More frequent, post-incorporation monitoring is essential. We are hopeful that the SCB has already taken steps toward this objective. Last summer, the SCB announced that they were amending the DARE Act, many months before the FTX fiasco. The regulations should also be continuously reviewed and updated to respond to rapidly changing developments in this industry.

Third, as with banking, insurance, and investment fund companies, the SCB should appoint a local, not a foreign, auditing firm to monitor all DARE Act licensees to whom the SCB can quickly refer for vital organizational and operational information regarding the licensee. The corollary to this is that professionals who desire to work in the digital asset space must educate themselves about the complexities of the industry. All stakeholders must understand the language of the industry if they want to participate fully.

Fourth, periodic reports to the SCB should be mandated for all DARE Act licensees regarding the company’s corporate governance protocols and internal control weaknesses. These reports should not wait for the licensee to file annual audited financial statements. Instead, these more frequent reports can serve as an early warning system for possible weaknesses and malfeasance by licensees. It is considerably easier to monitor and regulate domestically based service providers.

Fifth, as we operate in a rapidly changing cyber universe, in the fullness of time, our regulator should seriously consider moving to real-time, online monitoring of DARE Act licensees.

Finally, the regulator must ensure that real or perceived conflicts of interest are avoided in selecting all service providers for DARE Act licensees.


Conclusion

The Bahamas will continue to improve its regulatory protocols and to approve digital asset businesses in this jurisdiction. As a leader in the regulation of this arena, I am confident that the SCB will constantly review and update first-world, state-of-the-art protocols and regulations to enable industry stakeholders to compete effectively and promote a more robust regulatory framework.

Attorney General Pinder encouraged us, “Those entrepreneurs who are ready to create new financial products that serve a broader range of consumers remain welcome to come to The Bahamas. They can be certain that we have a principled, fair, comprehensive, and ethical regulatory regime in place. They can also be certain we will act quickly and decisively to enforce it, if and when our laws and regulations are breached.”

Hopefully, we will learn from this episode and emerge stronger and even more able to handle future businesses in this emerging sector like the professionals we are. And above all, like all things, the FTX fiasco shall pass!


• Philip C. Galanis is the managing partner of HLB Bahamas, Advisors and Chartered Accountants. He served 15 years in Parliament. Please send your comments to
pgalanis@gmail.com.

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