While all my friends were in Miami for the Web3 Summit and Miami Art Basel, I was stuck in dreary St. Louis watching the Senate Ag. Committee’s hearing “Why Congress Needs to Act: Lessons Learned from the FTX Collapse.”
The only witness to the hearing was Rostin Behnam, who is the current Chairman of the CFTC. Behnam came under fire in the wake of the FTX collapse due to his connection to SBF, and his support of a bill introduced by Senators Debbie Stabenow (D-MI) and John Boozman (R-AR) regarding the regulation of “digital commodities.” The bill, which was drafted with heavy input from FTX, would have put crypto regulation in the US largely under the purview of the CFTC as opposed to the SEC.
The video of the hearing is available here for anybody who wants to watch. For people who don’t want to watch all 3 hours, I have included my notes/live reactions below. These are live notes, so miss me with any comments about typos. I will come back and edit later, but wanted to get the info out to the public ASAP while still doing the job I am actually paid for today.
Sen. Stabenow opened the hearing discussing how the FTX collapse unfolded, and how this was at best a failure of oversight and controls, and at worse a fraud committed by FTX leaders.
There is currently is no federal market regulation of spot crypto assets which are not securities, which Sen. Stabenow said “includes Bitcoin and Ether” which continues the general statements by many regulators who agree the two most heavily traded cryptocurrencies are not securities. The conduct which lead to FTX collapse and consumer harm which came from it is the exact type of thing that consumer protection laws are intended to protect against.
Sen. Stabenow finished by saying the LedgerX, a company which was purchased by FTX and which was registered with the CFTC, was one of the sole businesses which was run ethically and had a balance sheet which could meet customer deposit demands. This shows how properly regulated markets and businesses can protect consumers.
Sen. Boozman spoke next, largely echoing Sen. Stabenow’s statements that Bitcoin is a commodity. Exchanges which trade commodities, be it wheat, oil, or Bitcoin, should be regulated. Regulation by enforcement drives entities off-shore, which still hurts US users, but makes it impossible for US regulators to protect against bad actors. He also further advocated why the CFTC is in the best position to regulate large amounts of the cryptocurrency industry.
Sen. Boozman also stated he intends to use this hearing to explain how the proposed Digital Commodities Consumer Protection Act (“DCCPA”) as written could have prevented the FTX collapse and how the bill can be improved knowing what we know now was happening at FTX behind the scenes. He remains committed to giving the CFTC expanded powers under the bill, and moving the bill forward in the upcoming legislative session.
Behnam Opening Remarks
Behnam started by saying that patchwork of federal and state regulation is an unsuitable replacement to comprehensive approach to regulating the industry. Failure to act at a congressional level will leave consumers who invest in digital commodities unprotected. He also stated that, even in the face of CFTC’s limited enforcement and investigation authority, it has still brought many actions involving digital assets and have levied over $800 million in fines based on these regulatory actions.
He also said he supports a system which puts the SEC in charge of regulating digital asset securities, while placing the CFTC in charge of overseeing “the more limited” asset class of digital asset commodities. He also echoed the statement that LedgerX is one of the few FTX entities that did not file for bankruptcy because it kept customer assets secure and has sufficient assets to protect customer assets. He credited this to the entity being registered with the CFTC and subject to the CFTC’s regulatory protections, which worked here.
Without new authority for the CFTC, there will remain gaps in a federal regulatory framework in spot markets for crypto assets which are commodities and not securities.
Questions From Senators
After the opening statements, Senators were given seven minutes each to ask questions of Behnam.
Stabenow started by asking what he believes the cause of the FTX collapse and how LedgerX was protected from that. Behnam said that LedgerX was walled off from other FTX entities due to its registration status with the CFTC. His understanding of the larger collapse was due to a liquidity crunch.
She then asked for more info into the CFTC’s recent interactions with FTX regarding their request for approval for a US commodities clearinghouse. Behnam has reviewed his calendar and he and his team met with FTX 10 times in regard to the FTX digital clearinghouse application. By law, the CFTC was required to respond to this application. Behnam decided early in the process this needed to be a transparent and public process. He listed the various ways the CFTC engaged with the public through requests for public comments, roundtables, meetings with others in the industry and elsewhere, etc. The application was made in December of 2021 and withdrawn in November 2022 with no decision or recommendation by the CFTC.
Finally, he was asked if FTX could have been prevented by the measures in the DCCPA. He said the DCCPA does address and prohibit lots of the comingling and sloppy accounting issues which led to the FTX collapse.
Boozman’s Questions (Pro Crypto)
Boozman went next, asking if the reporting regarding the CFTC’s regulatory and enforcement being a “soft-touch” regulator. Behnam disputed this, pointing again to LedgerX as showing their regulation works, and their enforcement record this past year had over $2.5 billion in asset penalties on a few hundred million dollar budget. Additionally, future markets have been used as models of effective consumer protection.
Boozeman asked if the CFTC could have prevented this under the DCCPA. Behnam stated under the CFTC’s current authority there was no way they could prevent what happened. But under the DCCPA, they could have prohibited in advance many of the issues which led to the collapse. Behnam stated that if there was a regulatory framework in the US, more entities would come to the US and that would give US regulators more power to protect US consumers. Boozeman went on to ask about the current definition of a “dealer” under the current draft of the DCCPA. Behnam agreed the priority should be protecting retail consumers and investors, which should be addressed in that definition.
Klobuchar Questions (Pro Crypto)
Sen. Klobuchar went next. She started by asking to what extent did centralization and vertical integration of FTX play into its ability to conceal operation risk and fraud. Behnam agreed the vertical integration issue was very important during the FTX clearinghouse application process. On one-hand, it is a product of technology and ability to have direct execution which may have merit, but there are also lots of potential risks.
She then asked how the balance between the SEC and CFTC should be set up. Behnam responded it should act largely as it does now with just more clarity on which tokens are commodities and which are securities. She also asked what disclosures should be required regarding risk of underlying assets. He agreed disclosures are critically important, and more must be done there in crypto.
She focused on Superbowl and influencer ads to create FOMO, and the use of social media in crypto fraud and scams. Behnam stated he is close collaboration with other regulators to address these issues.
Sen. Marshall Questions (Anti-Crypto)
Sen. Marshall asked if there should be a pause in the crypto world until the regulators can get their arms around understanding and comprehensively regulating it. Behnam stated whether it occurs in the US or offshore, these markets are going to move forward and the CFTC can’t just sit back and wait.
He also stated the concern over the use of cryptocurrency in ransomware attacks, human trafficking, drug trafficking, and how crypto is the major currency being used for these things. (Editor note: BS! The US Dollar DWARFS cryptocurrency in its use for illegal transactions. Sen. Marshall is now on this writer’s personal shit list). Behnam agreed that “cryptocurrency is potentially a threat to national security.” But he said there is no real way to put a pause on this, because even if they prohibit it in the US it will still be used here.
Sen. Smith Questions (Anti-Crypto)
Sen. Smith said she has joined with Sen. Warren and others to call on Fidelity and others to remove cryptocurrencies from retirement funds. She also asked if crypto exchanges are required to keep customer assets separate from their own assets, which Behnam said it is not required now but the SEC has the authority to require that.
She went through similar questions regarding fiduciary duties, best execution duties, and KYC duties. Behnam gave the same answer, with the caveat that this only applies to security tokens in regards to the SEC’s authorities. He also said the state money transmitter and FINCEN licenses have AML and KYC protections already in place.
Behnam said that traditional banking and financial systems have been silo’ed off from crypto instability. But the US can’t just assume that will stay the same in future crises which will continue to occur without appropriate regulation.
Sen. Tuberville Questions (Pro-Crypto)
Says he feels bad for Behnam, and feels like Behnam is getting criticized for losing a football game when the other team didn’t play by the rules. Said the US needs to get control over these issues so people can have confidence in digital assets.
Tuberville asked about if there were emails or texts between Behnam and SBF. Behnam said all communications were in relation to the FTX’s pending clearinghouse application. Tuberville went on to criticize Gensler’s use of the situation as a power grab for the SEC, and how the SEC has made it virtually impossible to “come in and register” without facing adverse consequences. He asked what the CFTC has done to encourage market participants register appropriately with the CFTC. Behnam responded that the heart of the problem is there is a influx of firms who want to list crypto derivatives products, but regulation of cash markets for crypto commodities is something the CFTC doesn’t currently have the power to do.
Tuberville took a shot at Environmental, Social, and Governance (“ESG”) ratings, and how FTX had great ESG ratings but turned out to be actually shitty. Behnam didn’t have a real response on who can govern rating agencies for ESG. Doesn’t know if that is appropriate as a separate bill or something that should be included in the DCCPA.
Sen. Brown Questions (Neutral; leans Anti-Crypto)
Also started with questions regarding the use of crypto in illicit finance. Is combatting the use of crypto in illicit finance something that needs to be addressed in all US regulatory policy in this sector? Behnam responded that CFTC will certainly work with OFAC, FinCEN, and treasury to address illicit use of funds.
Next asked questions regarding vertical integration of a single party acting as a dealer, lender, and custodian and how it doesn’t work. It isn’t allowed in traditional finance and shouldn’t be permitted in crypto. Behnam agreed preventing these single actor conflicts of interests in the same way it is prevented in traditional finance should be a priority.
Sen. Grassley Questions (Neutral)
Started with questions about if the CFTC had any insider tips or whistleblowers about FTX before this, and Behnam said they didn’t have any tips beforehand. Says it is a huge priority to make sure those tipsters can come forward in a safe and protected manner, and he is hoping that Sen. Grassley’s whistleblower payment bill is upheld.
Behnam was questioned if his calendar and meetings with SBF has been made public. Behnam said they have done an internal check, and confirmed all communications were regarding FTX’s clearinghouse application and nothing to do with the offshore collapse.
Asked how the CFTC missed this complete lack of corporate controls stated by John Ray in the bankruptcy filings. Behnam clarified that because the CFTC does not have the authority to go beyond the regulated entity (LedgerX), the CFTC’s hands were tied and had no authority to look into the non-regulated entities which have now applied for bankruptcy.
Grassley asked if there should be changes to the DCCPA based on what happened here. Behnam said, based on what he knows know, he thinks there should be a close look and tightening of language in the bill regarding disclosures and conflicts of interest.
Sen. Lujan (Neutral, leans Pro-Crypto)
Focus began on the LedgerX acquisition and the ability of potential bad acting entities to purchase regulated and good acting entities. Asked about the risk this ability to purchase regulated entities without the CFTC being able to investigate those purchasing entities represents. Behnam said this has huge potential impacts on US investors, but also the silo’ing that is required for registered entities protects customer assets in those regulated entities, regardless of the owner.
CFTC is in communication on a daily basis with LedgerX and also the custodian currently overseeing the company. The entity is operational and well capitalized, and every requirement under CFTC law is currently being met.
Asked about what special considerations are necessary for digital asset marketplaces. Behnam said the core functions and regulations of markets in traditional assets should be the starting point baseline, but there needs to be additional protections in the form of system safeguards against cyberattacks, and also how custody of digital assets is handled. These would be done through agency rulemaking.
Sen. Thune Questions (Neutral)
Thune started with what is going on currently in the FTX investigation. Behnam said he cannot talk about ongoing actions, but hit on the need once again for comprehensive framework so the CFTC can be more protective beforehand and less reliant on reactionary actions which only occur after consumers have already been harmed. The CFTC is working with the SEC in its current investigation of FTX.
Behnam said that they cannot regulate cryptocurrency out of existence or regulate in ways that wall off the US from potential dangers of cryptocurrencies. So cannot just ignore it. Need to take action.
Sen. Durbin Questions (Anti-Crypto)
Starting with saying SBF’s tweet lead consumers up to the edge of the cliff, and that SBF was actively contributing to politicians (including Sen. Durbin). Wanted to know how long it will take to “unpack the FTX mess.” Behnam said they have a high level understanding now, but it will takes months for the CFTC and SEC and others to fully unwind and fully understand everything that happened.
Mentioned the conflict between the fight between no regulation (law is code) and CFTC being too small for daily regulation for an industry that is mushrooming in size if it is going to take months to investigate this single incident. Also questioned how the CFTC will be able to fund this investigation on its current budget, because unlike the SEC who is mostly funded through fees, the CFTC is dependent on appropriations for funding. Behnam said funding would be primarily through fees (similar to how SEC is currently funded) but was open to other solutions.
Sen. Hoeven Questions (Unclear?)
Asked if the CFTC had direct oversight over any other entity other than LedgerX. Behnam confirmed that is the only entity that the CFTC had direct regulatory oversight and insight into. Confirmed LedgerX is solvent and the CFTC has daily authority to view their books and records. CFTC is able to confirm they stay solvent absent some fraud.
Said before crypto can be regulated, there needs to be proper definition on what is a commodity aspect, security aspect, and currency aspect. How is that defined and how is that coordinated? Behnam confirmed stablecoins would be outside the CFTC’s purview, but said there needs to be further work on what the defining features of a digital asset security and a digital asset commodity are. Sen. Hoeven questioned how they can possibly do that level of coordination between agencies. Behnam said it starts with working with Gensler to develop the characteristics of what is a security and commodity, and going through the 200+ tokens on the largest US exchange (aka, Coinbase) and definitely defining which are securities and which are commodities based on those characteristics.
Sen. Bennet Questions (Unclear?)
Why did FTX lobby so hard for a bill that the CFTC said could have prevented this and that FTX could never comply with? Behnam said he had similar questions because FTX was so out of compliance of the requirements of that bill that they couldn’t have met the bills requirements.
Bennet agreed they need to regulate, but is concerned that regulation creates a potential seal of approval over a complex industry which isn’t fully understood yet. Behnam said the two collapses in crypto this year hasn’t resulted in market contagion, and that resilience shouldn’t change going forward. Those regulations work in traditional markets, and hopefully regulation eliminates these collapses occurring in the first place, which would further prevent contagion.
Bennet questioned the wisdom of splitting oversight between two agencies (CFTC and SEC) rather than putting this all under a single agency. Behnam said there are already dual regulation over futures and swaps markets which has worked, and he sees as working going forward in crypto.
Sen. Braun Questions (Pro-Crypto)
Asked if cryptocurrencies can ever become a legitimate means of exchange in the same way fiat currency works or if volatility will be inherent to cryptocurrencies going forward. Behnam stated that in the past 6 months Bitcoin’s volatility has narrowed, and it is possible this is a trend throughout the space that will continue.
Braun compared this to the dotcom boom. Went on to ask if there is any need for everything to be regulated under either one or the other of the SEC vs. CFTC. Behnam said the fundamental test created by Howey should continue to govern going forward, with potentially some clarification as it applies to digital assets.
Bruan said he didn’t want to let a single bad actor put a wet blanket on this technology as a whole which has unknown potential.
Sen. Booker Questions (Pro-Crypto)
Millions of Americans have been hurt by this “FTX scam” which is still revealing regulatory gaps and how they can work for the opportunities for the technology in the future. Booker saw the best potential for this technology is the access for traditionally unbanked to have access to financial markets, but fears that the pending legislation still leaves these vulnerable consumers at risk in the same way they are at risk to be taken advantage of in traditional banking.
Booker, who is a co-sponsor of the DCCPA, then asked if the DCCPA is an “FTX” or “SBF” bill. Behnam confirmed that while FTX was involved in the process of creating the bill, this was a bill created with input from many in the industry and it was an inclusive process.
Financial criminality is not new, and in those cases, enforcement and transparency are the most important issues. The DCCPA was written to, among other things, give CFTC more authority and resources to have preventative enforcement instead of simply reactionary enforcement. Right now every action being brought by the CFTC is because somebody came forward with a complaint. This is not a good framework to protect consumers to prevent as opposed to react to consumer harms.
If you have any questions or would like me to write about anything else, let me know on either of my twitter pages! As always, I am an attorney, I am not your attorney. For legal advice, you should always consult (and pay for) an attorney.
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