Breakingviews – Crypto Watchdogs Have a Giant Offshore Problem

LONDON, Nov 17 (Reuters Breakingviews) – Stricter regulation of cryptocurrencies is inevitable after the collapse of the FTX exchange. Even so, there will always be places the rules don’t touch. Big players like Binance, as well as services based on so-called decentralized finance, may remain out of reach. This ensures that the sharper aspects of crypto will endure.

Sam Bankman-Fried’s now-bankrupt company transferred $10 billion in client money to cover losses from its sister hedge fund, according to Reuters, which also reported that at least $1 billion was missing. This destroys FTX’s commitment to users that their deposits will “remain with you at all times”. The obvious regulatory solution is to require crypto firms to hold customer funds in the form in which they were deposited in the future, rather than using the money to trade or make loans.

The mammoth of the European Union crypto regulation would help. Known as MiCA and recently approved by lawmakers, the regulation requires custodians to segregate customers’ crypto holdings from the company’s own assets. Of them bills introduced this year by US senators also contain prohibitions against this practice, known as “co-mingling”. The common goal is to ensure that users’ assets, whether held in bitcoin or in a token linked to an actual tender like the dollar, are available when they wish to withdraw.

But it’s unclear whether the watchdogs – which in the EU will be the national financial regulators, and in the US would most likely fall under the Commodity Futures Trading Commission – could enforce it across the board.

The first risk is that they do not capture decentralized finance projects. This corner of crypto, where developers write software to facilitate automated trading and lending products generally on the Ethereum blockchain, is by definition free of middlemen. According to the website DéfiLlama, supposedly DeFi has over $40 billion in total value “locked up,” crypto-jargon for money deposited in decentralized exchanges and other services. It is borderless and often pseudonymous, which makes it difficult to control. Chainalysis Security Company account nearly three-quarters of stolen crypto in 2021 was taken from DeFi services.

The second problem will be to identify companies based elsewhere. Take Binance, by far the largest crypto exchange. It has an American affiliate company, Binance.US, but this company is tiny compared to the parent company. The danger is that regulators in their backyard can’t see what’s going on with someone else. Global coordination has proven difficult on other issues such as minimum corporate tax rates; a common framework for something as complex as crypto is a pipe dream.

The industry’s best hope is that regions with clear, user-friendly rules will attract big institutional capital and protect retail traders. But borders are porous, and money finds a way to deliver the greatest rewards. Bankman-Fried initially said that the US division of FTX was immune to problems at its Bahamas-based exchange. Yet on Friday he filed for bankruptcy alongside the larger group. The next wave of regulation may protect the good, but it won’t stop the reckless.

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FTX suffered a “severe liquidity crisis” that led to its bankruptcy, according to court documents dated Nov. 14. The collapsed cryptocurrency exchange may have over a million creditors.

FTX filed for bankruptcy on November 11, after traders rushed to withdraw $6 billion from the platform in just 72 hours and rival exchange Binance scrapped a proposed bailout deal.

Bitcoin was trading at around $16,600 as of 08:35 GMT on November 17, up from around $20,500 at the start of the month.

Editing by John Foley and Streisand Neto

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The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and non-partisanship by principles of trust.


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