Introducing the “Crypto Chronicles,” a captivating series brought to you by Cointelegraph that delves into the fascinating history of cryptocurrency. Powered by Phemex, this timeline allows members of the crypto community to reflect on the significant events that have shaped the industry as we know it today.
In this installment, we explore the aftermath of the FTX exchange collapse in November 2022, which triggered one of the most infamous crypto winters in the history of digital assets.
The period following the FTX exchange collapse is widely regarded as one of the darkest chapters in the annals of crypto history. The downfall of FTX and its extensive network of over 130 subsidiaries set off a domino effect of bankruptcies and layoffs within the Web3 sector, giving rise to an unprecedented and protracted crypto winter. During this tumultuous period, the price of Bitcoin (BTC) hit rock bottom at $16,000.
In the wake of the catastrophic loss of $8.9 billion in investor funds, regulators were compelled to take swift action and develop frameworks that prioritize investor safety and transparency for crypto exchanges and service providers. In a bold move, U.S. regulators levied some of the largest criminal fines in history against Binance, despite no evidence of misappropriation of user funds. Additionally, they imposed fines on smaller exchanges as part of a hawkish effort to avert potential FTX-like meltdowns.
So, how did the FTX collapse come to pass? Nearly a year and a half ago, the now-infamous FTX exchange crumbled, sending shockwaves throughout global crypto markets and erasing tens of billions of dollars in value within a matter of days. The collapse of FTX can be attributed to the misappropriation of user funds, resulting in billions of dollars in trading losses for its sister company, Alameda Research. Bankman-Fried, the founder of FTX, transferred customer funds to Alameda Research without their consent to cover the firm’s trading losses, now famously known as “the Alameda gap.” Prior to receiving its quantitative trading protocol from Gary Wang, Alameda was hemorrhaging over $500,000 per day for an entire month, according to Michael Lewis’ biography on Bankman-Fried.
The misappropriation of user funds began to unravel in November 2022, when it was revealed that a significant portion of Alameda’s balance sheet was comprised of FTX’s FTT token. This revelation triggered a massive sell-off, causing the price of the FTT token to plummet and raising concerns about the financial stability of both FTX and Alameda Research. Consequently, customers withdrew a staggering $6 billion within a three-day period, overwhelming FTX’s ability to meet the withdrawal demands and forcing them to suspend withdrawals. On November 11, 2022, FTX filed for bankruptcy. Bankman-Fried was subsequently arrested in the Bahamas on December 12, 2022, following criminal charges filed against him by U.S. prosecutors. He was extradited to the U.S. in January 2023 and sentenced to 25 years in federal prison on March 28, 2024.
The collapse of FTX had far-reaching consequences and triggered a regulatory crackdown by the United States Securities and Exchange Commission (SEC). The SEC took an aggressive stance, initiating a broader crackdown on crypto exchanges in order to prevent another potential FTX-like meltdown. In June 2023, the SEC filed lawsuits against Coinbase and Binance Exchange for alleged securities violations. In the case of Binance, the SEC accused the company and its founder, Changpeng Zhao, of misappropriating billions of dollars in user funds. Despite the absence of evidence of misappropriation, Binance was charged with violating Anti-Money Laundering laws and was ordered to pay a record-breaking criminal fine of $4.3 billion.
In the case of Coinbase, the SEC alleged that the exchange operated as an unregistered exchange, broker, and clearing agency, and violated securities laws by listing 13 tokens that were deemed securities. Coinbase sought to have the case dismissed by questioning the SEC’s authority over crypto exchanges, but their motion was denied on March 27, allowing the SEC to proceed with the lawsuit.
The immediate response from regulators focused on enforcement and prosecutions rather than the implementation of blockchain-specific regulations, as Ashar Burney, the legal head of TDeFi, pointed out. According to Burney, the FTX collapse was primarily a case of criminal fraud rather than a failure of regulatory frameworks.
In the wake of the FTX collapse, crypto exchanges have made concerted efforts to enhance transparency, spearheaded by Binance, the largest exchange in the world. By the end of November 2022, Binance introduced its Proof-of-Reserves (PoR) system, which provides users with visibility into the underlying assets held by the exchange on their behalf. This third-party audit aims to assure users that the exchange possesses sufficient assets to fulfill potential withdrawal requests. As of April 12, Binance’s main assets were overcollateralized by at least 102%, as confirmed by its PoR page. Other top exchanges, including Coinbase, OKX, Crypto.com, Kraken, and Bybit, have followed suit in their pursuit of transparency.
Despite the implementation of new PoR audit systems, investors must still exercise due diligence, as even FTX had undergone numerous financial audits that failed to uncover the fraud, as noted by Ashar Burney. In addition to the transparency initiatives undertaken by crypto exchanges, governments worldwide have taken a more collaborative approach to regulating the nascent crypto industry, as highlighted by James Wo, the founder and CEO of DFG. In May 2023, the European Council introduced the first comprehensive legal framework for the crypto industry, known as the Markets in Crypto Assets (MiCA) framework. This framework aims to safeguard investors through stricter transparency standards and anti-money laundering (AML) rules.
Thanks to the MiCA bill, crypto exchanges will become fully regulated entities by the end of 2024, according to Vyara Savova, senior policy lead at the European Crypto Initiative. However, the effectiveness of MiCA will hinge on the implementation by member states, as Savova explained. Hong Kong and Dubai have also implemented crypto regulations that foster innovation in an effort to establish themselves as global crypto hubs. However, the most significant regulatory development occurred in January 2024 with the approval of spot Bitcoin exchange-traded funds (ETFs).
The approval of spot Bitcoin ETFs represents a positive step towards fostering innovation and displays an open-minded approach from U.S. regulators, according to James Wo. This approval has also inspired other jurisdictions to follow suit. The Securities Regulatory Commission (SFC) of Hong Kong is expected to approve the first four spot Bitcoin ETF applications by April 15, after expediting the approval process.
Despite the significant global regulatory advancements, such as ETFs and increased regulations for crypto exchanges, investors are not necessarily shielded from another FTX-like meltdown, cautioned James Wo. Consequently, vigilance and caution remain crucial in the crypto industry.
Looking ahead to 2024 and beyond, the collapse of FTX has sparked unprecedented collaboration among global regulators to prevent future high-profile meltdowns. Leading economies have implemented new regulations for crypto exchanges, and Europe has set the benchmark with its comprehensive MiCA framework. Nevertheless, the MiCA framework is still a work in progress, with the next major update focusing on establishing marketing communication standards for crypto exchanges. This development could have implications for crypto service providers in Europe, as highlighted by Vyara Savova. The outcome of the ongoing consultation package for reverse solicitation guidelines under MiCA will influence the final implementation of MiCA in December.
According to Ashar Burney, crypto service providers may face increased regulatory scrutiny, including more stringent disclosure and compliance requirements, ultimately leading to a more mature industry. Despite the challenges, the future of the crypto industry remains bright, fueled by ongoing innovation and regulatory developments that seek to strike a balance between investor protection and technological advancement.