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Lessons from FTX: What we learned about transparency, accountability and regulations

"Transparency is essential for customers to be able to make informed decisions," said one crypto CEO

Former FTX chief executive Sam Bankman-Fried, who faces fraud charges over the collapse of the bankrupt cryptocurrency exchange, walks from the Manhattan federal court after securing bail in New York City, U.S. December 22, 2022.  REUTERS/Jeenah Moon
Former FTX chief executive Sam Bankman-Fried, who faces fraud charges over the collapse of the bankrupt cryptocurrency exchange, walks from the Manhattan federal court after securing bail in New York City, U.S. December 22, 2022. REUTERS/Jeenah Moon

Crypto investors, regulators and executives are taking stock of some of the difficult lessons learned in the wake of the extraordinary and swift downfall of crypto exchange FTX and its executives.

The collapse of FTX has brought issues such as the need for more transparency, accountability and rule enforcement to the forefront. It has also prompted an increasing number of investors to ask questions and demand more from the crypto firms they use.

"You need to look into what platform you're going to interact with," Brian Mosoff, chief executive officer of Ether Capital Corp., a firm focused on the ethereum ecosystem, told Yahoo Finance Canada in a phone interview.

Before trusting any platform, he says investors should determine what registrations the platform has, whether customer funds are separate from other activities, as well as the company's governance practices, among other items.

He adds that many investors are starting to do more homework on firms but there's still a long way to go.

If you are a customer on FTX, and you knew the extent of their financial situation … you would have made different decisions with your moneyBitvo CEO Pam Draper

As Sam Bankman-Fried faces charges, it highlights that just because an executive makes many public appearances, it doesn't necessarily mean the inner workings of their company go by the book.

Mosoff says many investors assumed FTX was an "institution-grade platform" and put Bankman-Fried on a pedestal because of FTX's backers and his presence in the media.

NEW YORK, NEW YORK - JUNE 23: Harry Adjmi and Sam Bankman-Fried are seen onstage during the first annual Moonlight Gala benefitting CARE - Children With Special Needs - hosted by Michael Cayre, Roy Nachum and MegaMoon Museum at Casa Cipriani on June 23, 2022 in New York City. (Photo by Craig Barritt/Getty Images for CARE For Special Children )
NEW YORK, NEW YORK - JUNE 23: Harry Adjmi and Sam Bankman-Fried are seen onstage during the first annual Moonlight Gala benefitting CARE - Children With Special Needs - hosted by Michael Cayre, Roy Nachum and MegaMoon Museum at Casa Cipriani on June 23, 2022 in New York City. (Photo by Craig Barritt/Getty Images for CARE For Special Children )

Bankman-Fried became a poster boy for the crypto world and was known to be an advocate of more industry regulation.

"It's not enough to just talk the talk. Sam Bankman-Fried was famous for going on the news and doing interviews and actually being a real promoter of regulation," said Pam Draper, chief executive officer of Calgary-based crypto exchange Bitvo Inc., via phone.

"While he was saying that, clearly, his own house was not following what he was saying at all."

Bitvo was in the process of being acquired by FTX when the scandal began to unfold. Bitvo ultimately announced the termination of the proposed deal in mid-November. Draper points out Bankman-Fried touted in a June press release that the deal was a way for FTX to work with regulators in different geographies.

Enforcement of regulations

Regulators around the world are still in various stages of implementing rules and frameworks for the fast-moving crypto industry.

Canada has been applauded for being ahead of many countries in developing a crypto regime and offering products such as exchange-traded funds but it lags peers such as the U.S. on enforcement.

"Even though Canada has this well-defined regime, and Bitvo and a few others are a part of it, there're still a lot of platforms (that are) able to operate in Canada without being a part of that regime. The regulators are trying to pull them in, but again, it's not happening fast enough to protect consumers from these failures, like you saw at FTX," Draper said.

Wayne Logan, a partner at Miller Thomson LLP, echoes that Canada's regulation framework is well-developed but enforcement remains an issue.

"That's probably where the U.S. is ahead of us because there's that much more activity," Logan said by phone.

Show me the proof (of reserves)

In the wake of FTX's bankruptcy, some rival crypto exchanges have vowed to start providing "proof of reserves," an independent audit showing a company's holdings.

One of the issues at FTX was that customer funds were unknowingly being transferred to Bankman-Fried's trading firm Alameda Research.

U.S. attorney Damian Williams speaks to the media regarding the indictment of Samuel Bankman-Fried the founder of failed crypto exchange FTX in New York City, U.S., December 13, 2022. REUTERS/David 'Dee' Delgado
U.S. attorney Damian Williams speaks to the media regarding the indictment of Samuel Bankman-Fried the founder of failed crypto exchange FTX in New York City, U.S., December 13, 2022. REUTERS/David 'Dee' Delgado

Providing proof of reserves sounds like a good idea, Mosoff says, but adds that a "snapshot of one point in time" might not be enough.

"You need a fair amount of information to get a holistic picture of what's happening inside of those businesses," he said.

Without additional information such as company liabilities or how funds are being segregated, infrequent displays of proof of reserves will likely not be very helpful to customers looking to gauge the health of an exchange.

Retail investors are increasingly thinking about this and if exchanges don't comply, they face one of two outcomes, Mosoff says. Either the exchanges will "smarten up" or customers will get nervous about the exchange's balance sheet and pull their funds.

"If you are a customer on FTX, and you knew the extent of their financial situation — and that they were lending out your funds and your funds weren't necessarily accessible to you when you wanted them — you would have made different decisions with your money," Bitvo's Draper said.

"Transparency is essential for customers to be able to make informed decisions. I think that regulation helps with that."

To self-custody or not

For investors whose confidence about leaving money deposited on exchanges has been shaken, they could consider self-custody of their assets. Self-custody is when an individual has sole possession of the "keys" to their crypto assets, rather than entrusting the "keys" to an exchange.

Mosoff says more and more users are starting to take possession of their assets instead of holding them on a platform. While users have more control, it's not totally risk-free.

"It's just a different set of responsibilities. Now you have to understand: Do you have a backup? Where do you keep the backup? What happens if you pass away? There's all these things to consider," he said.

"So people need to be thoughtful about not just what centralized exchange they're going to use, but also if they want to do self-custody. Understand that there are some risks there too. Doesn't mean that they shouldn't do it. Just make sure you do your homework and make sure what you are shoring up is appropriate."

Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.

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