Lessons from the FTX Collapse

The FTX collapse is a major blow to the crypto industry. It is a reminder that the industry is still in its early stages and that there are many risks associated with investing in crypto assets. The collapse of FTX is also a reminder that the crypto industry is highly volatile and that investors should be prepared for losses.

There was a conflict of interest between Alameda and FTX because Alameda was both an investor in FTX and held a minority stake in the company. The legal separation between banking and non-banking financial institutions is important because it protects depositors from risks associated with investing in non-bank financial institutions. When a non-bank financial institution collapses, depositors are generally not well-protected by regulators. Consumer protection is on a much firmer footing when the institution concerned is classified as a ‘banking institution’.

Unsurprisingly, whether or not customers’ deposits with custodial crypto exchanges actually amount to ‘deposits’ in the legal sense is a significant battleground in this unfolding saga. The larger question here, of course, is the following – should custodial crypto exchanges be treated like banks?

There is no one-size-fits-all answer to this question, as the regulatory treatment of custodial crypto exchanges may vary depending on the specific circumstances of each case. However, in general, it may be helpful to think of custodial crypto exchanges as being similar to banks or other financial institutions, in that they may be subject to similar regulations with respect to anti-money laundering (AML) and countering the financing of terrorism (CFT). In addition, custodial crypto exchanges may also be subject to regulations governing the custody and safeguarding of customer funds, as well as other requirements designed to protect investors.

The broad lessons from the FTX debacle for end users, however, seem clear.

1. don’t put all your eggs in one basket.
2. don’t rely on a single custodian for your crypto assets.
3. exercise due diligence when choosing a custodian for your crypto assets.
4. be aware of the risks associated with holding crypto assets on a custodial exchange.

The regulatory response to crypto following the FTX collapse is likely to be swift and severe. This will only serve to further underscore the importance of the lessons learned from this debacle.