The case of the collapse of FTX, unsurprisingly, shook the crypto world, ranging from operators to users, generating an understandable wave of fear and distrust. The resulting FUD, as was to be expected, clearly affected the cryptocurrency market by dragging values down.
Many people have written about this affair, from the most emblazoned newspapers to a number of improvised commentators, who are always very present on the web, even spreading information that is not technically correct.
It is appropriate to set the record straight, both because the case itself has several controversial aspects, and because at stake are also the life savings of people who have blamelessly trusted a platform that presented itself as one of the most important and reliable on the market.
FTX case: exchange initiates Chapter 11 proceedings
The first issue concerns the so-called Chapter 11 procedure, voluntarily initiated by the group in the United States (more precisely in the Federal Court of Delaware), which some news outlets have improperly described as a bankruptcy. In reality, Chapter 11 proceedings under Title 11 of the US Code can be likened to receivership proceedings.
Indeed, the bankruptcy procedure in the strict sense is the one governed by Chapter 7 of the same Title 11.
Thus, it is not a total liquidation of assets and activities, aimed at redistributing the proceeds to creditors, according to their degree of priority, but a process of corporate reorganization that is managed by a specially appointed commissioner.
Without going too much into the technical aspects, the purpose of this specific procedure is to attempt to get the company back on track through the elimination of unnecessarily burdensome relationships, the liquidation of assets that may be non-strategic, and ultimately, to recover resources where possible, and so on, all in order to put the company back in a position to operate effectively in the market. The first step in this procedure is to freeze assets, accounts and relationships until an assessment of the overall situation has been completed.
Whether or not the operation can succeed obviously depends on the size of the available assets, the mass of accumulated debts, and a host of other asset and production factors that must be the subject of rigorous reconstruction.
In the case of FTX, it is important to keep in mind that we are talking about a galaxy of more than 130 entities scattered around the globe, of which little is known concerning group and control relationships and according to an organizational chart that is far from easy to reconstruct accurately.
Herein lies an aspect that merits reflection: namely, that Chapter 11 proceedings have been initiated not only with reference to Alameda Research LLC (a US-registered company that constitutes the parent company of the entire group), but also for many of the non-US-registered entities.
The complex network of FTX
It is enough to mention that the company that owns the trading platform aimed at international customers outside the United States, FTX Digital Markets, is a Bahamian-registered company, headquartered in Nassau, and that for that company, as for every single other company in the group, a specific autonomous Chapter 11 application was filed, again with the Delaware Court.
An autonomous similar application, for example, was also filed with the same US court for the company under Cyprus law FTX EU Ltd, which was originally issued a license by European state authorities that allowed the group to operate within the European Union. A license that, according to the Cypriot SEC website, is currently suspended.
Now, the complex structure of the group (as mentioned, more than 130 companies involved!) and a situation of blatant uncertainty about the extent of the liabilities (there is talk of a liability that would fluctuate in a very wide range, between 10 and 50 billion) suggest that, even in the most optimistic of perspectives, the procedure will take a very long time before it is possible to understand whether a light at the end of the tunnel can be glimpsed or whether, as seems more likely, we will have to move to a Chapter 7 procedure, i.e., full-blown bankruptcy.
However, the interplay between the proceedings initiated in Delaware and the jurisdictions in which non-US entities fall is crucial. This is because, at least on paper, the admission to Chapter 11, and the consequent adoption of any freezing of funds, assets or otherwise, by the receivership, on foreign companies (such as, for example, the Cypriot one), could not be legitimately opposed to users (creditors) who are not subject to US jurisdiction.
Indeed, the latter could not be denied the right to make legitimate demands with respect to claims against any of the individual group companies, which themselves are also not subject to US jurisdiction, by turning to the courts that are naturally competent to hear those relations.
And in fact, it was just a couple of days ago that the bodies appointed by the Securities Commission of Bahamas to the bankruptcy proceedings for the liquidation of FTX Digital Markets (which is one of the group’s main entities and which, as mentioned, is a Bahamian company under Bahamian law, based in Nassau) disavowed the validity of the Chapter 11 proceedings initiated in Delaware and initiated an action in the US Bankruptcy Court in New York for the purpose of obtaining data and documentation and blocking any transfer of the company’s assets and funds.
A puzzle that is difficult to piece together, that’s for sure. And there is no doubt that the incident offers arguments to the detractors of the crypto world.
Centralization takes over the nature of crypto and blockchain technology
However, there is one crucially important aspect that should not be missed. Namely that a case like FTX is a direct result of the process of propelled centralization brought about by the dizzying growth of the major exchange platforms.
What does this mean? That the moment users entrust their resources (be they in fiat currency or cryptocurrency) to a third party to manage them on their behalf, no matter if they then trade cryptocurrencies and allocate them on a wallet (of which they will hold and access keys), this party will still remain an intermediary, in exactly the same way as a banking or financial intermediary.
The consequence is that the moment I rely on such an intermediary, the paradigm of trust completely changes. Indeed, it is no longer centered on the blockchain network and its technological features, but it is centered on the trust that one decides to give to that intermediary.
That principle that “the code is the law” no longer works. The rule here is that of a negotiating nature that is dictated by the relationship between users and the platform.
To clarify further, if I make an on-chain, peer-to-peer transaction (such as transferring cryptocurrencies from one wallet to someone else’s wallet) I attribute trust to a distributed ledger, on the assumption that it is able to verify the capacity of my wallet and validate the transaction, with a degree of certainty (even in terms of date and time), etc.
In contrast, if I make a transaction through an intermediary (such as an exchange might be), I trust that that intermediary, having received my funds (crypto or fiat), will execute the orders given and not make inappropriate use of them. And that is, I trust that he will be able to store them safely, that he will not use them for absurdly risky investments and thus lose them, or worse buy himself a mansion in the Bahamas, fill the garage with Lamborghinis or have sex, drugs and rock ‘n roll parties there.
Which is exactly the same kind of trust I give to a bank: I trust that my money is kept in a vault with armed security, that risky investments meet clear criteria and are reasonably safe. This, at least, in an ideal world.
The difference is that in the latter case if nothing else, there are clear rules (subject to the ability to circumvent or violate them) that require banking intermediaries to meet professional and capital requirements that can guarantee customers, and a host of rules of conduct that, at least on paper, should protect the saver who relies on a bank. And when we read the word “bank” in the name, again on paper, we should be led to trust that behind that word there are professionalism, funds and assets to guarantee any risk, and that there are supervisory bodies ready to intervene (supposedly) in case of problems.
More stringent regulation or a rush to decentralization?
This is something that does not exist today (or at least, not yet) for exchange platforms, which, as we all know, in order to operate are not required to meet any particular capitalization or professionalism requirements, are not constrained as to how they deploy and invest their funds, nor are they subject to certain risk parameters, and are not subject to specific forms of supervision by public authorities unless they are managing what in essence can be characterized as financial asset (or securities) transactions.
Thus, in conclusion, when cases such as FTX or, going back in time, Mt. Gox, or Quadriga CX occur, i.e., cases of de facto centralized exchanges that “blow up,” whatever the reason, dragging users’ virtual assets with them, the central issue is not that crypto assets are more or less inherently risky and volatile.
The crucial point is that the trust that is placed in entities that come to raise billions in savers’ and investors’ assets on the market has a purely reputational premise, but is not assisted by concrete forms of protection, either regulatory or financial.
With respect to case histories of this kind, the problem that needs to be addressed and solved, therefore, is not that of regulation or the introduction of regulatory limitations in the use and creation of cryptographic assets or the digital structures that can be used in activities that may be of financial significance.
The problem that needs to be solved at the regulatory level is that of the trustworthiness of entities that go to the market to solicit an audience of savers or non-professional investors to entrust them with resources, even if they consist of cryptographic assets, and that these entities that go to the market be bound by clear and strict rules of conduct, because the social impact that is generated when nine-figure sums are put on the line can be destructive and this cannot be ignored.
The crux, therefore, is not in the decentralization or the deregulated and hardly regulatable (if not at the risk of unjustified compression of individual freedoms) nature of cryptocurrencies and distributed ledger technologies. The real crux is those entities that, not only centralize, but, given the stratospheric amounts they manage, centralize the management of masses of interests and resources that belong to vast amounts of individuals.
In conclusion, lawmakers, regulators, and central bankers, rather than tearing their hair out and sounding alarms about the volatility of cryptocurrencies and the dangers of blockchain would do better to turn the spotlight on the potential risk factor posed by these kinds of actors who now concentrate enormous economic power in their hands.
And history teaches us that when vast power is concentrated unchecked in the hands of a few, it almost never ends well.