Exclusive How FTX Became the ‘Most Regulated’ Cryptocurrency Exchange

  • FTX buys 10% of IEX with option to acquire 100%
  • FTX Spends $2 Billion on “Acquisition for Regulatory Purposes”
  • FTX sees its regulatory status as a way to attract fresh capital from major investors, filings show

Nov 18 (Reuters) – Before collapsing this month, FTX stood out from many rivals in the largely unregulated cryptocurrency industry, boasting that it was the “most regulated” on earth. exchanges, and invite greater scrutiny from the authorities.

Now, company documents seen by Reuters shed light on the strategy and tactics behind founder Sam Bankman-Fried’s regulatory agenda, including the terms of a deal with IEX Group announced earlier this year for Michael Lewis. Lewis’ book “Flash Boys”. ” About fast, computer-driven transactions.

As part of the deal, Bankman-Fried bought a 10 percent stake in IEX with an option to buy it out entirely within the next two-and-a-half years, according to a June 7 filing. The tie-up gives the 30-year-old executive the opportunity to lobby IEX’s watchdog, the SEC, on cryptocurrency regulation.

That deal and others mentioned in the document, including business updates, meeting minutes and strategy papers, articulate a broader goal for FTX: to quickly carve out a suitable regulation for itself by acquiring stakes in companies already licensed by authorities. framework to shorten the often lengthy approval process.

FTX documents from a Sept. 19 meeting seen by Reuters show that FTX spent about $2 billion on “acquisitions for regulatory purposes.” For example, last year, it acquired the futures exchange LedgerX LLC and gave it three Commodity Futures Trading Commission licenses at once. These licenses enable FTX to enter the US commodity derivatives market as a regulated exchange. Derivatives are securities that derive value from another asset.

FTX also sees its regulatory status as a way to attract new capital from major investors, the documents show. In documents supporting its application for hundreds of millions of dollars in funding, it cited its license as a key competitive advantage. “Regulatory moats” create barriers for rivals and will enable them to enter lucrative new markets and partnerships that unregulated entities cannot, it said.

“FTX has the cleanest brand in the cryptocurrency space,” the exchange declared in a filing to investors in June.

Bankman-Fried did not respond to a request for comment on questions about FTX’s regulatory strategy. FTX did not respond to a request for comment.

A spokesman for the SEC declined to comment for this article. The CFTC also declined to comment.

In a text exchange with Vox this week, Bankman-Fried made a shift on the regulatory issue. Asked whether his previous praise for regulation was “just PR,” he said in a series of texts: “Yeah, it’s just PR…fuck the regulators…they To make everything worse…they don’t protect customers at all.“

An IEX spokesperson declined to confirm details of the deal with FTX, saying only that FTX’s “minority stake” in IEX could not be sold to a third party without its consent. “We are currently evaluating our legal options with respect to the prior transaction,” the spokesman said.

patchwork of regulators

FTX crashed last week after Bankman-Fried made a futile bid to raise emergency funds. It has received some regulatory oversight through dozens of licenses acquired through multiple acquisitions. But that didn’t protect its customers and investors, who now face losses totaling billions of dollars. As Reuters reported, FTX has been secretly taking risks with client funds, using $10 billion in deposits to prop up a trading firm owned by Bankman-Fried.

The fact that Bankman-Fried is courting regulators while taking huge risks with client funds without anyone noticing exposes a huge regulatory loophole in the cryptocurrency industry, according to four lawyers. “It’s a patchwork of regulators around the world — and there are huge gaps even domestically,” said Aitan Goelman, an attorney for Zuckerman Spaeder, a former prosecutor and the CFTC’s director of enforcement. “It’s the fault of the regulatory system that it took too long Time to adapt to the emergence of cryptocurrencies.”

A person familiar with the SEC’s thinking on cryptocurrency regulation said the agency believes cryptocurrency firms operate illegally outside of U.S. securities laws, relying instead on other licenses that offer minimal consumer protections. “These statements, while nominally true, did not cover their activities,” the person said.

Reuters photo Reuters photo

“Step 1: License”

Bankman-Fried has big ambitions for FTX. Starting in 2019, FTX’s revenue has grown to more than $1 billion this year, accounting for about 10% of the global cryptocurrency market trading volume. He wants to develop a financial app where users can trade stocks and tokens, transfer and transfer money, according to an undated document titled “FTX Roadmap 2022.”

The “roadmap” document says the “first step” towards this goal is to “obtain permission as far as reasonably possible”.

“Partly to ensure we are regulated and compliant; partly to be able to expand our product offerings,” the filing said.

According to the document, this is where FTX’s acquisition spree comes from. Instead of applying for each license, Bankman-Fried decided to buy them, which can take years and sometimes fraught with troubling problems.

But the strategy has its limits: Sometimes, the documents show, the companies it buys don’t have the exact licenses they need.

According to the filing, one of FTX’s goals is to open up the U.S. derivatives market to clients in the country. The market is estimated to bring in an additional $50 billion in daily transaction volume, generating millions of dollars in revenue. To do so, it will need to convince the CFTC to amend one of the licenses held by FTX’s newly acquired futures exchange, LedgerX.

The application process lasted several months, and FTX had to pay $250 million into the default insurance fund, a standard requirement. According to the minutes of the March meeting of the FTX Advisory Committee, FTX expects that the CFTC may ask it to increase the fund to $1 billion.

FTX went out of business before it could be approved and has now withdrawn its application.

Acquiring a company for a license has other advantages, according to documents seen by Reuters: It would give Bankman-Fried the regulatory access he wants.

A prime example is the IEX deal announced in April. In a joint interview with CNBC, Bankman-Fried and IEX CEO Brad Katsuyama said they want to “create regulations that ultimately protect investors.” Bankman-Fried added that the most important thing here is “there is transparency and protection against fraud.”

Reuters could not determine how much FTX paid for the stake.

Bankman-Fried was invited to meet with SEC Chairman Gary Gensler and other SEC officials, as well as Katsuyama, in March.

A source close to IEX said the purpose of the meeting was to give the SEC an early look at its deal with FTX, which was not yet public, and to discuss the possibility of IEX creating a venue for trading digital assets, such as bitcoin. The role of FTX is to provide crypto trading infrastructure, sources said.

Sources familiar with the SEC’s thinking said SEC officials outright rejected their initial plan because it would have involved creating a less regulated non-exchange trading venue, the agency opposed to cryptocurrencies.

Reuters could not determine the extent of Bankman-Fried’s involvement in subsequent conversations with the SEC. Sources familiar with the SEC’s thinking said that, in their view, SEC officials had agreed to meet with Katsuyama in March, and Bankman-Fried was simply following the crowd. He remained virtually silent during the meeting, with Katsuyama in the “driver’s seat,” the source added.

Regardless of his involvement, FTX narrates its discussions to its investors. FTX said at a meeting of its advisory board in September that the talks with the SEC had been “very constructive.”

“We are likely to take the lead there,” it said, according to the minutes of the meeting.

People familiar with the SEC’s thinking said they would question FTX’s “leading position.” Anything the SEC does to regulate crypto exchanges will be open to all market participants, the sources said.

Sources close to IEX said the exchange never entered into any operating agreement with FTX, adding that it never got to this point.

A May filing by FTX provided a summary of FTX’s contacts with various regulators. The document, which has not been reported before, shows how FTX, for the most part, resolves issues that pop up.

In February, for example, South African authorities issued a warning to consumers that FTX and other cryptocurrency exchanges were not licensed to operate there. Therefore, FTX entered into a commercial agreement with a local exchange to continue providing services. “FTX is now fully formalized in terms of its current activities in South Africa,” FTX said.

Regulator South Africa’s Financial Sector Conduct Authority did not respond to a request for comment.

The May filing also revealed that FTX had crossed paths with the SEC. The SEC launched an investigation earlier this year into how cryptocurrency firms handle customer deposits. Some companies are offering interest on deposits that the SEC says can make them securities and should be registered under its rules. In its list of regulatory interactions, FTX noted that the investigation is looking at whether the assets were “loaned or otherwise used for operational purposes.”

This month, as Reuters reported, news emerged that FTX did just that, moving billions of dollars in client funds to Bankman-Fried’s trading firm, Alameda Research.

In a May filing, FTX said that SEC reviewers tasked with reviewing market conduct that could pose risk to investors were concerned about another thing: the rewards program it offered customers, under which it would pay for crypto. Currency deposits pay interest.

According to the filing, FTX told the regulator that it did not have the same issues with products from other vendors the agency has investigated.

“We confirm that these are solely reward-based and do not involve lending (or other use) of deposited cryptocurrencies,” FTX wrote. The SEC wrote back that it had completed an “informal investigation” and that “this When” No further information is required.

The SEC did not comment on the investigation. In an email to Reuters, Bankman-Fried wrote: “FTX’s response is accurate; FTX US’s rewards program does not involve lending any assets.”

Reporting by Chris Prentice and Hannah Lang in Washington and Angus Berwick in London; Editing by Megan Davies, Paritosh Bansal and Chris Sanders

Our Standards: The Thomson Reuters Trust Principles.

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