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Last week, the crypto industry was rocked by the news that Sam Bankman-Fried – the former CEO of the failed FTX exchange – was arrested in the Bahamas, where he is awaiting extradition to the United States.
The news broke on December 12, when the US Department of Justice (DoJ) announced that it had charged Bankman-Fried with money laundering, fraud and other crimes.
The next day, the DoJ released an indictment detailing the charges and allegations against Bankman-Fried, in what one senior DoJ official called “one of the largest financial frauds in history.” Among the charges against Bankman-Fried, the department alleges that he used funds from FTX clients to make political campaign donations, which he misreported under campaign finance laws.
The Justice Department’s accusations are complemented by actions by two federal regulators: the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). The SEC’s complaint alleges that Bankman-Fried engaged in fraud by continuously misleading clients and investors of FTX about the company’s financial status, and by misappropriating client funds from operations.
The SEC also alleges that Bankman-Fried instructed FTX employees to create code that allowed Alameda to maintain a persistent — and ever-increasing — negative balance in violation of company policy. Thus, as Alameda’s financial position deteriorated, her negative account balance became a colossal hole that Bankman-Fried rushed to fill with client money.
The CFTC, for its part, charged Bankman-Fried, FTX and Alameda with fraud and misrepresentation in the sale of cryptoassets. The CFTC alleges that despite claims that FTX is a well-run, compliant and conservative company, “Alameda and FTX commingled funds and freely used FTX’s client funds as their own, including as capital for use in their own trading and investment activities.”
Upon information and belief, Bankman-Fried, his parents and other FTX and Alameda employees used FTX client funds for various personal expenses, including the purchase of luxury real estate, private jets, documented and undocumented personal loans, and personal political donations.”
Bankman-Fried’s bail application was rejected by a court in the Bahamas, where he will remain in custody pending extradition to the US.
The actions could be just the tip of the iceberg in terms of criminal charges in the US and elsewhere against Bankman-Fried and FTX. The Department of Justice also filed a motion to seize Bankman-Fried’s assets as part of the criminal case against him.
One question that remains unresolved is who was behind a series of transactions in which more than $470 million was siphoned from FTX just days after its collapse. These are the funds that our team at Elliptic tracked across the blockchain as they were transferred through services such as decentralized exchanges and cross-bridges, common money laundering typologies we identified in our Multi-Chain Crime Report.
US lawmakers unveiled proposed crypto AML reforms
Bipartisan legislation has been introduced in the US Congress that would expand the scope of anti-money laundering and countering the financing of terrorism (AML/CFT) measures to cover a wide range of cryptocurrency-related activities – with potentially severe consequences.
On December 14, US Senators Elizabeth Warren and Roger Marshall released a draft of the Digital Assets Anti-Money Laundering Act of 2022. The legislation would require the US Treasury Department’s Financial Crimes Enforcement Network (FinCEN) to expand AML/CFT requirements to parties in the crypto space such as miners and non-custodial wallet providers, which FinCEN stated in previous guidance are excluded from its regulatory oversight.
The legislation would also require FinCEN to finalize previous proposed rules on non-hosted wallets that have been on hiatus after a period of industry opposition. Additionally, it would require FinCEN to prohibit financial institutions from enabling transactions involving mixers, privacy coins, or other technologies that enhance anonymity.
The bill faces a long road to becoming law; it would need to pass committee review and approval before it even comes before the full House and Senate for a vote. But it has already drawn criticism from the industry. CoinCenter – an industry policy advocacy group – called the bill “unconstitutional” threatening to extend AML/CFT provisions to non-custodial and non-financial services businesses.
FSB to prioritize crypto regulatory framework in 2023
Global financial watchdogs intend to pressure countries to implement crypto regulatory measures designed to prevent the next FTX. On December 13, Financial Times reported that the Financial Stability Board (FSB) – the multilateral body tasked with identifying new financial risks and articulating standards to address them – intends to use the first part of 2023 to accelerate work based on the consultation it held on cryptocurrency this year.
FSB Secretary General Dietrich Domaski indicated that the organization will articulate a timeline for regulators globally to implement its recommendations on preventing crypto market volatility from affecting the broader financial sector. The FSB’s warning comes after the G20 indicated that India’s presidency is focused on establishing a clear set of policy principles for countries to follow in regulating crypto markets.
Australia plans comprehensive crypto regulations
Amid growing calls for stronger regulation of cryptocurrencies globally, the Australian government has indicated it plans to update the country’s digital asset framework in 2023 in an effort to modernize its approach to financial services.
In a statement on December 14, the Australian Treasury pledged that the government of Prime Minister Anthony Albanese – who took office earlier this year – “is taking action to improve the regulation of crypto service providers and ensure additional safeguards for Australians.
Although the Ministry of Finance did not specify exact timelines, the government plans to complete a token mapping exercise next year to determine how to treat different cryptoassets under Australian law, and then set out cryptocurrency custody plans and a licensing framework.
Thai regulators plan to strengthen consumer protection
Thai regulators have indicated their intention to strengthen crypto rules in response to recent market turmoil. According to the report from Bangkok PostThailand’s Securities and Exchange Commission (SEC) plans to develop regulations aimed at making scenarios like FTX and Terra/UST less likely to fail.
This will include rules on preventing conflicts of interest in crypto firms, protecting client assets, strengthening cybersecurity controls, and improving consumer protection measures related to advertisements of crypto products and services.
The SEC has not yet offered an implementation timeline, but the proposed measures broadly reflect the direction of other regulators globally and resemble certain provisions in the European Union’s Markets in Crypto-Asset (MiCA) Regulation, which Elliptic noted in our regulatory review Report 2023 will serve as an important model for regulators looking to respond to the FTX saga globally.
France will consider eliminating the optional licensing framework in light of market developments
France is reportedly considering tightening restrictions on crypto companies to prevent them from taking advantage of existing provisions that make registration with regulators optional.
Under the country’s current cryptoasset legal framework, crypto exchanges and custodians must register with the Autorite Marches de Financiers (AMF) to provide services in the country – however, other cryptoasset service providers do not need to register with the AMF and can choose to will register on a voluntary basis. Under French law, this opt-in regime will last until 2026, which is roughly two years after MiCA is expected to come into effect.
This regulatory framework has encouraged some in the industry to see France as a hub for cryptocurrencies, but the unfolding FTX scandal appears to have prompted French lawmakers to reconsider the approach. The French Senate has proposed measures that would make registration for all crypto-asset service providers in France mandatory from October 2023 if adopted by the French legislature.
NYDFS chief appointed to key watchdog as regulatory focus turns to banks’ exposure to cryptocurrencies
Moving back to the US, a major federal watchdog brought in the New York state regulator in a move that could signal a more aggressive regulatory stance towards cryptocurrencies is looming in the US.
On December 13, it was announced that Adrienne Harris – the superintendent of the New York Department of Financial Services (NYDFS) – will serve as the representative of state regulators on the Financial Stability Oversight Council (FSOC), effective January 1.
The FSOC is an oversight body established after the global financial crisis that aims to “monitor the safety and stability of the nation’s financial system, identify risks to the system, and coordinate responses to any threat.”
The FSOC board is made up of federal financial supervisors including the U.S. Treasury Department, the Federal Reserve, the Office of the Comptroller of the Currency and the SEC, among others, while Harris will offer the group the perspective of state banking regulators.
The NYDFS is known in the crypto industry for administering the BitLicense regulatory framework, which requires crypto companies serving New York State to obtain approval from the NYDFS and adhere to strict AML and other measures. Harris’ appointment to the watchdog could therefore signal a growing focus among regulators across the country on the risks associated with cryptocurrencies.
In a November 2021 report on stablecoins, senior US regulators suggested that the FSOC might consider designating stablecoins (and potentially other crypto services) as “systemically important financial market utilities” – a designation that would allow regulators to step up coordinated supervision of those markets.
Although the FSOC has not yet taken that step, in November 2022 it issued a report outlining the risks present in crypto markets, noting the following: “The volume of crypto-asset activity has increased significantly in recent years.
Although interconnections with the traditional financial system are currently relatively limited, they could potentially increase rapidly.” Some observers have speculated that the likelihood of FSCO intervening in crypto markets could increase if the US Congress does not pass a legislative framework to issue stablecoins.
Supervisor Harris’ appointment to the FSOC comes amid increasing regulatory scrutiny of banks’ exposure to cryptocurrencies. On Dec. 16, the NYDFS issued guidance to banks in New York, reminding them to seek prior approval for any cryptocurrency-related activities they plan to conduct, and articulating governance, risk management, consumer protection and other principles banks must address before offering crypto products or services.
On the same day, the Basel Committee on Banking Supervision agreed standards on the prudential treatment of banks’ exposure to cryptocurrencies – indicating that banks should ensure that their exposure to crypto-assets other than stablecoins should not exceed 2% of their Tier 1 capital.
This emphasis on ensuring that banks manage their cryptocurrency exposure is not surprising. On the Elliptical, we predicted in ours “2023 Regulatory Outlook Report” that this will be a major area of regulatory focus next year.
Regulation on compliance with the law
