Cockroaches of crypto flee the contagion — but where?
New Zealand can turn currency crisis into an opportunity, writes Warren Couillault
The collapse of the FTX cryptocurrency exchange has left the financial markets reeling. It’s a massive fall from grace from what was once the darling of the crypto world.
It has left crypto investors nervously looking around, wondering who’s next and how much the contagion will spread.
We call it the “cockroach theory” in financial markets. If you see one cockroach there must be hundreds, if not thousands, elsewhere . . .
Some commentators are even calling this the end of crypto, claiming the industry will never be able to regain the standing and the trust that the FTX collapse has lost.
Founded in 2019, FTX grew rapidly to become the second-largest crypto exchange in the world, transacting over US$2 billion ($3.19b) a day in crypto assets.
Its annual revenue leapt to more than US$1B in 2021, almost 20 times more than it had been the previous year. That’s warning No 1, by the way: Revenue seemingly appearing from nowhere.
At one stage, the company’s shares were valued at more than US$32B and it had recently taken in investment from major professional and institutional investors, such as the Ontario Teachers’ pension fund, Singaporean Sovereign Wealth Fund, Temasek, and leading high-profile United States venture capital firms Tiger Global and Sequoia Capital.
Over the past year, the FTX founder and previous chief executive Sam Bankman-fried (SBF, as he’s referred to on Twitter) had been on a charm offensive around the world.
He spent time in Washington advocating for increased crypto regulation and getting friendly with government figures, lawmakers and lobbyists. He was the largest donor to Democratic campaigns in the recent US midterm elections.
Earlier in the year, he was referred to as the modern-day equivalent of J. Piermont Morgan, a saviour of the US banking system in the early 1900s, after he and FTX bailed out a number of crypto-related firms.
A black box
On November 11, 2022, FTX filed for bankruptcy in the US, owing creditors a staggering but probably tip-of-theiceberg US$3.1B.
It appears unlikely at this stage that people who had deposited funds in the firm (to trade currency) will get any of their money back, because it looks to have been used for other purposes.
Rather than being the next generation of firm to drive forward the new economy, it appears that FTX was instead a black box with no systems or controls in place.
Client funds were used to fund an affiliated hedge fund, doing heavens knows what, as well as being misappropriated to issue loans, sometimes undocumented, worth hundreds of millions of dollars to staff and associates of the firm. Warning No 2, by the way.
The administrator John Ray (who also oversaw the administration of Enron) has made his thoughts on the systems and processes very clear.
“Never in my career have I seen such a complete failure of corporate controls and complete absence of trustworthy financial information,” he said. It’s now clear that FTX was simply being used as Bankmanfried’s own personal fiefdom.
This situation never would have been allowed to happen in a properly regulated environment.
The core tenets of a robust financial regulatory system include prohibiting, limiting and monitoring related-party transactions, requiring appropriate systems to be in place and ensuring separation of business and client assets.
If these rules had been in place, they may have stopped the spectacular fall of FTX.
Here in New Zealand, these rules apply to my private wealth advisory business, Kiwisaver business and the wider financial services sector — it’s not rocket science.
Those who argue that FTX was regulated anyway need to recognise that the Bahamas was chosen as the domicile and jurisdiction simply because it was an easy regulatory world with comparatively limited oversight.
End of crypto?
Many commentators are talking about this being the end of crypto and that all trust has been broken: If FTX can fail, then anyone can fail.
In my view, the only thing that will reinstate and normalise the crypto industry will be regulation. As a securities and financial services industry, we need to do a much better job at protecting everyday investors who cannot afford to suffer the losses we’ve seen over the past six months.
The industry needs to remember that with strong and effective regulation comes trust, which is what the industry is sorely lacking at the moment.
Former Prime Minister Sir John Key talked often about making NZ a financial and technology hub — at times referred to as the Switzerland of the South Pacific — and maybe this is our opportunity.
Countries like Singapore and, previously, Hong Kong have done a great job of attracting financial services and financial technology companies to their countries because of their innovative regulatory stances.
Being innovative doesn’t necessarily mean being cavalier, loose or relaxed: It means recognising new trends and technologies and working with industry to create effective regulations to suit those new technologies, protecting investors but not stifling innovation.
At present, crypto regulation is not clear-cut in New Zealand. That should change because we need to designate cryptocurrencies as financial assets and create legislation that ensures investors’ funds are always kept safe.
The NZ approach to financial regulation has traditionally been somewhat reactionary: We put in place regulation after a crisis, when people have already lost money and confidence.
With crypto, the regulators have said clearly that they will continue to watch before deciding the best way to regulate.
The FTX collapse is not a crisis that has broadly and directly affected investors in NZ, but we can turn this situation into our opportunity.
How can crypto businesses and financial services regulators here work together to design a set of rules and policies that protect investors?
Regulation doesn’t need to look and feel like existing securities legislation — it can even use innovative and new technologies like the blockchain, but we need to accept that it’s necessary.
The country that can quickly develop a workable set of regulations will be where the jobs, investment and money flow will be when the current crypto winter ends. We’ll be the Switzerland of the South Pacific, but without its winters . . .