FTX fallout shows tension between need for regulation and push for decentralization

TORONTO — The collapse of crypto-exchange giant FTX is being held up as both a clear example of the importance of industry regulation and, on the other hand, the need for bitcoin to get back to its roots. decentralized roots.

The two opposing findings underscore the tension between the ideals of bitcoin’s early devotees and the speculative fervor that helped Sam Bankman-Fried build FTX from scratch in 2019 to become the world’s third-largest exchange by volume with a valuation of $32 billion, before he stepped down from the helm last week as the company filed for bankruptcy protection.

“There’s an irony in the crypto space that’s becoming increasingly clear,” said Ryan Clements, chair of business law and regulation at the University of Calgary’s Faculty of Law.

“Crypto was supposed to be about getting rid of banks and getting rid of intermediaries. The evolution of the crypto market has become a market where intermediaries are widely used. And intermediaries take custody of customer funds and customer crypto like banks do.

The growing “bancification” of crypto has created a need for regulators to intervene in the space to prevent meltdowns such as that of FTX, which ultimately collapsed into the equivalent of a bank run, from hitting the broader stock market or leave retail investors destitute.

Canadian regulators learned that lesson with the implosion of Quadriga, which vaporized $169 million in client funds when it collapsed in 2018. An Ontario Securities Commission review found the firm worked like a Ponzi scheme and concluded in a 2020 report that what happened at Quadriga “was old-fashioned fraud wrapped in modern technology.”

In response, provincial securities regulators have notably coordinated their response to crypto exchanges with a focus on intermediaries, as they have established rules regarding the need for third parties to hold crypto assets, requirements for of insurance and the limits of what can be exchanged. .

The rules mean that some of the alleged practices at FTX, including the use of client funds for company transactions, would not be permitted by Canadian registered exchanges.

“We actually have a pretty strong regulatory framework in this country that was created after Quadriga,” Clements said.

Several Canadian exchanges have emphasized their adherence to these measures in recent days as they attempt to distance themselves from FTX.

“While some view the regulations as overkill, they play a vital role in ensuring these tragedies do not occur,” Coinsquare Chief Executive Martin Piszel said in a statement.

“While we were working with regulators … our global competitors were launching products like 100x margin, unregulated derivatives and lending client assets. We’ve all seen the results of some of these experiments,” Piszel said.

The ability to trade options or derivatives and other risky bets in more active markets, however, has prompted some Canadians to look overseas, Clements said, noting the potential need for regulators to deploy more efforts to restrict access to international scholarships.

“If you are a Canadian, you should use a registered trading platform. Because there are better controls for you. The problem is these huge offshore rigs… just because something is bigger and because something has celebrities doesn’t mean it’s backed it doesn’t necessarily mean it’s more safe.

But while some cite the FTX debacle as an example of the need for more regulation, others say it’s a sign for people to move away from exchanges altogether and instead own crypto on an individual level.

Compared to centralized FTX, “much of the bitcoin movement has been against it, (bitcoin) has always been fundamentally this idea of ​​self-custody,” said Mariam Humayun, assistant professor at the Telfer School of Management at the University. University of Ottawa.

She said what is happening at FTX shows that keeping crypto on an exchange creates a risk of losing it, pointing to the phrase “not your keys, not your coins” as the philosophy of many bitcoin enthusiasts. .

Holding crypto offline in so-called cold wallets comes with its own risks, including physical theft and loss of passwords and should not be taken lightly, said Schulich School associate professor Henry Kim. of Business at York University and Director of the School’s Blockchain. Laboratory.

“For those who are really, really savvy, they can still hold crypto in their wallet…you have to know what you’re doing. And I wouldn’t recommend that unless you do.

He said that while exchanges can fail, most long-term investors would do well to hold their crypto on an established promininet exchange.

Still, the collapse of FTX shows just how difficult that search can be.

“There is a contagion effect because FTX was the gold standard, because they were heavily involved in investments,” Kim said. “It says that there is not enough regulation. He says it’s too centralized. That says we still don’t have enough adults in the room.

Several Canadian crypto companies have already announced ripple effects of FTX.

Calgary-based Bitvo Inc. announced in June that FTX would buy it for an undisclosed sum. On Monday, the company clarified that the transaction was not completed and that it remains independent from the FTX group of companies.

The company also stressed that it operates on a full reserve basis and in accordance with Canadian regulations.

Vancouver-based Layer Zero Labs said it bought out FTX’s positions in the company and considers the $11.5 million it had at FTX to be nil at this time as the company digests the fallout.

“This one definitely hits differently,” said co-founder Bryan Pellegrino. “I think it’s because we’ve evolved so much over the last decade and FTX and Sam were at the center of what everyone seems to be merging as the future of the industry.”

He said, however, that the company is still committed to moving forward with crypto as it continues to evolve.

“Through all the fund blasts, dog coins, overleveraged monkeys and Ponzis, the underlying technology has never ceased to amaze us and we are all as obsessed with the core mission as ever.”

This report from The Canadian Press was first published on November 14, 2022.

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