If the Commodity Futures Trading Commission had the authority to regulate crypto spot markets, it would have been able to prevent FTX’s failure, the agency's chairman testified Thursday before the Senate Agriculture Committee.
“We need the authority to get into a CFTC registered exchange…if we have that authority, and they were registered, given what we know from the facts about conflicts of interest, commingling funds, books and records, we would have been able to prohibit it,” CFTC Chair Rostin Behnam said in the first of several congressional hearings to examine FTX’s failures.
He continued, “We don’t have authority to register cash market exchanges or any intermediary broker dealer within that structure and that’s what concerns me — this is the gap that exists.”
Behnam, which called FTX’s failure a classic run based on a liquidity crunch, noted significant conflicts of interest within the crypto company such as commingling customer assets with house assets, using custody to protect customer property, and lacking proper recording keeping, corporate governance and risk controls. He also said ensuring that an individual entity cannot wear multiple hats offering different services to the same customer was also necessary.
At the beginning of this year, offshore exchange FTX and its U.S subsidiary carried a combined value of $40 billion. They and 101 affiliate firms filed jointly for Chapter 11 bankruptcy in the second week of November.
More than half of total customer assets were spent by affiliate hedge fund Alameda Research to shore up illiquid trades, leaving the debtor estate without an estimated $8 billion of assets it owes FTX customers.
In a hearing that was non-confrontational and focused on next steps, the CFTC chairman emphasized the need for speed, while some members of Congress still conveyed concern over progressing legislation in haste.
“I strongly believe that we need to move quickly on a thoughtful, regulatory approach to establish guardrails in these fast-growing markets of evolving risk, or they will remain an unsafe venture for customers and could present a growing risk to the broader financial system,” Behnam said. “If we don’t do something customers are going to continue to lose money and we’re gonna be right back here again in a couple months.”
As an example of the CFTC's authority and limitation in regulating crypto, Behnam pointed to LedgerX, a derivatives exchange and clearinghouse purchased by FTX and registered with the CFTC in 2017.
Pointing to LedgerX's solvency, he suggested an exchange registered with the CFTC would not have succumbed to the same failure like parent company FTX.
"LedgerX is one of the few FTX entities to not file for bankruptcy," Behnam said in his testimony, adding the CFTC is in communication on a daily basis with LedgerX and its custodian to ensure customer money is safe and that the exchange is well capitalized with no conflicts of interest.
The Digital Commodities Consumer Protection Act (DCCPA)
Behnam said a bill introduced by Senate Agriculture Committee Chairwoman Debbie Stabenow (D-MI) along with ranking member John Boozman (R-AK) that would offer the CFTC authority to regulate spot crypto assets that are not securities — including two of the most heavily traded cryptocurrencies, Bitcoin and Ether — would have prevented FTX’s failure.
There currently is no federal market regulation of crypto spot markets. The CFTC chair said the bill addresses the major issues involved with FTX from comingling of assets to lack of risk controls and corporate governance and would have prevented those activities from happening at FTX.
Though he acknowledged the need to "take a fresh look" at the bill under the circumstances, Behnam reiterated the need for Congress to act.
"Strengthening the bill and filling the gaps is one thing. We need to move forward as soon as possible. We don't want this to happen again in the next few months and have the risk of customers losing money because of these gaps," he said in response to the question of moving too quickly.
CFTC Chair met with FTX’s Bankman-Fried 10 times in 14 months
Before the collapse of FTX, the CFTC was reviewing a proposal by FTX, to introduce a new model that combined clearing and settlement of futures contracts under one business.
Behnam told the Senate Agriculture Committee that he personally met with FTX founder Sam Bankman-Fried 10 times over the course of the past 14 months—all regarding the crypto exchanges new clearing-house proposal.
He said nine of the 10 meetings were in Washington, D.C., with one at a conference in Florida. There were also two phone calls and a number of messages answering questions pertaining to the application.
Though Behnam had previously expressed an openness to reviewing the proposal, calling it a “unique” idea, he stressed that no decision was ever made on the application and that by law the CFTC needed to address and respond to the application and could not disregard it or sideline it.
David Hollerith is a senior reporter at Yahoo Finance covering the cryptocurrency and stock markets. Follow him on Twitter at @DsHollers