This Week in Policy (11/28)

This Week in Policy (11/28)

Hello Fintech Friends!

I hope you all enjoyed a relaxing break, which was absolutely deserved after the past tumultuous weeks in crypto land. Do you know that some communities in the U.S., primarily Native Americans, do not celebrate Thanksgiving Day and instead observe what they call a National Day of Mourning?

This week, we continue our coverage of FTX-related news. We also catch up on some exciting central-bank-digital-currency (CBDC) developments that happened over the past weeks.

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1.       FTX

Last Tuesday, CoinDesk published a letter from Sam Bankman-Fried (SBF) that had been shared internally on the FTX Slack channel by a current employee because SBF no longer has access. SBF did not comment on the claims that FTX lent out customers’ assets to FTX’s sister company Alameda Research without customers’ approval, or that Alameda Research extended loans to FTX senior officers, including SBF himself. He rather focused on how successive market crashes quickly pushed FTX from solvency (with $60B in collateral and $2B in liabilities) to insolvency (with over $8B in uncovered liabilities) in the span of 10 months only. Remember our discussion of how the crypto winter happened? This is the part of the FTX story that SBF talked about. The other part, of course, is FTX’s high leverage (i.e., high indebtedness) and lack of transparency.

What is happening to FTX now? Following FTX’s crash on November 11, two parallel bankruptcy proceedings were initiated before U.S. courts. The first were initiated by FTX itself under Chapter 11 of the U.S. Bankruptcy Code in Delaware through which FTX hoped to get extraterritorial protection for its assets all over the world. The second were filed by Bahamian liquidators under Chapter 15 in New York on the grounds that FTX is a Bahamian company that is going through foreign insolvency proceedings outside of the U.S. and, thus, is not entitled to Chapter 11 protection. Last Tuesday, the two parties reached an agreement to transfer the New York proceedings to the Delaware Court, which means that U.S. law would play the main role in the bankruptcy process.

On November 11, right after FTX filed for bankruptcy, blockchain forensics firm Elliptic revealed that $663M worth of tokens on FTX was hacked, out of which $477M is thought to have been stolen, while the rest is believed to have been securely transferred by FTX itself. In its court filing, new FTX CEO John Jay Ray III accused the Bahamian government of “directing unauthorized access” to FTX’s assets. On November 17, the Securities Commission of The Bahamas announced that, on November 12, it did direct “the transfer of all digital assets of FTX…to a digital wallet controlled by the Commission, for safekeeping.” The Commission later clarified that the “hacking attempts” on FTX’s assets “reinforc[e] the wisdom of the Commission’s prompt action to secure these digital assets.”

Meanwhile, many are wondering about what will happen to the generous political donations SBF and his Co-CEOs spent during the 2022 midterm cycle. Some lawmakers, including Sen. Kirsten Gillibrand (D-NY), Rep. Chuy Garcia (D-IL), and Rep. Kevin Hern (R-Ok), announced that they will give all FTX donations to charity. Legal expert, John Deaton, seems to think that this is not the right approach, suggesting that these donations could be restored by FTX’s creditors through preference claims (which aim to protect the creditors of a bankrupt debtor). Last March, eight of the recipients of these donations, four Democrat and four Republican House members, tried to slow down information requests made by the Securities and Exchange Commission (SEC) to various crypto exchanges, including FTX, by questioning the authority of SEC Chair, Gary Gensler, to make such requests. Interestingly, the leader of that group, Rep. Tom Emmer (R-MN), is currently one of the main voices that blame the FTX fiasco on both Gensler and SBF.

2.       CBDCs

Let’s turn to some uplifting CBDC news, which we did not have a chance to cover last week. On November 7, the President of the European Central Bank, Christine Lagarde, announced that EU authorities have made progress in exploring the rationale, benefits, and risks of the digital euro and that the EU Commission will present a legislative framework for the digital euro in the near future. In the same vein, the Bank of Japan confirmed last week that it will be working with three Japanese megabanks as well as several regional banks on a CBDC pilot, which reverses its earlier decision last summer to halt a digital yen pilot for lack of popular interest. By the end of the pilot in 2026, the Bank of Japan is expected to roll out its CBDC.

What about the U.S.? Three major developments happened over the past three weeks. On November 4, the Innovation Center of the Federal Reserve Bank of New York (NY Fed) released a report on the first phase of Project Cedar—a wholesale (i.e., intermediated) CBDC pilot conducted in collaboration with the Monetary Authority of Singapore. In this first phase, a foreign exchange spot transaction (an agreement to exchange two currencies at a certain rate), which usually takes two days to complete, was done in under 10 seconds. In less than two weeks, on November 15, the Innovation Center of the NY Fed announced that it will be leading the Regulated Liability Network, which is a proof-of-concept project that explores how various forms of digital money can be interoperable on the same multi-entity distributed ledger. Besides the NY Fed, the list of participants includes Citi, BNY Mellon, Wells Fargo, HSBC, Mastercard, and SWIFT. The third major development was a paper published by the Fed on November 17, which included a pioneering discussion of how the payment of interest could be integrated into the design of a future U.S. CBDC. The most notable aspect of the paper is its conclusion that paying interest “is arguably the key design feature that any central bank would want to contemplate,” and that “[a] CBDC that pays no interest is consigned to the role of a medium of exchange.” Can you imagine what an interest-bearing CBDC could mean for other digital means of payments, especially stablecoins, that pay no interest?

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See you next week!