How FTX bought its way to become the “most regulated” crypto exchange

Before this month’s collapse, FTX set itself apart from many of its peers in the largely unregulated crypto industry by boasting of being the “most regulated” exchange in the world and facing closer scrutiny from authorities demanded.

Now, company documents seen by Reuters reveal the strategy and tactics behind founder Sam Bankman-Fried’s regulatory agenda, including the previously undisclosed terms of a deal announced earlier this year with IEX Group, the US equity trading platform featured in Michael Lewis’ book Flash Boys” on fast, computerized trading.

As part of that transaction, Bankman-Fried acquired a 10 percent stake in IEX with an option to buy it outright over the next two and a half years, according to a June 7 document. The partnership gave the 30-year-old executive the opportunity to lobby for crypto regulation at the regulator of IEX, the US Securities and Exchange Commission.

This deal and others referenced in the documents, including business updates, meeting minutes and strategy papers, illustrate one of FTX’s broader goals: to rapidly create a congenial regulatory framework for itself by acquiring stakes in companies that already have regulatory Licenses decreed to shorten the lengthy approval process.

FTX spent around $2 billion on “acquisitions for regulatory purposes,” according to FTX documents seen by Reuters from a Sept. 19 meeting. Last year, for example, she bought LedgerX LLC, a futures exchange, which gave her three licenses from the Commodity Futures Trading Commission in one fell swoop. The licenses gave FTX access to the US commodity derivatives markets as a regulated exchange. Derivatives are securities that derive their value from another asset.

FTX also saw its regulatory status as a way to attract new capital from large investors, the documents show. In documents supporting its request for hundreds of millions of dollars in funds, it highlighted its licenses as a key competitive advantage. The “regulatory moats,” it said, created barriers for competitors and would give it access to lucrative new markets and partnerships unattainable for unregulated companies.

“FTX has the cleanest brand in crypto,” the exchange proclaimed in a June document shared with investors.

Bankman-Fried did not respond to a request for comment on questions about FTX’s regulatory strategy. FTX did not respond to requests for comment.

An SEC spokesman declined to comment on the article. The CFTC also declined to comment.

In a text exchange this week with Vox, Bankman-Fried made an about-face on regulatory issues. Asked if his previous praise for regulations was “just PR,” he said in a text string, “Yeah, just PR…fuck the regulators…they make things worse…they don’t protect customers at all.” ”

An IEX spokesman declined to confirm details of the transaction with FTX, except to say that FTX’s “small minority stake” in IEX cannot be sold to a third party without its approval. “We are currently reviewing our legal options in relation to the previous transaction,” the spokesman said.

PATCHWORK OF REGULATORS

FTX collapsed last week after a failed bid by Bankman-Fried to raise emergency funds. It had come under some regulatory oversight through the dozens of licenses acquired through its many acquisitions. But that hasn’t protected its customers and investors, who are now suffering billions of dollars in losses. As Reuters reported, FTX secretly took risks with client funds, using $10 billion in deposits to prop up a trading firm owned by Bankman-Fried.

Four lawyers said the fact that Bankman-Fried was courting regulators while taking massive risks with client funds without anyone noticing revealed a yawning regulatory gap in the cryptocurrency industry. “It’s a patchwork quilt of global regulators — and even domestically there are huge gaps,” said Aitan Goelman, an attorney at Zuckerman Spaeder and a former prosecutor and director of enforcement at the CFTC. “That’s the fault of a regulatory system that has taken too long to adjust to the advent of crypto.”

A person familiar with the SEC’s deliberations on crypto regulation said the agency believes crypto firms are operating illegally outside of US securities laws, instead relying on other licenses that offer minimal consumer protections. “These accounts, while nominally true, do not cover their activities,” the person said.

“STEP 1: LICENSES”

Bankman-Fried had big ambitions for FTX, which by this year had grown to more than $1 billion in revenue and accounted for about 10% of trading in the global crypto market, from a standing start in 2019. He wanted a financial Develop an app where users could trade stocks and tokens, transfer money and do banking, according to an undated document titled “FTX Roadmap 2022”.

“Step 1” toward that goal, the “roadmap” document states, “is to become as licensed as reasonably possible.”

“Part of that is to make sure we are regulated and compliant; In part, this should be able to expand our product offering,” the document says.

This is where FTX’s takeover frenzy came into play, according to the documents. Instead of applying for each license, which can take years and sometimes uncomfortable questions, Bankman-Fried decided to buy.

But the strategy also had its limits: some of the companies acquired did not have the exact licenses required, as the documents show.

According to the documents, one of FTX’s goals was to open the US derivatives markets to its clients in the country. It was estimated that the market would bring an additional $50 billion in trading volume per day and generate millions of dollars in revenue. To do so, it had to convince the CFTC to change one of the licenses of LedgerX, FTX’s newly acquired futures exchange.

The application process took months, and FTX had to raise $250 million for a default insurance fund, a standard requirement. FTX expected the CFTC to ask them to increase the fund to $1 billion, according to minutes of a meeting of its advisory board in March.

FTX collapsed before it could get approval and has now withdrawn its application.

Buying companies for licenses had other benefits as well, documents reviewed by Reuters show: It could give Bankman-Fried desired access to regulators.

A prime example is the IEX deal announced in April. In a joint interview with CNBC, Bankman-Fried and IEX CEO Brad Katsuyama said they wanted to “design regulation that ultimately protects investors.” What’s most important here, Bankman-Fried added, is that “there is transparency and fraud protection.”

Reuters was unable to determine how much FTX paid for the stake.

Bankman-Fried was invited to meet SEC Chairman Gary Gensler and other SEC officials along with Katsuyama in March.

A source close to IEX said the purpose of the meeting was to give the SEC advance notice of its deal with FTX, which had not been publicly announced at the time, and to discuss the possibility of IEX becoming a trading venue creates for digital assets. like bitcoin. FTX’s role was to provide the infrastructure for crypto trading, the source said.

SEC officials flatly rejected their original plan because it would have involved the creation of a less regulated non-exchange trading venue, something the cryptocurrency agency opposes, the source familiar with the SEC’s deliberations said.

Reuters was unable to determine the extent of Bankman-Fried’s involvement in subsequent discussions with the SEC. According to her, SEC officials agreed to meet with Katsuyama in March, and Bankman-Fried just came along, the source familiar with the SEC’s mindset said. He was mostly silent during the meeting, with Katsuyama in the “driver’s seat,” the source added.

Regardless of its holdings, FTX has conducted its discussions with its investors. At an advisory board meeting in September, FTX said discussions with the SEC had been “extremely constructive.”

“We probably have the pole position there,” it said according to the minutes of the meeting.

The person familiar with the SEC’s mindset said they would dispute that FTX is in “pole position.” Anything the SEC does to regulate crypto trades would be open to all market participants, the source said.

The source close to IEX said the exchange has never made operational arrangements with FTX, adding that it never got to that point.

A May FTX document provides an overview of FTX’s contacts with individual regulators. The previously unpublished document shows how FTX was able to solve the problems encountered in most cases.

For example, in February, South African authorities issued a warning to consumers that FTX and other crypto exchanges were not authorized to operate there. Therefore, FTX entered into a commercial agreement with a local exchange to continue providing the services. “FTX is now fully legalized in relation to its current operations in South Africa,” FTX said.

The regulator, the South African Financial Sector Conduct Authority, did not respond to a request for comment.

The May document also reveals that FTX has run afoul of the SEC. Earlier this year, the SEC conducted investigations into how crypto companies are handling customer deposits. Some firms were offering interest on deposits, which the SEC said they could turn into securities and should be registered under their rules. In listing its regulatory interactions, FTX noted that the investigation looked at whether those assets were “lent or otherwise used for operational purposes.”

As Reuters reported, it emerged this month that FTX had done just that, transferring billions of dollars in client funds to Alameda Research, Bankman-Fried’s trading firm.

In the May document, FTX said the SEC’s audit staff, which investigates market practices that may pose risk to investors, is concerned about another matter: a rewards program it offers to customers under which it pays interest on crypto deposits.

According to the document, FTX told the regulator that it didn’t have the same issues as other vendors’ products that the agency investigated.

“We have confirmed that this is based solely on rewards and does not involve lending (or any other use) of the deposited crypto,” FTX wrote. The SEC wrote back and said it had completed its “informal investigation” and needed no further information “at this time.”

The SEC had no comment on the investigation. In an email to Reuters, Bankman-Fried wrote: “FTX’s response was correct; FTX US rewards program did not involve lending assets.”