Cryptocurrencies: how regulators lost control
FTX has filed for bankruptcy protection in the US after the struggling cryptocurrency exchange failed in a last-ditch effort to secure a rescue package. Earlier this year, leading voices from the cryptocurrency industry, including FTX's Sam Bankman-Fried and Binance CEO 'CZ', told the story of how the cryptocurrency industry ballooned into a market worth more than $2tn with little regulatory oversight. How did regulators lose control and can they get a grip now?
Produced, directed and edited by Daniel Garrahan. Filmed by Petros Gioumpasis, Gregory Bobillot and Donell Newkirk. Graphics by Russell Birkett
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This is a story about money. A lot of money has been bet on cryptocurrencies.
This is a story of maybe one of the most interesting financial innovations in recent years.
I think you can divide rooms. It's sort of a financial market moment.
This industry is the future of finance.
It's a wild west.
It's going to have to start playing by some rules.
That $250,000 was just gone. I couldn't believe it! OK.
Regulators are definitely feeling that there's a pressure to act.
Careless regulation could end up having a lot of collateral damage.
This is an industry that's grown from very, very little a few years ago to being huge, very much front and centre right now. The speed of growth and the way that it's done it with a very, very little regulatory oversight has made it a really fascinating news story.
The cryptocurrency industry really began with Bitcoin in the wake of the financial crisis in 2008. A lot of people, I think, lost trust.
An anonymous person, Satoshi Nakamoto, person or persons - we may never know who was involved in creating this project - came up with a way to re-imagine money.
Over time, there can only be so many bitcoins minted. The idea that there's a limit on bitcoin is really, really important because central banks, obviously to finance these huge interventions they've done really since the financial crisis, have poured trillions and trillions of dollars into the financial system.
Some people say, well we live in this world where there's all this fake money and I want to hold something that I know is limited.
There is a conceptual shift away from oh, I can go to a bank and they'll handle this stuff for me to well actually, I want to be in control.
If you got a £5 note out of your pocket you will see it says on it I promise to pay the bearer on demand the sum of £5. Signed by the Bank of England. The reason that you think it's worth £5 and I think it's worth £5 is that we trust the Bank of England. We trust the UK government.
Imagine a world where that establishment doesn't exist and you're not relying on these guys to tell you that £5 is worth £5.
The whole idea of crypto is a distributed ledger, so everything is decentralised. The transaction processing itself is done by individuals. They record these transactions on this digital ledger, this digital record.
It's a system of trust that's fragmented across the blockchain, fragmented across technology. If I can prove that I've had computers solve a puzzle to unlock this code, that chunk of code is worth whatever the next person is prepared to pay for it.
It was almost a thought project when it came to light in 2008 and the first coin started circulating in 2009. Now, it's a $2tn industry.
You could compare it to some of the newer products that have revolutionised finance in recent years. Credit derivatives, the credit default swaps that were part of the financial crisis, but those had a purpose. Everybody knew the use of them. They could see the utility. This is an asset in search of a use.
Do people want to believe in banks, and regulators, and central banks after all this disillusionment with the system or do people want to try something new?
I love the idea of decentralisation. I love the distributed nature of decision making. It was like when I first saw the internet. The first time I got into Netscape, a browser on the internet, I thought I'd died and gone to heaven. I just fell in love with the whole concept of distributed system, this internet that was going to change our world.
There is a school of thought amongst some of the crypto diehards that the cryptocurrency market will effectively replace other currencies as we know them. If that is true there has to be a certain level of governance. There has to be a certain level of supervision.
The big concern among regulators is just the lack of consumer protection.
That there in a tight spot. There is a huge segment of the financial world that's outside of their sphere and they have very few levers.
They're going to have to carve out new regulations and really think about what they want to do and what kind of consumer protections to put in place.
Most of the markets in which serious money is invested these days, there are rules of the road. There are investor protections.
A bank account in many countries up to a certain amount is insured by the government. Banks have to go through stress tests.
Send money to the wrong account, you can probably get that money back. Or if someone scams you, you can go to the financial compensation scheme.
When you hold crypto, typically it's not protected in any way.
There's no one to turn to.
If your money is gone, it is gone and you cannot get it back.
A lot of it is traded on leverage. There's a massive risk there.
Bitcoin can move 10 per cent, 15 per cent, 20 per cent in a day quite easily. Some of the smaller coins could lose all of their value. They can evaporate. These crypto wallets, you basically have a public key and a private key. And the private key unlocks your crypto account. Well if a hacker steals that, they can make away with a lot of money.
The initial problem is definitional. What is cryptocurrency? I got to pay taxes to the United States government. I can't pay it in bitcoin. I can't pay it in other crypto, so I want to get paid in dollars. Most people are starting to describe it as a highly speculative asset.
And they exist in traditional finance too, by the way. I mean, people trade penny stocks. They trade debt in bankrupt companies.
If you think of a normal currency like sterling or the dollar, you have a central bank. You can name the people at the central bank who are the most influential there. With crypto, it doesn't work like that at all. You have a bunch of people who are very influential in terms of moving the price of bitcoins.
Things that have led to this day. One of the cars...
People like Elon Musk. People like CZ, chief executive of Binance.
Binance is a cryptocurrency exchange. We are, by far, the world's largest exchange.
It includes organisations like Coinbase, which is a listed exchange in the states.
From the very beginning we've engaged with regulators in a constructive way looking to support the right kind of regulation to help the crypto ecosystem grow.
Everybody's involved, but nobody's in charge. And that's one of the things that spooks regulators the most.
It's quite hard to track what's happening in crypto land because it's not controlled by sort of your traditional financial system. That's made it potentially easier for there to be money laundering that happens, the financing of terrorism.
No crypto transactions should be outside the field of enforcement when it comes to money laundering and terrorism. That's very important.
They are also quite concerned about the potential for fraud.
Investors be the individuals or financial institutions, they have to be aware of the risk they are taking.
And there's all sorts of scam coins.
There's a lot of pump and dump coins. There's plenty which get promoted on YouTube. You know, YouTubers are paid to promote these coins and then they get pushed up. Then the founders sell out. Make a lot of money, and then the viewers who have been buying these coins it goes to 0 and they've lost their money.
Anyone can make a random coin and sell it on the internet, but that shouldn't be the easiest to do, in my opinion. They need to maybe submit stuff to the FCC, like a company would if they were going to file on the stock market.
They're also trading derivatives of bitcoin. So there's ways to magnify your potential gains and losses massively by doing things like bitcoin futures or bitcoin options. This looks a lot like things you can do in the financial markets, yet with no checks and balances. If you're a regulator, that kind of thing probably keeps you up at night.
I started mucking around with leverage trading and there's a million people on YouTube bringing lambs to the slaughter. Retail investors believe the dream that there's easy money out there. They're supremely manipulated and have always been in this market. The main platform I started using was Binance, which is when all the problems started to happen.
The price, just like any other asset, goes up a lot when a lot of people have demand for it. And it can tumble really, really quickly when people get freaked out for some reason. That happened a few months ago when China announced a crackdown on Bitcoin. The price just completely crashed out of nowhere.
The Binance system was glitchy. Things weren't working. Now, I looked at what was going on. I thought there's something wrong here. I'm going to assume that there's technical issues that will be fixed because I've been naive. You just think that well, there's technical issues.
Surely if there's a technical issue the company will compensate if their platform doesn't work in times of trouble. You don't question that. The market was volatile, but I had no warning that there was anything wrong with my account.
Text messages or changes in my dashboard that says you're at risk. They liquidated my complete account. I was at $250,000 US was just gone. I had no warning that there was anything wrong with my account. I couldn't believe it.
I think I just went into this post-traumatic stress disorder. I didn't know what to do. Who do I complain to? There's no representation for retail.
There's many unreasonable users with unreasonable demands. There are even scammers that make a living just by scheming people. We can't just give in all the time, so we let the legal system decide that. There are situations where an exchange outage do cause negative financial impact to people. And when we can identify that clearly we decompensate for that.
I didn't know that they were not responsible. In their mind they're not responsible for the failure of their tech platform.
The regulators were very late to this game. Suddenly, you have $2tn that they have no oversight over.
In the US there's several financial regulators. It's sort of designed like that on purpose. It's like a checks and balances system.
The difficulty of this system and one of the flaws of the system is new products. Roll back to the financial crisis, we had something called credit default swaps. What happened when nobody regulated it? It went crazy.
Innovation pops up somewhere in the market and the regulators don't want to stifle it. And at some point it does become systemic and regulation has to be fleshed out. It's now right about time for regulators to get their act together and agree on how they want to regulate.
By the time regulators started seriously entering some pieces of the industry there's already a lot of infrastructure built out. And it had already gotten way further than they were hoping.
You've got the SEC who regulate securities. You got the CFTC who regulate futures.
A lot of crypto has been deemed a commodity. As a commodity it would come under the auspices of the Commodities Futures Trading Commission in America which, to make things more complicated, doesn't regulate commodities. It regulates the futures trading.
The CFTC, not put words into their mouth but if I were them I would feel surprised that there have been so little engagement with them given the importance of derivatives to the crypto industry.
Then, there's a question of securities. The Securities and Exchange Commission regulates securities. Now what we've been seeing is that Gary Gensler, the chair of the SEC has been making the case that the SEC has jurisdiction in cryptocurrencies.
I think it's a dogfight. The regulators want to increase their patch. And whilst that process happens billions, trillions of dollars worth of cryptocurrencies will be traded every day.
Question is what regulators are actually trying to do. I'm not sure they know. Consumer protection is one thing. Beyond putting a big flashing sign on it saying you can lose all your money what can they do?
Some operators, they crop up in one jurisdiction one day and they disappear the next. They label products one way one day and then they remove that label the next. They move around. It's very unclear where they're based.
For regulators trying to pin them down and say you know, stop doing this thing in this jurisdiction, it is very much like a game of whack-a-mole. They pop up and they disappear. In the UK the FCA decided to really try and get its arms around Binance.
You can't sell crypto derivatives, things like futures, to retail traders. And so if you were operating here, if your business was actually based here, the FCA could just say cut it out.
The FCA said these products are incredibly risky. Users should exercise extreme caution when they're dealing with Binance. You had very similar warnings from Cayman Islands, from Italy, from Japan, from Singapore, from Malaysia.
So it's set off quite a chain reaction of different regulators.
The exchange is still available to residents of those jurisdictions because they operate as an offshore exchange.
We hear a lot about Binance because of its size. It claims to be one of, if not, the biggest crypto exchange in the world. When you throw around claims like that you get a certain amount of scrutiny and this is what's happened here.
The FCA was forced effectively to say that Binance cannot be properly supervised in the UK because of the way that it offers a lot of its services through web channels that are not in the UK. The FCA did manage to get Binance to post some warnings on its website, on its UK website, but users can still go and avail themselves of its services.
In traditional finance circles people live in dread of getting in trouble with regulators. Doesn't work like that amongst some of the crypto exchanges.
I don't think anyone's dared to do this before, to sort of say we're not responsible for what we do in your country. We're not going to be answering your questions because we're based in the cloud.
The industry regulators have gotten off on the wrong foot in some places where regulators feel like industry is already massively overstepped and is doing things that regulators are not happy with. And they just jump straight to enforcement and a focus on enforcement instead of licencing and regulation.
We are the largest exchange by most measures in the world. And guess what? When regulators want to look at this space, they look at us first.
If you look at crypto businesses there are various different moving parts. You have the e money side of things, bringing fiat currency onto the platform and being able to liquidate crypto back into fiat.
If you want to get out of Bitcoin and into Ethereum, or out of Bitcoin into Dogecoin, it's much, much easier to navigate your way around the crypto market if your base currency is not sterling, or euros, or dollars. If it's a stablecoin, Tether, USDC, they track normal currencies like dollars one for one.
They're backed one for one. Some of them find it quite difficult to prove that those dollar assets really exist. If they are speaking absolutely truthfully about the amount of assets that they hold, then they are some of the biggest asset holders on the planet.
With great size comes great responsibility, and comes great regulation.
Because this is an entirely new sector existing rules don't neatly apply. And it's not really a case of saying well the securities rules could just be kind of shoehorned into that area. It doesn't really work that simply.
The right thing to do would have been to try to start differently in the beginning. Have people sort of proactively reaching out to the SEC. Have communications around that and at the same point have the SEC feel comfortable with the environment enough to give guidance on what, roughly speaking, they think is a security, what they think isn't a security and what one would do if something was a security.
And I think that dialogue really hasn't been happening much on either side. Instead, what you get is a jump to some of the cases that we're seeing today. Obviously, Ripple has been the most prominent of those.
Regulating crypto is the same as regulating anything else. You want to prevent the bad players from doing bad things and you want to encourage the good players to do more of the good things.
The chair of the Securities and Exchange Commission said it's a wild west. Such things have existed before and particularly in the United States where we're not as heavily regulated a place as many other countries.
Crypto at the moment can be broken down into parts where they're sort of grown a bit, as you have bitcoin, traditional exchanges, the safe parts. And then you've got that complete wild west part where it's all sorts of nefarious activities happening.
Some of the other exchanges interact differently with regulators than the way we would. Just break it first and then try to fix it kind of mindset.
There are people that are trying to play straight that are registering with regulators. And one of the big messages out of the US recently from the chairman of the SEC has been why don't you ask permission rather than begging for forgiveness.
I'm seeing a lot more traditional compliance folks being hired at these companies. And some of them are starting to act more like normal companies.
Building trust with regulators is a way to help build out the ecosystem. That's what our customers want to see as well.
Our underlying clients are big global banks, so they're highly regulated entities already. It's certainly in my interest and in my clie'nts interest to get some further clarity from the regulators.
The big story in crypto prices has been that there was a massive rally up to around 2017. Late that year is when it really started to fall apart. Regulators thought to themselves OK, that was a fun little distraction while it lasted but I think we've all learned that regulated finance is the way forward.
That was the opportunity for them to take a much more proactive stance and they missed it. And then since then the price has gone way beyond where we were at that point. And the market's just become too big. Had regulators acted in 2018 or earlier I don't think we'd be in the situation we are now.
We mainly get financial reforms in the United States after a disaster. The Glass-Steagall reforms of the 30s followed the Depression, as did the creation of the Securities and Exchange Commission. Dodd-Frank followed the financial crisis of '08.
It's very rare that American legislators get their act together unless there's been some terrible disaster that results in howls of protest.
Many people expect there to be perfect regulations before the industry develops. That's impossible.
The spirit of the regulation is to let people in business figure out new approaches. It doesn't have to be regulated right away.
Crypto space will be harder to regulate, which is always true for any new industry. Uber was kind of hard to regulate for the taxi industry. Just because it's difficult doesn't mean it's impossible.
The tech guys have grown up in a different freer, more libertarian environment. Some of them really don't recognise the need even to respond to the government.
Coinbase is listed in the states. They said we're tech kids. We're not really from the financial establishment. So they said, we do not have the same compliance culture as financial services firms. Even people in this industry acknowledge that they're cut from a completely different cloth.
Big crypto companies are concerned about being regulated away.
If an industry is over-regulated, it does kill innovation which basically kills the industry.
You can achieve oversight without needing to add too many speed bumps. You could end up in a situation where you're legally obligated to introduce a lot of different parties into each transaction. In a way that makes the whole thing worse for users and clunkier.
We want to see regulation build up over time in a way that allows for that innovation to continue. One of the exciting aspects of crypto is its ability to find solutions that haven't been there before to reimagine finance. And it would be a shame if regulation ultimately led to a slowing down of innovation or customers not being able to benefit from the products that we'd like to roll out.
This whole space 100 per cent needs global co-ordination.
It's going to be very hard to apply all your traditional financial regulations to an industry that's decentralised and inherently works quite differently.
There is multilateral action coming. The Bank for International Settlements through its Basel bank regulatory arm has been very forthright about this. New rules are coming for banks that want to get involved.
BCBS has come out with a proposal to divide crypto assets into two groups. One group fulfilling certain conditions would be subject to traditional capital requirements, and that includes some tokenised traditional assets and that would include also some stablecoins.
Group two, not fulfilling the conditions, would be subject to much higher capital requirements and that includes bitcoin.
Crypto is a little bit like the internet of money. Regulating the internet globally is impossible. It's not what happens now.
And I think we're all in retrospect pretty happy that the internet was allowed to grow out and that people were allowed to build on it fairly freely.
Facebook and Twitter. It's still not clear to me if they're actually regulated or not. Global regulators working together, it's not news to say that it's rare and takes a long time.
We're living in a new world. The exchanges here are accessed by people on their phones and computers. The Securities and Exchange Commission is created by a law written in the 30s by people who are all dead and who never saw a computer or smartphone.
What I would really like to see is just a lot more effort on both sides. On the one hand, acknowledgment from the crypto industry that this is a regulated space. It always has been and that's really important to its future.
Financial services are regulated businesses. These are businesses close to the heart of the government. It's not like delivering books, or pizzas, or picking people up for rides. These are industries that are central to the mechanics of our capitalist system. Regulation is part of the game.
You could imagine a world in which the exchanges are regulated much more heavily than the underlying blockchains are.
There's a nub of innovation here that's important. Distributed ledger technology is here to stay, that the blockchain is here to stay. A lot of financial services functions will move on to the blockchain, but whether that means people will buy Dogecoin, or will trade on Sushiswap is another question.
It's impossible to regulate overnight and solve for every issue or problem that might transpire. So I think a step by step approach is what we would advocate for.
It should be flexible. It should be dynamic. It should change as and when it needs to with new technology.
Over time, the different countries have to compete. The regulators have to come up with very innovative and also good regulations that are well balanced that protects consumers, while at the same time encouraging innovation.
A number of countries have recognised the benefits that crypto could bring both in terms of job creation and in terms of driving an innovative area of financial services. And of course the crypto industry has to advocate for what those benefits might look like and make the case.
They're definitely building a lobby in Washington DC. Trade groups that are now operational and the companies are investing massively in PR.
In the short term, there'll be some bumps here. There'll be some setbacks. There'll be some overly restrictive areas. There'll be some other issues, but that's why we're here. We're here to solve those issues and then we can make our civilisation progress forward.
The more that you come in line with regulation and compliance the less you're able to get massive profits from doing it. I think that's going to be a big balancing act in the industry is figuring out how they can continue doing their main business, but with a lot more regulation and compliance because it just becomes less exciting and potentially less lucrative.
There is this libertarian screw the system streak to certain parts of the market. This would really knock the fun out of it for them. But ultimately if they want to be taking in the sorts of money that they're taking in, particularly from unsophisticated retail investors, then this is a game that they're going to have to play.
I love trading. I love the whole premise of being out of work on a beach with my computer. I haven't given up on that dream, but I'm a lot more pragmatic.
If there's a complete lack of regulation, and a framework, and a structure, then you might have people or companies that are actually just afraid to even get involved in the space.
I think any industry of the size and scale and aspirations of the crypto industry needs regulation.
If you're going to be a big crypto company, you're realising that you're going to learn to have to play nice.
A healthy relationship between regulators and industry and crypto, I wouldn't say I'm confident that will happen. I'm cautiously optimistic that the future is going to work out.
Many of these unregulated or wild west markets rev up, attract money, gain accolades. And then something happens that everybody turns around and says boy, we should have taken it easy. We should have been more careful.
Crypto used to be the wild west. We've moved way beyond that. There are many, many serious people in it with very serious money.
If this is going to become a really grown-up market that everybody takes seriously, it's going to have to start playing by some rules.
Eventually, regulators are going to figure it out and they always do catch up eventually.
Cryptocurrencies do need some regulations to survive.