…Further Down South, Don’t We Need A Rescue Yet?

A lot of cascading events in recent weeks in the crypto world has necessitated the penning down of my opinion and thoughts. The last two weeks witnessed the downfall of the second largest cryptocurrency exchange – FTX, comprising FTX.com, FTX.us and Alameda Research. While Ftx.com and ftx.us are cryptocurrency exchanges allowing customers’ crypto trading outside and inside of US respectively, Alameda Research served as the proprietary trading/asset management arm of the Company. The group has filed Chapter 11 Bankruptcy in the US.

FTX, started operations in 2019 as a cryptocurrency exchange. The founders, Sam Bankman-Fried and Zixaio “Garry” Wang though started a trading firm, Alameda Research, earlier in 2017. FTX attracted several investors including Binance founder, Changpeng Zhao, who bought a 20% stake in the Company for a $100m within six months of starting operations. The Company had a trading depth and volume of $10bn - $15bn per day and was valued at a whooping amount of $32bn in January 2022. The company, which is just about 3 years has raised over $2bn in its life span from well-known venture capitalists, angels and private equity investors. The Company also made several acquisitions and investments in affiliates and subsidiaries all over the world.

A lot of reasons have been adduced to the downfall of the crypto giant. From dominance rivalry between the two billionaire owners (of the two exchanges controlling the majority of the market) Mr. Zhao of Binance and Samuel Bankman-Fried himself (Bankman-Fried bought back the 20% investment of the former at $2bn, partially paid for by FTX native token); insider related dealings, lack of transparency and regulatory oversight, among others. This event has visibly shaken the industry, making it loose existing disciples and believers, and consolidating the doubts of erstwhile skeptics and “thomases”. Before judgements can be passed or positions taken however, it is important to have a total view of events that precipitated the fall of this giant. I have listed several online links for your readership as appendix to this write up.

Proponents of cryptocurrency have always advocated the transparency that cryptocurrency operation brings to everyone on the block chain, the inability of any player to tamper with the record/ledger and the near zero cost of transaction unlike conventional banking system and legal tenders. They have also always preached the total exclusion of government intervention or control. They have argued that intervention by the latter would bring red tape and reduce the amount of returns that may be available from such investment opportunity. This later argument, may have been premised on the principle of free market capitalism as proposed by Adams Smith himself in his theory of self-interest and competition, propagated through his book, An Inquiry into the Nature and Causes of the Wealth of Nations—commonly referred to simply as The Wealth of Nations. He explained further that in market economy, where individuals and businesses own the factors of production and resources, and take decisions voluntarily in their own self-interest, greatest personal benefits will be achieved from market place activities and transactions. In this type of system, the government plays a small role, and the economy is shaped by two forces: self-interest and competition. In his words, “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” Adam Smith's self-interest economic theory proposes that capitalism fueled by self-interest is ultimately the best way to a thriving economy. Because of human desire for money, success, or fame, they will be motivated to improve their quality of work, products, and compete with others. In many cases, this competition fueled by self-interest will also lead to increased innovation. Countries that have fully supported unregulated crypto market include Elsavador.

Critics of cryptocurrency, on the other hand, are of two different folds. There are those who believe that crypto currency is a devil in itself and should be totally prohibited and not supported. Such group calls for total ban to all activities relating to it and imposition of heavy fines and punishment on erring members of the citizenry.?A lot of countries, including Nigeria, Egypt and China, have taken this approach. The other fold is milder, believing that cryptocurrency can add vast value to the economy, but must be closely monitored and regulated. This is the position that countries like the US, UK, Australia among many others take. An event such as the bankruptcy of FTX would be showcased by this group, as a reason why their position is valid.

In evaluating this situation critically, it is important to be objective as much as possible. For one, the innovations that this industry gave us (and still giving) is unprecedented and cannot be ignored. This is the beauty of capitalism/free market. The new ways (and or alternative options) of transacting businesses that makes one marvel – using cryptocurrencies as store of value, for transaction payment and settlement, for money transfer, capital mobilization and financial intermediation etc. among others. The speed at which this is done is also very fascinating, irrespective of location, distance or time. This buttresses the continuous relevance of market capitalism where government role is pushed to the back and self-interest and competition is allowed to prevail. Like every other new financial asset/investment class though, there are those who are in it for its speculative purpose, that is, the ability to be able to make mouth-watering, generation-defying returns on investments within the shortest and unprecedented time periods.

Second, these innovations, without some forms of control, would not be able to reach optimality due to the same self-interest theory/principle. Unbridled application of self-interest theory most always leads to greed, corruption, fraud and facilitation of crime. Hence, the innovation it creates would be scuttled by scandals and facades. As John Jay Ray III, who replaced Sam Bankman-Fried as CEO, would find out in the FTX Bankruptcy proceedings "Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented”. Revisiting the Adams Smith theory, the role of government, which is pushed to the back, is still required to create some form of stability, checks and balances on the excesses of self-interest theory. These roles may be in the form of setting regulatory rules, licensing, periodic monitoring and evaluation, imposition of penalty and fines, blacklisting, and sometimes rescuing and bailout.?Government control would not have allowed one person to carryout exchange, custody and proprietary trading services without some very strict regulations and restrictions.????

Thirdly, there is the need to protect the vulnerable, in the society. Since, there will always be speculators, who are looking for humongous returns at all cost, there would also always be innocent members of the society falling victim to this set of people and loosing their investments over and over again. Hence, government intervention (and control) takes this form sometimes. Further findings in the FTX case revealed that the exchange, FTX, which also acts as custodian of clients’ deposit, had been advancing money to Alameda research, its trading arm, to enable it trade. A larger portion of the money advanced included clients’ deposit in the former’s custody. Alameda also made significant investments in the exchange's primary token, the FTT, which made the trading company directly exposed to same volatilities the exchange (eventually) faced while it also used a sizable amount of the fund to offset other previously borrowed loans. These clients, who are largely retail and diversified individual investors, have lost all their investments/deposits with the exchange – over $8bn in unsettled withdrawal requests. Most may never recover. Some institutional investors are also affected. For example, Nestcoin, a Nigerian web3 startup company, has made an announcement to investors that it lost certain investments (cash and stable coins) in the FTX saga and as a result would be laying off some of its employees. Alameda Research was an investor in Nestcoin.

Lastly, sovereign and legitimate governments are the only institutions that are believed to exist in perpetuity. Hence, investments in their instruments are always considered risk-free. This legitimacy comes with a social intangible asset called citizens’ trust, which is the belief that government would continue to operate in perpetuity. Hence, whatever it supports, proposes or oversees would be as good as it is claimed to be and would survive as long as such government’s existence. Where rumors exist in a market, a press conference by the relevant regulator/agency of government would douse any tension (even where the rumor may be partially true) and prevent panic buying, selling or withdrawal as was the case with FTX where a bank run led to a withdrawal of over $6bn from the exchange within 72 hours. In a related manner, being regulated brings some form of protection, as seen in other industries, where government provided bailout options for ailing companies, protecting the integrity of the system and saving depositors/customers.??

While the recent event has deepened the doubts in the mind of skeptics and believers about the industry, I believe lots of economic value and benefits can still be extracted from cryptocurrencies and countries like Nigeria would need to reconsider. My proposal would be to provide relevant regulations in line with the various usages to which cryptocurrencies are put. Thus, tech companies providing crypto exchange, brokerage and capital raising services would be under the supervision of the Securities and Exchange Commission (SECs) as a self-regulatory organization, digital assets brokers/sub-brokers and issuing houses, similar to what currently exist for stocks, derivatives and commodities. Those providing money transfer services, loan capital and payment settlements services among others would be under the supervision of the Central Banks. These crypto companies would be subject to the same regulations with respect to registration, licensing, filing, disclosure, penalty, and review as other conventional companies in these sectors.

In conclusion, I believe that in the absence of government regulations, corporate entities, start-ups and tech companies inclusive, should be able to setup an internal regulatory system that would guaranty continuous existence and growth of the business. These internal regulations relate to two important setups that every company, especially ones with fiduciary duties, must put in place irrespective of size. First is the corporate governance setup. Second is a proper internal control system.

Corporate governance involves the setting up of proper board of directors to whom the management team of the company would be reporting and accountable. The Board comprises a Chairman and independent and/or non-executive and executive directors. The powers, functions and duties of the Board are well laid down in the Companies and Allied Matters Act (CAMA) 2020 and the Nigerian Corporate Governance Code 2018, as issued by Financial Reporting Council of Nigeria (Other versions include that of CBN, NAICOM and SEC). Other international organizations like the OECD, IFC and UN all have various corporate governance codes and guidelines to which companies of different sizes are expected to adhere before being granted a compliance status.

Internal control on the other hand relates to checks, balances, processes and controls designed, implemented and maintained by board of directors, management and other personnel of a company to provide reasonable assurance to stakeholders with regard to reliability of its financial reporting, effectiveness and efficiency of its operations, and its compliance with applicable laws and regulation. Internal Control covers several areas of the business and where well implemented, prevents catastrophic events like fraud, mismanagement and embezzlement from happening. Internal Control ensures definitions of roles and responsibilities, adherence to processes and procedures, and provides needed checks and balances that ensures continuous growth and prosperity of a Company.

It is therefore important that startups and growth-stage companies, in tech or any other sector, embrace regulation, whether internally, by putting up relevant corporate governance and internal control structure, or externally as provided by the government through the setting up of level playing ground (and rules) required for companies to operate.

Please note that you can contact me for assistance with implementing internal regulatory structure for your company or business– corporate governance or internal control, and related advisory services.

?Further Readings and References:

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1.?https://www.reuters.com/technology/exclusive-behind-ftxs-fall-battling-billionaires-failed-bid-save-crypto-2022-11-10/

2.?https://www.usatoday.com/story/money/2022/11/16/ftx-bankman-frieds-crypto-bankruptcy/10710734002/

3.https://qz.com/ftx-bankruptcy-filing-reveals-a-remarkably-convoluted-c-1849797496

4.?https://pacer-documents.s3.amazonaws.com/33/188450/042020648197.pdf