The 2022 FTX collapse resulted in customer losses of $8 billion in one of the biggest frauds in U.S. history.
This incident underscores the volatility and regulatory challenges in the crypto market, highlighting the urgent need for comprehensive understanding and risk management strategies in this rapidly evolving sector. Founder and former billionaire Sam Bankman-Fried, widely known as SBF, was convicted on seven fraud and conspiracy charges and later sentenced to 25 years in prison.
This scheme has cast a dark cloud over the crypto sector for some investors and has invited greater scrutiny by regulators. Yet as digital assets continue to grow in popularity and solidify their place as a key component of global commerce, what lies ahead?
Jessica Cath, Head of Financial Crime at Thistle Initiatives, and Mardi MacGregor, Partner at Fox Williams LLP, joined Converge to discuss the fallout from the fraud and what regulatory changes they expect to see implemented.
How FTX eroded trust in cryptocurrency investments
“[This case] does raise a lot of questions about fraud more generally and also questions around trust in the crypto industry,” Cath said. “It really eroded trust in the space due to the prevalence of crypto scams, which have played a significant role in undermining confidence.”
As Cath describes, the situation ultimately boils down to weak governance and crypto risk management controls. In such a fast-growing company — FTX once added $7 billion of value in just a few months — maintaining robust compliance is easier said than done.
Now, however, other crypto players can learn valuable lessons. Being vigilant against crypto scams, including giveaway scams and the challenges of recovering funds after falling for a crypto scam, is essential to reframe how many people think about cryptocurrencies and their exchange platforms.
Additionally, diversifying investments across different cryptocurrencies as part of a well-thought-out crypto portfolio strategy can mitigate risk. Emphasizing crypto trading risk management is crucial in protecting against losses and shifting consumer sentiment in the crypto space, as these scams, often involving impersonation of well-known figures, further erode confidence in digital assets.
Crypto companies and exchanges are leaning toward more regulation in the wake of the FTX fraud as both a form of legitimacy and a way to gain trust with investors surrounding digital assets, according to MacGregor.
“I think transparency and regulatory compliance are crucial when it comes to rebuilding trust in the crypto industry,” she says.
Building authority for crypto trading risk management in the U.K. and beyond
The Financial Conduct Authority (FCA) regulates 50,000 financial services firms and markets in the U.K., but MacGregor said it’s a work in progress.
“At the moment, we’ve got a patchwork of crypto regulation here in the U.K. We don’t have one cohesive regime, and that’s a little bit of a problem.”
This contrasts sharply with the more uniform and stringent regulatory frameworks seen in traditional financial markets, where regulations have long been established to manage risks, including the use of hedging strategies to protect against market volatility. The crypto market’s regulatory landscape, by comparison, exposes traders to a higher potential for fraud and scams due to its less regulated nature.
She added that while the government and treasury offer supportive rhetoric for crypto assets, regulators have been much more skeptical as they seek to protect investors from FTX-type fraud. The result? Complicated regulations.
That has created higher barriers to entry for crypto firms, which can mean higher compliance costs, according to Cath. “There are a lot of costs involved in getting your compliance structures in place before you can launch and offer your services in the U.K.”
Planning and regulatory compliance for crypto assets in a shifting landscape
Registering crypto companies with the FCA requires a clear regulatory and growth plan. Cath said the next step is building out a large suite of compliance policies and procedures in the world of digital assets.
The one policy she said is crucial to get right is cryptocurrency risk management, emphasizing the importance of effective risk management in the crypto industry. This involves a systematic and structured process to identify, analyze, assess and develop treatment plans for the risks associated with investing in cryptocurrencies.
There are key tools to accomplish this such as risk checklists, risk registers, risk workshops for thorough risk identification. These come in addition to other risk mitigation techniques including avoidance, reduction, transfer and acceptance to effectively manage the risks associated with cryptocurrency investments.
Such an approach ensures companies not only consider how their products might be used for nefarious purposes but also build controls that map against those risks to ensure strong governance.
It is also essential to emphasize the security of digital assets, particularly the importance of securing private keys. Losing access to private keys means a permanent loss of crypto assets, highlighting the need for backing up private keys and moving assets into cold storage to maintain full custody and mitigate risks.
Building authority for crypto trading risk management in the U.K. and beyond
Meanwhile, MacGregor stressed crypto exchanges must prioritize protecting customers. “The main regulatory concern in this space is consumer protection, and I think the FTX case really underlines that.”
She also said regulators are still working out the balance between looking after consumers and onerous corporate regulations for crypto assets.
“If regulation is too excessive or disproportionate, it’s going to create an unacceptable barrier for entry to businesses. But equally — as we know from the FTX case — where there’s no regulation, customers aren’t protected.”
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