How FTX Paid To Be The World’s Most Regulated Crypto Exchange
Before it collapsed this month, FTX broke away from many rivals in the unregulated crypto industry by boasting that it was the “most regulated exchange” in the world and inviting regulatory scrutiny. Now, company documents seen by Reuters reveal the strategy and tactics behind founder Sam Bankman-Fried’s takeover plan, including previously unreported terms of a deal announced earlier this year with IEX Group, the American stock exchange featured in Michael Lewis’ book “Flash Boys. about fast, computer-driven trading.
As part of that deal, Bankman-Fried bought a 10 percent stake in IEX, with an option to buy it outright over the next two and a half years, according to a June 7 filing. The partnership gave the 30-year-old executive an opportunity to lobby IEX’s regulator, the US Securities and Exchange Commission. Exchange Commission, regarding crypto regulation.
That agreement and others cited in documents, including business reviews, meeting minutes and strategy papers, shed light on one of FTX’s broader goals: to quickly create a unified regulatory framework by acquiring parts of companies that already have licenses from the authorities, cutting multiple times. issued approval process.
FTX has spent about $2 billion (about Rs. 16,300 crore) on “acquisitions for regulatory purposes,” FTX documents seen by Reuters at a conference call on September 19. Last year, for example, it bought LedgerX, a futures exchange , giving it three Commodity Futures Trading Commission licenses at once. The licenses gave FTX access to US derivatives markets as a regulated exchange. Derivatives are securities that derive their value from another asset.
FTX also saw its regulatory status as a way to attract new capital from large investors, the filings said. In documents supporting its bid for hundreds of millions of dollars, it touted its licenses as a key competitive advantage. “Regulatory measures,” it said, created barriers for competitors and would give them access to new profitable markets and synergies beyond the control of unregulated companies.
“FTX has the cleanest product in crypto,” the exchange announced in a June document presented to investors.
Bankman-Fried did not respond to a request for comment on questions about FTX’s regulatory strategy. FTX did not respond to requests for comment.
A spokeswoman for the SEC declined to comment for this article. The CFTC also declined to comment.
In a text interview this week with Vox, Bankman-Fried talked about regulatory issues. Asked if his previous praise for the rules was “just PR,” he said in a text sequence: “yeah, PR regulators… f— just… they make everything worse… they don’t protect the customers. They’re all. “
An IEX spokesman declined to confirm the details of the transaction with FTX, except to say that FTX’s “small stake” in IEX would not be sold to a third party without its consent. “We are currently considering our legal options in relation to the previous practice,” the spokesperson said.
Patchwork of regulators
FTX fell last week after Bankman-Fried’s failed bid to raise emergency funds. It had come under legal supervision through the many licenses it had acquired through many of its acquisitions. But that did not protect its customers and investors, who are now facing losses totaling billions of dollars. As Reuters reported, FTX was privately risking clients’ funds, using $10 billion (roughly Rs. 81,700 crore) in deposits to fund a trading firm owned by Bankman-Fried.
The four attorneys said the fact that Bankman-Fried was cozying up to regulators while taking huge risks with clients’ funds without anyone noticing exposed a yawning regulatory gap in the cryptocurrency industry. “It’s a mix of global regulators — and domestically there are big gaps,” said Aitan Goelman, a lawyer at Zuckerman Spaeder and a former prosecutor and director of the CFTC. “That is the fault of the regulatory system that took too long to adapt to the advent of crypto.”
A person familiar with the SEC’s thinking on crypto regulation said the agency believes crypto firms are operating illegally outside of US securities laws and are instead relying on other licenses that provide little protection for consumers. “Those representations, while true, do not cover their work,” the person said.
Step 1: Licenses
Bankman-Fried had big ambitions for FTX, which this year has grown to more than $1 billion (roughly Rs. 8,100 crore) in revenue and accounted for nearly 10 percent of global crypto market trading, since the beginning of the year 2019. He wanted to create a financial app, where users can trade stocks and tokens, transfer money and bank, according to an undated document titled, “FTX Roadmap 2022.”
“Step 1” of that goal, the “Roadmap” document said, “is to license as much as possible.”
“Part of this is to make sure we are regulated and compliant; Partly this is to be able to increase our productivity,” the document said.
That’s where the FTX discovery came in, according to the documents. Instead of applying for all the licenses, which can take years and sometimes uncomfortable questions, Bankman-Fried decided to buy them.
But the strategy also had its limitations: Sometimes, the companies that acquired them didn’t have the exact licenses they needed, the documents show.
One of FTX’s goals, according to the documents, was to open markets out of the US to its clients in the country. It estimated that the market would generate an additional trading volume of up to $50 billion per day, generating millions of dollars in revenue. To do that, it was necessary to persuade the CFTC to amend one of the licenses held by LedgerX, FTX’s newly acquired futures exchange.
The application process went on for months, and FTX had to raise $250 million (roughly Rs. 2,041 crore) to get a designated insurance fund, a standard requirement. FTX expects the CFTC to ask it to increase the fund to $1 billion, according to minutes of a March meeting of its advisory board.
FTX collapsed before it could get approval, and has now withdrawn its application.
Buying the licensing companies also had other benefits, documents reviewed by Reuters show: It would give Bankman-Fried the access she wanted to regulators.
A good example is the IEX deal, which was announced in April. In a joint interview with CNBC, Bankman-Fried and IEX CEO Brad Katsuyama said they want to “shape the rules that ultimately protect investors.” Most important here, Bankman-Fried added, is that “there is transparency and protection against fraud.”
Reuters could not specify how much FTX paid for the stake.
Bankman-Fried was invited to meet with SEC Chairman Gary Gensler and other SEC officials along with Katsuyama in March.
A source close to IEX said the purpose of the meeting was to inform the SEC in advance about its agreement with FTX, which had not been publicly announced at the time, and to discuss the possibility of IEX creating a digital asset trading platform. Depositing bitcoin. FTX’s role was to provide crypto-trading infrastructure, the source said.
SEC officials rejected their original plan outright because it would have involved the creation of a less regulated exchange, something the agency opposes for cryptocurrencies, a source familiar with the SEC’s thinking said.
Reuters could not determine the extent of Bankman-Fried’s involvement in subsequent discussions with the SEC. In their minds, SEC officials had agreed to meet with Katsuyama in March, and Bankman-Fried had just tagged along, said a source familiar with the SEC’s thinking. He kept very quiet during the meeting, with Katsuyama “in the driver’s seat,” the source added.
Regardless of his involvement, FTX spoke about its discussions with its investors. At a September meeting of its advisory board, FTX said discussions with the SEC were “very constructive.”
“We may have a place there,” the statement said, according to the minutes of the meeting.
A person familiar with the SEC’s thinking said they would oppose FTX “from a pole position.” Whatever the SEC does to regulate crypto trading will be open to all market participants, the source said.
A source close to IEX said the exchange had not entered into any operating agreements with FTX, adding that it had not reached that point.
The May FTX document provides a contact list of FTX and individual administrators. This document, which has not been reported before, shows how in many cases FTX was able to solve the problems of compression.
In February, for example, South African authorities published a warning to consumers that FTX and other crypto markets are not authorized to operate there. So FTX entered into a commercial agreement with a local exchange to continue providing services. “FTX is now fully licensed for its current operations in South Africa,” FTX said.
The regulator, the South African Financial Sector Conduct Authority, did not respond to a request for comment.
The May document also shows that FTX had a brush with the SEC. The SEC made inquiries earlier this year about how crypto companies handled customer deposits. Some companies were offering interest on deposits, the SEC said they could make securities and they had to be registered under its rules. In a list of its regulatory engagements, FTX noted that the investigation was looking at whether those assets were “lent or used for operational purposes.”
This month, as Reuters reported, it appeared that FTX had done just that, moving billions of dollars in client funds to Bankman-Fried’s trading firm, Alameda Research.
In a May filing, FTX said the SEC’s inspection staff, which scrutinizes market practices that could pose a risk to investors, is concerned about a different issue: the rewards program it offers to customers, under which it pays interest on crypto deposits.
According to the document, FTX told the regulator that it does not have similar problems with products from other suppliers investigated by the agency.
“We have confirmed that these are rewards only and do not involve lending (or other use) of the included crypto,” wrote FTX. The SEC wrote back, saying it had completed an “informal investigation” and did not need more information “at this time.”
The SEC did not comment on the investigation. In an email to Reuters, Bankman-Fried wrote: “FTX’s response was accurate; the FTX US rewards program does not involve lending any assets.”
© Thomson Reuters 2022
