On November 11, 2022, FTX, one of the world's largest cryptocurrency exchanges, filed for Chapter 11 bankruptcy protection in the United States along with over 100 affiliated entities1. The bankruptcy was triggered by a liquidity crisis led by an 80% value decline of the platform's native token – FTT, but was rooted in the failures of corporate control, absence of trustworthy financial information, and lack of regulatory oversight.
The sudden collapse of FTX, following a series of bankruptcies of prominent industry players sent the cryptocurrency industry into further distress during an already tough year. However, thanks to the stringent requirements placed by Canadian regulators on Canadian crypto trading platforms, Canadian clients were protected from some of the contagion impacting international crypto trading platforms.
The Collapse
FTX was founded by Sam Bankman-Fried with its headquarters in the Bahamas. Under an overlapping management team, FTX has a number of affiliated entities, which include Alameda Research, a cryptocurrency trading firm and FTX.US, a registered cryptocurrency exchange for US-based uses. Since its incorporation in 2019, FTX quickly emerged as a widely-known and heavily-used cryptocurrency exchange that offers cryptocurrency derivatives, leveraged products and spot trading for over 460 cryptocurrency pairs2. As the third largest centralized cryptocurrency exchange by volume, FTX was valued at $32 billion at the closing of its series C round in January 20223.
In early November, Coindesk published a report challenging the stability of the exchange4. It found that Alameda Research had a significant portion of its assets tied up in FTT tokens. To the surprise of many, Alameda was shown to be heavily reliant on a coin that its sister company invented, calling into question the separation between the companies and their liquidity.
Further discoveries of FTX's mishandling of customer funds and their poor financial state sent shockwaves throughout the industry. According to The Wall Street Journal5, FTX had secretly lent funds in an amount near $10 billion to Alameda for its investments, as well as paying back loans taken by Alameda for its investments. Much of those funds have now been lost, including a $500 million loan to the now bankrupted crypto lender, Voyager Digital.
FTX is alleged to have misappropriated customer's deposits by transferring funds from FTX to Alameda.6 US Justice Department, Securities and Exchange Commission and Commodity Futures Trading Commission have all initiated investigations of the matter. It was reported that FTX faced $9 billion in liabilities before the bankruptcy7. Together with FTX, FTX.US and Alameda Research also filed for bankruptcy in Delaware on November 11.8 Sam Bankman-Fried resigned as the exchange's CEO on the same day. On December 13, he was arrested in the Bahamas as local authorities anticipated a formal request for his extradition to the U.S. In addition to civil securities fraud charges filed by U.S. regulators, Sam Bankman-Fried has been charged with eight federal criminal charges; if convicted, he faces the possibility of decades in prison.
FTX Contagion and impact to Canadian market
Major cryptocurrencies, including Bitcoin, witnessed greater than a 20% drop in value following FTX's collapse. In addition to the plunging price, the fallout also created significate asset contagion risks across the industry, particularly towards those that were heavily tied to FTX and its affiliated companies. A week after FTX's implosion, cryptocurrency lender BlockFi also filed for Chapter 11 bankruptcy protection after declaring it had significant exposure to FTX and Alameda.9 As FTX contagion spreads, Canadian investors and industry players have also been impacted.
In March 2021, the Ontario Securities Commission (OSC) announced the requirement of crypto asset trading platforms that offer trading in derivatives or securities to become compliant with Ontario securities law. Subsequently, this limited the services that FTX could offer in Ontario until it was properly registered and obtained restricted dealer status in the province. To work around this, FTX considered the acquisition of a registered Canadian trading platform to gain access to the registrations it held in Canada. FTX's subsequent collapse suggests that regulated Canadian platforms should be very diligent in reviewing potential foreign acquirors.
Unlike many investors across the world who have their funds with FTX, Canadians that invest in cryptocurrencies through registered crypto asset trading platforms were able to dodge the shockwaves. Canadian-based WonderFi Technologies Inc., which owns crypto trading platforms Bitbuy and Coinberry, issued a statement10 on November 10 and reassured its clients and investors that, despite its early investment into FTX, the fallout will have no material impact on its operation. Similar to WonderFi, many Canadian registered cryptocurrency-trading platforms have also taken the opportunity to reassure investors in Canada of their solvency and the safety of customer funds, thanks to Canada's regulatory oversight and requirements to ensure all customer assets are managed in a secured and insured way.
Market expects move actions from regulators
FTX's collapse had many investors, including institutional investors, suffering. As the market reflects on the lessons learned, there is now more impetus than ever for the industry to work with regulators in developing and improving the legal framework targeted for this sector.
Canada has emerged as a leading jurisdiction in implementing effective regulatory framework around the crypto industry, making the crisis around FTX difficult to occur within the country. Particularly, for any crypto asset trading platform to be registered in Canada, it has to first apply to become a Restricted Dealer under the Canadian securities law by meeting a series of requirements, including but not limited to, i) employing qualified personnel and certified representatives; ii) having a dedicated compliance officer; iii) maintaining a certain amount of net working capital at all times; and iv) obtaining a minimum level of financial bond insurance covering fidelity, on premises, in transit, forgery/alterations, and securities. Any registered trading platforms will be required to have operations approved by Canadian regulators, who also expect the platforms to have appropriate "know-your-client" procedures in place and hold at least 80% of client assets in cold storage with a qualified custodian at all times.
Takeaways
While Canada's regulatory regime eliminates some risk factors that may directly contribute to FTX's collapse, the crashes in prices and loss of market confidence have still affected the value of the crypto assets that Canadians hold. FTX's collapse openly alerted investors to the undue risk to which they expose themselves when they invest through unregulated or unregistered platforms. It also made many Canadian investors appreciate the scrutiny and enforcement activities undertaken by Canadian regulators.
With ample demand from the industry for more protection and oversight, regulators are continuously faced with the difficult task in balancing the need of promoting innovation with protecting investors against the multitude of risks that the crypto industry poses. In response to recent events, the Canadian Securities Administrators have stated that to strengthen their approach to oversight, it will be expanding existing requirements for platforms that currently operate in Canada.11 While commenting on the FTX meltdown, Grant Vingoe, chief executive of the OSC articulated the industry needs regulation "on a collaborative basis, globally." 12 As we move towards the future, other jurisdictions may look towards Canada's regime as we work towards the essential goal of global collaboration on this front.
Footnotes
1 https://www.pymnts.com/cryptocurrency/2022/more-than-130-ftx-group-companies-file-bankruptcy/
2 https://help.ftx.com/hc/en-us/articles/360055304412-Supported-Assets-
3 https://www.prnewswire.com/news-releases/ftx-trading-ltd-closes-400m-series-c-round-301471084.html
4 https://www.coindesk.com/business/2022/11/02/divisions-in-sam-bankman-frieds-crypto-empire-blur-on-his-trading-titan-alamedas-balance-sheet/
5 https://www.wsj.com/articles/ftx-tapped-into-customer-accounts-to-fund-risky-bets-setting-up-its-downfall-11668093732?mod=e2tw
7 https://archive.ph/k1sML Gara, Antoine; Shubber, Kadhim; Oliver, Joshua (12 November 2022). "FTX held less than $1bn in liquid assets against $9bn in liabilities". Archived from the original on 12 November 2022. Retrieved 12 November 2022.
8 https://www.pymnts.com/cryptocurrency/2022/more-than-130-ftx-group-companies-file-bankruptcy/
10 https://finance.yahoo.com/news/wonderfi-confirms-no-material-exposure-161600183.html
11 https://www.osc.ca/en/news-events/news/csa-provides-update-crypto-trading-platforms-operating-canada
12 https://financialpost.com/fp-finance/cryptocurrency/crypto-casualty-coordinated-international-oversight-canadian-regulators
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