Over these past 6 months, a domino effect of falling crypto firms have shook up the world both in terms of scale and depth. This time, the world's second largest crypto exchange by volume, FTX, has fallen from grace and its dark secret behind the scene is revealed. Not to anyone's surprise, the collapse has led to nothing but intensifying pressure on regulators to push out adequate rules to oversight the sector.

Figure 1: FTX collapse coverage on Globe and Mail. Source: Globe and Mail
A bunch of arrogant young kids
But before moving further, let’s have a quick recap of what actually happens. As one after another crypto firms went bankrupt and exposed for scam, major players are not only protecting themselves more tightly but also hurting their opponents when possible. As CZ, founder and CEO of the world largest exchange Binance, publicly selling FTT off their balance sheet, he might not expect to accidentally expose the dark and dirty secret at FTX to the world. In a simple way to explain the situation, a lack of integrity and arrogant youths with strong backgrounds managed to trick not only retail customers but also wealthy firms like Blackrock to invest in the potentially biggest Ponzi scheme in history.
As this story is widely promoted by both mainstream media and youtubers, it is clear that the former top bureau at FTX management team has no board to oversee their activities. In fact, as mentioned by Chamath Palihapitiya in the All-in podcast, the young management team at FTX straight up said “Go f*** yourself” when he suggested they should have a board. It is crystal clear that they are not only arrogant but also potentially thought of illegal activities before they met Chamath.
Liquidity Crisis
As most businesses are doing well in a 0-interest rate during 2020-2021, crypto firms also function well. However, the trouble only comes when it is tough to raise liquidity, especially at strong spenders for advertising with highly leverage related sister company Alameda like FTX. As crypto lost over 50-80% of value, an exchange balance sheet should have more cash than normal due to people's fear leading to withdrawal for cash and waiting at the sideline, similar to a bear stock market. That did not happen at FTX, as they hold FTT, which is a crypto issued themselves, among other small market cap crypto as cash equivalence, which should never happen (figure 2). This should have raised serious questions when they are audited but nothing came up to the public.

Figure 2: FTX balance sheet screenshot floating on Twitter. Source: Twitter
In fact, FTX auditor is now supporting CZ’s idea of “proof-of-reserve”. Proof-of-reserve is nothing more than proving that an exchange holding 1 to 1 assets equivalent to customers’ deposit on the behalf of their clients. However, this is meaningless, as there is still no regulation for crypto exchanges to not use that reserves as collateral for high leverage trades like what we have for stock exchanges. Michael Burry also recently came out saying proof-of-reserve is “essentially meaningless”. Thus, this reduces my trust for this auditing company significantly and I have to consider carefully any companies that are audited by this firm.
Aftermath
Now, it is to no surprise that anti-crypto regulators are coming out much more frequently than ever before. For example, the Senate Banking Chair recently suggested banning crypto altogether. This is in fact a lazy response from regulators as their job is to put adequate and reasonable rules to oversee things that directly impact the people and the nation. Simply banning things that are new and not easy to understand is just an easy way out. In fact, I wrote an article about why this issue, you can read more here. On the other hand, we have investment companies, both from the crypto world and outside, go on television to ask for more regulations. Senates and regulators should work together with firms to find a good solution.
I have to stress again the word “adequate” when applying rules over crypto currency. Having firms to monitor any transactions over 1000 CAD in Canada is simply capping the feature coin-as-a-payment. Moreover, in 2019, ECB suggested having a dedicated AML third party to issue “vouchers” to retail users to have certain transactions anonymous. They did not indicate the quantity or qualification to request for vouchers. Although I did not manage to find a similar idea in 2022 pilot paper, restricting retail users to a certain number of anonymous transactions a year is essentially pointless, as the small limited number of transactions between users alone is more than suspicious in auditing or investigation, regardless of the nature of the transactions to be legal or illegal.
In short, we need reasonable regulations to oversee crypto now for the sector to grow to its fullest potential. Otherwise, scammers and fraudsters will find their ways to trick people for their money again.
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