Senate committee to kick off public probe of FTX collapse

Lawmakers are scrambling to understand why FTX collapsed and how the implosion of a titanic cryptocurrency firm could upend the industry.

The Senate Agriculture Committee will hold a hearing Thursday with a top financial regulator focused on how the federal government can get a clearer view into the cryptocurrency industry and prevent future incidents like the FTX blowup. The hearing also comes amid a deepening crisis of confidence within the crypto industry unleashed by the demise of FTX.

“The failure of [FTX] will radically transform the cryptoecosystem, further shaking trust and raising doubts around its ongoing prospects,” analysts at Moody’s Analytics wrote in a Monday research note.

“At the same time, however, FTX’s rapid failure will invite further regulatory oversight and scrutiny of the sector, which we expect will ultimately translate into clearer guidelines for crypto market participants.”

FTX, one of the world’s largest cryptocurrency trading platforms, filed for bankruptcy earlier this month after a series of reports about its shoddy finances triggered a run on its books. FTX also lost billions of dollars in customer deposits on risky bets made by Alameda Research, an investment firm run by FTX founder Sam Bankman-Fried

Over a three-day span, FTX customers attempted to withdraw billions of dollars in deposits stored on the platform, but FTX lacked enough cash to make its customers whole.

Bankman-Fried has admitted to sending money deposited on FTX by customers to fund Alameda’s investments, many of which backfired as cryptocurrency values plunged throughout the year. He also said FTX lacked basic information about its liabilities and assets and drastically underestimated how much money the company owed its various creditors, including its customers.

“Although FTX International was a crypto exchange, its failure had virtually nothing to do with crypto. Rather, it was caused by garden-variety mismanagement and malfeasance,” argued the Blockchain Association, a trade group for cryptocurrency firms, in a letter to the Senate Agriculture Committee.

Even so, FTX’s deep financial connections to other crypto firms have plunged the broader industry into crisis.

Cryptocurrency lender BlockFi filed for bankruptcy Monday, citing a $275 million loan to FTX as part of their financial demise. Genesis, another crypto brokerage, is fighting to avoid bankruptcy after losing $175 million in funds locked up in FTX systems.

When financial institutions regulated and supervised by the federal government fail, customers can usually receive reimbursement for money lost by no fault of their own. The Federal Deposit Insurance Corp. was created in 1933 to prevent customer losses from bank runs, and the Securities Investor Protection Corporation was created in 1970 to serve a similar purpose for investment accounts.

But none of the three teetering crypto lenders have any backstop from the federal government, meaning their customers may see little, if any, compensation in bankruptcy proceedings.

“The fates of crypto investors are now determined by the fine prints of contracts they probably never read, and they took on a lot more risks than they thought they were,” said Tyler Gellasch, president and CEO of the pro-investment transparency Healthy Markets Association, in a Wednesday interview.

“At the end of the day, financial firms in the business of trading need to know what you own, and you need to know how you control what you have and what your risks are to your counterparties.”

The Thursday hearing will likely focus on what the federal government must do to prevent another FTX-like collapse and how to finally write a clear regulatory regime for cryptocurrency companies. Commodity Futures Trading Commission (CFTC) Chairman Rostin Behnam, who will testify before the Agriculture Committee, will also face questions about what the agency needs from lawmakers to step up its oversight.

The CFTC and Securities and Exchange Commission both oversee various parts of the cryptocurrency industry. But neither has the sole legal authority to investigate and regulate certain cryptocurrency companies, such as exchanges like FTX, because of the unique ways cryptocurrencies blur the lines between securities, commodities and futures contracts.

Several top members of the Agriculture Committee, which has jurisdiction over the CFTC, released a bill earlier this year, the Digital Commodities Consumer Protection Act (DCCPA), that would give the agency greater authority to oversee crypto firms. The bill, however, was championed by Bankman-Friend and FTX and seen by some crypto advocates as an attempt by the company to shape regulations to its liking.

Sen. Debbie Stabenow (D-Mich.), chairwoman of the Agriculture Committee and one of the DCCPA’s lead sponsors, has denied accusations the bill was essentially written by Bankman-Fried and has said it was influenced by a wide range of views.

“Members of the U.S. Senate have been working on a bipartisan basis over the past several months to draft legislation to bring needed safeguards to this industry. In fact, the DCCPA was designed to address the very risks that caused FTX’s collapse,” the committee said in a fact sheet released last week.

“It applies time-tested rules of financial regulation to crypto firms, to protect customer assets and eliminate conflicts.”

Critics of the bill counter that it would have done nothing to prevent the collapse of FTX because the firm was registered in the Bahamas, not the U.S., in part to avoid exposure to U.S. trading regulations.

“There is no US law or regulation that can prevent the failure of an offshore entity. The best way to address non-US exchanges is to develop a regulatory framework that attracts them to the US market, but the DCCPA would not achieve that goal,” the Blockchain Association argued.

“If FTX International had been subject to US jurisdiction, then existing US laws would have been sufficient to prohibit and enable detection of the transactions that led to its failure.”