Exclusive: How FTX Bought Its Way to Becoming the ‘Most Regulated’ Crypto Exchange

  • FTX buys 10% stake in IEX with option to take 100%
  • FTX spent $2 billion on “acquisitions for regulatory purposes”
  • The documents indicate that FTX saw its regulatory status as a way to attract fresh capital from large investors

(Reuters) – Prior to its crash this month, FTX was outdoing many rivals in the largely unregulated cryptocurrency industry by boasting that it was the “most regulated” exchange on the planet and calling for more scrutiny from the authorities.

Now, company documents seen by Reuters reveal the strategy and tactics behind founder Sam Bankman-Fried’s regulatory agenda, including the previously unreported terms of a deal announced earlier this year with IEX Group, the incoming US stock trading platform. In Michael Lewis’ book “Flash Boys” about computer-based rapid trading.

As part of that deal, Bankman-Fried bought a 10% stake in IEX, with an option to buy it outright in 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 IEX regulator, the US Securities and Exchange Commission, on regulating cryptocurrencies.

This deal and others referenced in the documents, which include business updates, meeting minutes and strategy papers, highlight one of FTX’s broader goals: to quickly craft a favorable regulatory framework for itself by acquiring stakes in companies that already have licenses from authorities, often shorting Lengthy approval process.

FTX has spent about $2 billion on “acquisitions for regulatory purposes,” according to FTX documents seen by Reuters from the Sept. 19 meeting. Last year, for example, it bought LedgerX LLC, a futures exchange, giving it three CFTC licenses in one go. 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.

The documents also showed that FTX saw its regulatory status as a way to attract new capital from large investors. In documents to support its claim to hundreds of millions of dollars in funds, it presented its licenses as a key competitive advantage. It said the “regulatory moats” created barriers for competitors and would allow them access to lucrative new markets and partnerships beyond the reach of unregulated entities.

“FTX has the cleanest brand in crypto,” the exchange declared in a June document provided to investors.

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

An SEC spokesperson declined to comment for this article. The CFTC also declined to comment.

In a text exchange this week with Vox, Bankman-Fried made a shake-up on regulatory matters. Asked if his previous praise for regulations was “only PR”, he said in a series of texts: “Yeah, only PR…fuck the regulators…they make everything worse…they don’t protect customers at all.” .”

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

patch regulators

FTX collapsed last week after Bankman-Fried’s futile attempt to raise emergency funds. It has come under some regulatory oversight with the dozens of licenses it has acquired through its many acquisitions. But that hasn’t protected its customers and investors, who now face billions of dollars in losses. As reported by Reuters, FTX has been secretly risking clients’ money, using $10 billion in deposits to back a trading firm owned by Fred Bankman.

The fact that Bankman-Fried has been courting regulators while massively risking clients’ money without anyone noticing exposes a major regulatory loophole in the cryptocurrency industry, four lawyers said. “It’s a patchwork of global regulators — and even domestically there are huge gaps,” said Eitan Goleman, attorney with Zuckerman Spyder, former attorney general and CFTC enforcement director. “This is the fault of the regulatory system that has taken so long to adapt to the advent of cryptocurrency.”

A person familiar with the SEC’s thinking about regulating cryptocurrency said the agency believes crypto firms operate illegally outside US securities laws and instead rely on other licenses that provide minimal consumer protection. The person said, “These assertions, while nominally true, do not cover their activity.”

Reuters Graphics Reuters

Step 1: Licenses

Bankman-Fried had high ambitions for FTX, which by this year had grown to over $1 billion in revenue and accounted for about 10% of the turnover in the global crypto market, from a steady start in 2019. He wanted to create a financial app, where users could trade Stocks and tokens, money transfers and banking, according to an undated document titled “FTX Roadmap 2022.”

The “roadmap” document states that the “first step” toward this goal “is to become as licensed as is reasonably possible.”

“This was partly to make sure we were regulated and compliant; partly it was in order to be able to expand our product offering.”

This is where FTX’s acquisition spree came in, according to the documents. Instead of applying for each license, which could take years and sometimes uncomfortable questions, Bankman-Fried decided to buy them.

But the strategy also had its limits: Sometimes the companies it acquired didn’t have the exact licenses they needed, documents show.

One of FTX’s goals, according to the documents, was to open the US derivatives markets to its clients in the country. It estimated that the market would bring in an additional $50 billion in trading volume per day, generating millions of dollars in revenue. To do this, it needed to convince the CFTC to amend one of the licenses held by LedgerX, the newly acquired futures exchange FTX.

The application process dragged on for months, and FTX had to pay $250 million to the default insurance fund, which is a standard requirement. FTX expected the CFTC to ask to increase the fund to $1 billion, according to the minutes of its advisory board’s March meeting.

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

Buying companies for licenses also has other advantages, as documents reviewed by Reuters show: It could give Bankman-Fried the access it desires to regulators.

A good example of this is the IEX deal, which was announced in April. In a joint interview with CNBC, Bankman-Fried and IEX CEO Brad Katsuyama said they want to “shape the regulations that ultimately protect investors.” The most important thing 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 with SEC Chairman Gary Gensler and other SEC officials besides Katsuyama in March.

A source close to IEX said the purpose of the meeting was to notify the SEC in advance of its deal with FTX, which at that point had not been publicly announced, and to discuss the possibility of IEX creating a trading venue in digital assets, such as bitcoin. The source said that the role of FTX was to provide the infrastructure for crypto trading.

The source familiar with the SEC’s thinking said that SEC officials outright rejected their initial plan because it would have involved creating a non-exchange trading venue that would be more subject to regulation, something the agency opposes for cryptocurrency.

Reuters could not determine the extent of Bankman Fried’s involvement in subsequent talks with the Securities and Exchange Commission. The source familiar with the SEC’s thinking said the SEC officials had in their minds agreed to meet with Katsuyama in March, with Bankman-Fried accompanying them. He was largely kept silent during the meeting, the source added, with Katsuyama in the “driver’s seat”.

Whatever his involvement, FTX has spoken out about its discussions with its investors. At its advisory board meeting in September, FTX said the talks with the SEC were “extremely constructive.”

“We’ll probably have center stage there,” the minutes said.

The person familiar with the SEC’s thinking said he might object that FTX was “center-stage.” The source said that anything the SEC does to regulate cryptocurrency trading will be open to all market participants.

The source close to IEX said the exchange never entered into any operational agreements with FTX, adding that it never got to that point.

FTX’s May document provides a summary of FTX’s contacts with individual regulators. The document, which was not previously reported, shows how in most cases FTX managed to solve the problems that arose.

In February, for example, South African authorities posted a warning to consumers that FTX and other crypto exchanges are not authorized to operate there. Therefore, FTX entered into a commercial agreement with a local exchange to continue providing services. “FTX is now fully regulated in relation to its current activities 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 shows that FTX has a brush with the Securities and Exchange Commission. The Securities and Exchange Commission (SEC) made inquiries earlier this year about how crypto companies handle customer deposits. Some companies were offering interest on deposits, which the SEC said could make them securities and must be registered under their rules. In its list of regulatory interactions, FTX indicated that the investigation was looking at whether those assets were “lent or used for operational purposes.”

This month, as Reuters reported, it turns out that FTX has done just that, moving billions of dollars in client funds into Bankman Fried’s trading firm Alameda Research.

In a May document, FTX said that SEC examiners, who scrutinize market practices that could pose a risk to investors, were concerned about a different matter: the rewards program it offered to clients, under which it paid interest on crypto deposits.

According to the document, FTX told the regulator it did not suffer from the same issues as products from other providers that the agency investigated.

“We have confirmed that these were based solely on bonuses and did not involve the lending (or other use) of deposited cryptocurrencies,” FTX wrote. The SEC responded, saying it had completed its “informal investigation” and needed no further information “at this time.”

The Securities and Exchange Commission had no comment on the investigation. In an email to Reuters, Bankman-Fried wrote: “FTX’s response there was subtle; the FTX US rewards program did not involve the lending of any assets.”

Additional reporting by Chris Prentice and Hannah Lang in Washington and Angus Berwick in London; Editing by Megan Davies, Paritosh Bansal and Chris Sanders

Our Standards: The Thomson Reuters Trust Principles.

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