Failed Crypto Firm FTX Lobbied on the Same Issues That Were Its Downfall

In the wake of the failure of the second largest cryptocurrency exchange, FTX, billions in company value and client funds disappeared practically overnight.

With such a spectacular demise and so much money missing, the company filed for bankruptcy. The Department of Justice, Commodity Futures Trading Commission (CFTC), and the Securities Exchange Commission (SEC) have all opened investigations.

Coincidentally enough, the company was also heavily involved in lobbying on crypto policy related to the very things that surrounded its downfall, and the company was spending heavily.

In 2022, the U.S. arm of FTX spent $640,000 on lobbying alone according to OpenSecrets. The CEO, Sam Bankman-Fried spent $38,837,000 in the federal election, making him the sixth largest donor in 2022, and he was the second largest donor to President Biden in 2020. When combined with other FTX representatives, total donations were around $69 million.

As the company threw money around before their collapse, there are unanswered questions as to why the company’s red flags weren’t caught sooner.

Direct Clearing of Derivatives

In particular, FTX was in talks with the SEC on the direct clearing of derivatives and they produced the plan for the CFTC to allow direct clearing. Currently, derivatives have to be cleared by a broker-dealer, but crypto firms are eager to have the process done automatically to enable more real-time transactions.

FTX met with the SEC in March of 2022 as part of an open comment period on the topic along with many other crypto firms. In third quarter lobbying disclosure filings, that topic is listed as something the company discussed with representatives of Congress, the Senate, the CFTC, U.S. Treasury, and the SEC.

Direct clearing was a contentious topic as some critics believed it would bypass the use of broker dealers and could lead to bank runs according to the financial nonprofit Better Markets and others.

According to the FinReg blog form the Duke University Financial Economics Center:

Given the extreme volatility of crypto-assets, automatic liquidations of retail positions may occur quickly and without warning. Retail investors may find their positions liquidated before they have a chance to close them out or post more margin…

Details are still scant, but that automated liquidation is suspected to be one part of FTX International’s collapse. As the value of FTX’s cryptocurrency, FTT, collapsed, all the derivatives that leaned on FTT for collateral were automatically liquidated. There was no opportunity for a broker-dealer to inject more cash and avoid liquidation. The liquidation of so many FTT tokens at once only hastened the downward spiral of its price.

FTX’s U.S. arm, FTX.us, was not affected by this as direct clearing is currently not legal in the U.S. Trading on FTX international is actually banned to U.S. citizens as well as a few other countries like Iran, Cuba, and the Donetsk People’s Republic.

Following the company’s collapse, FTX removed their proposal for direct clearing.

Similar to the stop-loss action that potentially led to FTX’s collapse, FTX was sued back in 2019 for market manipulation and selling unlicensed securities as well as running an unlicensed money transmission operation—about $100 million a day for FTX and $30 million a day for FTX’s associated hedge fund, Alameda, based on FTX’s own reported transactions—in a class action lawsuit under racketeering laws. The suit contends that FTX dumped cryptocurrencies on the Binance cryptocurrency market in a strategic way to hopefully trigger a stop-loss action—an automated trigger by cryptocurrency holders that would sell-off their assets before any further price drops.

No stop-loss action was actually triggered and the case was dismissed.

SEC Enforcement Rather Than CFTC

FTX was also heavily supportive of regulation of the crypto world being handled by the CFTC rather than the SEC. Not just lobbying extensively for CFTC oversight, Bankman-Fried even testifyied before congress on the subject and hired previous CFTC executives like the prior chair of the CFTC Mark Wetjen and CFTC Commissioner Jill Sommers.

Currently, the CFTC handles enforcement of cryptocurrencies as they are considered commodities. FTX was registered with the CFTC, but there appears to be no signs of CFTC enforcement related to the company.

Bankman-Fried was supportive of a bill sponsored by Senators Debbie Stabenow (D-MI) and John Boozman (R-AR) that would officially give power to the CFTC rather than the SEC to police cryptocurrencies. While the CFTC has many enforcement tools available, the SEC is a much larger organization with many more resources.

Commodities Versus Securities

Because of the vague definition of every variety of cryptocurrency, the SEC’s oversight of the crypto space isn’t as clear cut. There is an ongoing debate as to whether cryptocurrencies are securities that earn interest like stocks and deposits.

If so, they may fall under oversight by the SEC which comes with additional restrictions. As it stands the Stabenow bill doesn’t discretely define which cryptocurrencies would be considered securities.

If they are offering securities, then they need to register with the SEC as well as provide a prospectus to investors on the company’s financial condition and other details—something that might have helped expose FTX. The public release of a rough outline of FTX’s finances by the online publication CoinDesk and the litany of red flags therein is what originally led to FTX being outed as a house of cards.

During the same time as FTX’s downfall, the SEC won a legal battle against the crypto firm LBRY after designating the company’s cryptocurrency a security. LBRY is small in the crypto world as the market capitalization of its token is only around $7 to $8 million.

In February, the crypto lending firm BlockFi settled with the SEC for $100 million and agreed to register under the Securities and Exchange Act. Following that, the company made a deal with FTX so that FTX would lend it money and eventually buy it out as long as BlockFi achieved clearance from the SEC. Effectively, FTX was hoping to buy BlockFi’s SEC clearance without having to go through the process itself.

With the collapse of FTX, BlockFi halted all withdrawals.

FTX was also under investigation by the state of Texas after it was discovered that the company was offering interest bearing deposits without registering with the Texas State Securities Board.

Ponzi Enforcement With or Without Securities Classification

Whether or not a crypto is a security may be moot in some circumstances. Groups like Better Markets have argued that there are plenty of laws already on the books to regulate the cryptocurrency market and that agencies like the SEC just need more funding.

Whether or not a cryptocurrency is a security, the SEC still brings cases of impropriety against various cryptocurrency companies for fraud and acting as a Ponzi scheme by promising high returns with no risk. In 2021, the SEC charged BitConnect for a $2 billion fraud for promising high returns while using client funds.

Yet Alameda, FTX’s hedge fund, was promising something similar in promotional materials back in 2018 with no action from the SEC.

Similar to BitConnect, Alameda may have been inappropriately using FTX funds for investing based on the original CoinDesk story that initiated the sell-off in FTX funds.