Crypto space braces for double-edged sword of regulatory oversight in FTX's wake

If there's a silver lining to the abrupt implosion of the FTX cryptocurrency exchange, it might be the U.S. regulators will start to step up their game by providing more clarity and direction to the myriad players in the fast-growing space.

“I think this will catalyze regulators to come into the space,” said Matt Hougan, chief investment officer at Bitwise Asset Management.

Citing the apparent illegal activity of Sam Bankman-Fried, who has since resigned as head of what was the world’s second-largest crypto exchange, Hougan said U.S. regulatory actions related to crypto are at least partially responsible for investors doing business with Bahamas-based FTX.

“There’s some blame to be shared by U.S. regulators for moving too slowly,” he said. “That has forced institutions offshore in order to operate in this space.”

While not everyone is placing as much responsibility on the shoulders of U.S. regulators in the wake of the FTX collapse, Hougan believes the “black eye” FTX inflicted on crypto will force some aggressive regulatory action and ultimately make the crypto space stronger.

“What will get institutions to come off the sidelines is better regulations,” he said. “This will be a difficult period for crypto, and on the other side is when we go mainstream. I’m pretty hopeful, but I think there’s a lot of work to be done in Washington.”

William Pao, head of the fintech group at the law firm of O’Melveny & Myers, also believes “regulators will be emboldened by what has happened to FTX.”

“Very few people will be in a position to push back” against regulators, Pao added. “Be prepared for some very aggressive tactics.”

But even as participants across the crypto space have come out in support of better regulatory oversight in response to the billions of dollars investors lost as a result of the FTX collapse, Pao and others admit the regulators are walking a tightrope when it comes to the digital currencies.

“The agencies have been trying to balance protecting consumers with encouraging innovation," he said. "This may disrupt that. With so many people losing so much money, regulators will swing way over to the protection side.”

Ric Edelman, founder of the Digital Assets Council of Financial Professionals, is among those both welcoming and bracing for increased regulatory oversight.

“We know clearly what the rules are when it comes to stocks and bonds, but we don’t have similar rules when it comes to crypto,” he said. “It’s ridiculous that the regulators in Washington haven’t figured this out yet.”

Citing the global regulatory reactions following the FTX bankruptcy, Edelman said, “emergency regulatory action is highly likely.”

But as anyone involved at any level of the crypto space can attest, nothing is certain when it comes to regulatory oversight.

“Up until where we are right now, it’s been this game of regulatory hot potato, because no one has wanted to take the lead or own this space and the activity and entities in it,” said Nicholas Losurdo, partner at the law firm Goodwin Procter.

“What we’ve gotten from the chairman of the SEC over the last two years has been, ‘Come in and register with us,’ but that isn’t the reality of the way things work and it’s not always clear what capacity a party would register in or if registration is even required or appropriate,” Losurdo added. “For example, there have been dozens of spot crypto ETFs filed and they’ve all been rejected or delayed. The SEC hasn’t articulated how some participants or products fit into the U.S. regulatory system.”

While it’s easy to assume such a epic failure as FTX will solicit waves of political grandstanding and calls for action, the reality is closer to the status quo.

“To get to a place where we have long-term clarity, we need Congress to step in and regulate and define this space,” said John Sonsalla, senior financial analyst at the research firm Washington Analysis.

In the meantime, Sonsalla said the crypto space will have to accept persistent regulatory enforcement as the next best thing to clarity and guidance.

“Congress wants innovation to happen within the U.S., and regulators are focused on consumer protection,” he said, adding that the crypto industry might not want the kind of regulatory oversight it claims to be seeking.

“The industry wants beneficial clarity with more room to operate and innovate and make sure their tokens aren’t subjected to traditional securities law,” Sonsalla said. “I don’t see [SEC chairman Gary] Gensler moving in a direction that is going to provide beneficial clarity for the crypto space. In terms of any larger overhaul of crypto legislation, it almost reminds me of data privacy and security standards. Washington has been working on that for the better part of a decade.”

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