3 - 5 minute read
The collapse of FTX, a popular crypto exchange, shocked the financial world. In a new bankruptcy filing, it has been revealed that the exchange utilized a “non-enterprise solution” to manage its billions of dollars in assets, including cryptocurrency. FTX’s inadequate accounting method meant that none of its 56 entities produced financial statements of any kind, and QuickBooks was used to manage accounting for 35 FTX Group entities. Additionally, it relied on a “hodgepodge” of Google documents, Slack communications, shared drives, and Excel spreadsheets to manage assets and liabilities. These shortcomings in accounting meant it was difficult to determine how positions were marked, and it was impossible to comprehensively track transaction histories.
FTX CEO John J. Ray III, who replaced founder Sam Bankman-Fried, acknowledged that none of the FTX Group companies used an “appropriate” accounting system, especially when handling billions in securities, fiat currency, and cryptocurrency transactions across multiple continents and platforms. Ray also highlighted that FTX’s sister company, Alameda Research, kept such lackluster records that “it is difficult to determine how positions were marked.” The revelations raise a big question about how to regulate crypto exchanges and urge governments to introduce better regulatory measures on this nascent asset class.
Sam Bankman-Fried, the disgraced founder of FTX, is currently facing allegations of defrauding investors and mishandling customer assets, which resulted in the exchange being forced to halt customer withdrawals. If convicted, the founder could be sentenced to 115 years in prison. Bankman-Fried admitted to Alameda Research’s unauditable status, stating that “it is beyond the threshold of any auditor being able to even get partially through an audit.” He described the company’s balance sheet as unauditable, stating that their records were so poor that sometimes $50 million of assets were “lost track of; such is life.” This poor record-keeping practice is not only rife at FTX and Alameda Research but an industry-wide problem that needs regulation to put cryptos on equal footing with other asset classes.
In the wake of FTX’s bankruptcy filing and the allegations against Bankman-Fried, the entire crypto industry is under scrutiny. Experts are calling for more stringent regulatory measures that can hold crypto exchanges accountable for their records and transparency in their transactions. Industry watchdogs claim that while some crypto exchanges are providing audit reports about their financials, none of them are as comprehensive or as routine as the audited financials of traditional equity market exchanges. The result is that stakeholders and investors are left to rely on self-reported numbers that may not be entirely accurate.
What’s more, crypto exchanges have been notoriously non-compliant with Know-Your-Customer (KYC) and Anti-Money Laundering (AML) regulations. Cryptocurrencies transactions have facilitated illegal activities such as terrorism financing, drug trafficking, and other serious crimes. Such transactions are almost impossible to detect because of the anonymous nature of the digital asset. Therefore, the lack of proper accounting and audit of crypto exchanges’ records poses a significant threat to the safety and soundness of the financial system.
The Bottom Line
The collapse of FTX exposed the lack of appropriate accounting systems and poor record-keeping of some crypto exchanges, emphasizing the need for robust regulatory measures in the industry. The digital asset class’s lack of regulation, especially regarding KYC and AML procedures, has led to an increase in criminal activities such as money laundering and funding of terrorism. Therefore, it is essential for industry players to work closely with regulators to enhance transparency and accountability while keeping up with technological advancements. Investors must conduct due diligence before investing in any crypto asset and should be cautious, especially about exchanges with poor or non-existent records.
