Compiled by the Oliver Wyman Forum
The US government brought criminal and civil charges against former FTX chief executive Sam Bankman-Fried, who now resides in a Bahamian jail. A fresh call for legislation to tighten crypto regulation in the United States faces an uncertain future in Congress while global banking regulators endorse tough new capital requirements to cover banks’ exposures to crypto. These are among the significant developments in digital assets in the past fortnight.
Crypto in Crisis
Bankman-Fried Behind Bars
Authorities in the Bahamas arrested Sam Bankman-Fried on December 12 at the request of the US government after prosecutors filed fraud charges against him stemming from the collapse of FTX, the crypto exchange he founded and led until it filed for bankruptcy a month earlier.
An indictment released on December 12 by the US District Court for the Southern District of New York charged Bankman-Fried with multiple counts of wire fraud against customers and investors, commodities and securities fraud, money laundering, and violations of campaign finance laws.
A lawsuit filed by the US Securities and Exchange Commission on December 13 alleged that from the start of FTX’s founding in 2019, Bankman-Fried orchestrated “a massive, years-long fraud” that diverted billions of dollars of customer funds to Alameda Research, his crypto hedge fund, and to make “undisclosed venture investments, lavish real estate purchases, and large political donations.” It claimed he had defrauded investors who poured at least $1.8 billion into FTX since 2019, including $1.1 billion from approximately 90 US investors.
A separate lawsuit by the Commodities Futures Trading Commission alleged similar violations, including that Bankman-Fried directed the creation of features in FTX’s underlying code that allowed Alameda to maintain “an essentially unlimited line of credit on FTX.” By mid-2022, after Alameda faced a large number of margin calls because of market turmoil following the collapse the TerraUSD stablecoin, the hedge fund’s liability to FTX reached approximately $8 billion, it said.
Binance Hit By Withdrawals As Accounting Firm Halts Reserves Work
Investors withdrew a net $6 billion from Binance between December 12 and 14, the cryptocurrency exchange disclosed, while the accounting firm Mazars said on December 16 that it had “paused” its work providing proof of reserves reports for Binance and other crypto firms.
Binance said it was looking for another firm to conduct a proof of reserve report. Separately, the exchange’s chief executive, Changpenz Zhao, told staff in a memo to expect “bumpy” times in the coming months but that the exchange was “built to last and will survive any crypto winter,” CoinDesk reported.
Policy and Regulation
Basel Committee Endorses Conservative Capital Rules For Crypto
The oversight body of the Basel Committee on Banking Supervision endorsed a set of conservative capital and prudential standards for banks’ exposure to cryptoassets, saying the measures would promote responsible innovation while preserving financial stability.
The new rules, which the committee has been considering since 2019, will limit a bank’s exposure to unbacked cryptocurrencies, including Bitcoin, as well as tokenized assets that don’t pose the same credit and market risk as the non-tokenized form of the asset, to 2% of its Tier 1 capital, and say holdings should generally be below 1%. Such assets also will fall under a conservative approach that requires banks to hold at least $1 of capital for every dollar of exposure.
Stablecoins with effective stabilization measures and tokenized traditional assets that pose the same risks as the underlying asset will be subject to the same capital requirements as the underlying exposures.
The rules, which are due to come into effect in 2025 but require implementation by national authorities, contained some additional flexibility relative to earlier proposals, which banking groups had criticized as unnecessarily restrictive. A proposed 2.5% add-on capital charge to cover infrastructure risk for most cryptocurrencies, for instance, will be triggered based on observed weaknesses rather than imposed automatically.
Separately, the head of research at the Bank for International Settlements, which hosts the Basel Committee, said that if stablecoins are brought into the regulatory regime, their role as the entry point to the crypto ecosystem will need to be addressed to prevent crypto intertwining itself with the financial system. Crypto activities mainly involve trading other types of crypto rather than the wider economy, Hyun Song Shin wrote in a Financial Times column. A policy approach that focuses on central bank digital currencies (CBDCs) would be more likely to benefit real-world economic activity, he wrote.
US Urges Legislation To Tighten Crypto Regulation
The Biden Administration has called on Congress to pass legislation to close gaps in the regulation of cryptoassets and crypto service providers.
Digital assets are one of the five main financial risks facing the country, according to the annual report released on December 16 by the Financial Stability Oversight Council, which is chaired by Treasury Secretary Janet Yellen and includes the heads of the Federal Reserve and major regulatory bodies. Legislation should provide rulemaking authority for federal regulators over the spot market for cryptoassets that aren’t securities, address regulatory arbitrage, and undertake an assessment of whether vertically integrated market infrastructures can or should be accommodated under existing laws.
While the collapse of FTX and other turmoil in crypto markets has had little impact on the financial system, the report said interconnections between crypto markets and the traditional financial system “could increase rapidly,” including through stablecoin issuers’ reserve assets held by traditional financial firms.
In Congress, meanwhile, Senate and House committees held separate hearings on FTX but lawmakers showed no consensus on the prospects or content of legislation. John J. Ray III, the bankruptcy specialist who is now running FTX, told the House Committee on Financial Services that FTX was a case of “old-fashioned embezzlement” by a firm that lacked an accounting department or any controls to protect investor money.
CBDC Exploration Continues To Grow
There are now 114 countries accounting for more than 95% of global gross domestic product that are exploring a central bank digital currency (CBDC), researchers at the Atlantic Council’s GeoEconomics Center reported on December 15. That was up from 105 countries three months earlier and 35 in 2020, when the center began tracking CBDC developments.
Central banks don’t want to be left behind by the growing use of cryptocurrencies and stablecoins, notwithstanding a string of recent failures including FTX, the researchers said. They also cited the impact of Western sanctions on Russia over its invasion of Ukraine, saying it had led many countries to look at CBDCs as a “back-up plan” to avoid being cut off from global payments networks.
All members of the G7 countries are now deemed to be developing a CBDC following the November report by the Federal Reserve Bank of New York that it had tested a wholesale CBDC for use in cross-border payments.
New York Issues New Crypto Guidance For Banks
New York-registered banks seeking to engage in crypto-asset activities must first seek approval from state authorities, New York State’s Department of Financial Services announced in a guidance document released on December 15.
Banks wishing to conduct crypto-related activities must present their business plan, explain how they will manage crypto-related risk, and provide details on their corporate structure and how consumers will be protected. The guidance “is critical to ensuring that consumers’ hard-earned money is protected, that New York regulated banking organizations remain resilient and competitive.”
Goldman Plans To Ramp Up Investment In Crypto Firms
Goldman Sachs plans to spend tens of millions of dollars to buy or invest in crypto companies, regarding weakness in the sector following the collapse of FTX as an opportunity to grow, Mathew McDermott, the investment bank’s head of digital assets, told Reuters.
FTX’s failure has heightened the need for more trustworthy, regulated cryptocurrency players, and Goldman has experienced an increase in trading volumes, he said.
OneCoin Co-founder Pleads Guilty In Fraud Case
Karl Sebastian Greenwood, who co-founded Bulgaria’s OneCoin, a purported cryptocurrency that prosecutors alleged was a multi-billion-dollar pyramid scheme, pleaded guilty to wire fraud and money laundering charges in a US federal court in Manhattan on December 16.
OneCoin was sold through a multi-level marketing arrangement that gave members commissions for recruiting new buyers. The coin was not mined and did not have a blockchain, and its price – which only ever rose – was set by OneCoin, not the market. It generated over $4 billion in sales after its launch in 2014.
The coin’s other co-founder, Ruja Ignatova, also known as the “Cryptoqueen,” remains at large and is on the US Federal Bureau of Investigation’s Top Ten Most Wanted List.
Lessons From The Crypto Winter
The recent failure of the FTX cryptocurrency exchange and the industry shakeout unleashed by the collapse of the TerraUSD stablecoin in May 2022 underscore the risks of contagion that stem from the “massive interconnectedness” in crypto markets, the Organisation for Economic Cooperation and Development said in a paper published on December 14.
This year’s market turmoil “exposed new forms of financial engineering taking place in crypto-asset markets,” according to the paper, “Lessons From the Crypto Winter: DeFi versus DeFi.” Liquid staking, or the creation of derivatives backed by illiquid locked assets, creates “extreme liquidity transformation risk and maturity mismatches,” while consecutive rounds of re-hypothecation build up leverage in the system as investors lend their funds or lock them as collateral.
Players in centralized finance (CeFi) and decentralized finance (DeFi) are closely intertwined, with CeFi acting as the primary source of funds and collateral flowing into DeFi protocols enabled CeFi firms to take highly leveraged positions.
The market turmoil “highlights the urgent need for policy action” to promote transparency in crypto markets and provide protection for retail investors, the paper said.