Failure of leading exchange operator shows high risk of digital assets

It has long been argued that crypto-assets, or cryptocurrencies, whose values have no state-backed credibility, are used as tools for money games. The collapse of a major international exchange operator can be described as a wake-up call to this danger.

FTX Trading Ltd., a cryptocurrency exchange operator headquartered in the Bahamas, has filed for Chapter 11 of the U.S. Bankruptcy Code, the equivalent of Japan’s Civil Rehabilitation Law.

There are said to be more than 100,000 creditors, for debts that could run into several trillions of yen. It is believed to be one of the largest bankruptcies ever for this kind of business.

Cryptocurrencies are a type of asset that is exchanged online. There are many types, of which bitcoin is a prime example, and exchange operators such as FTX provide services such as brokering transactions.

Legal tender such as the yen and the dollar have the backing of central governments and central banks, but cryptocurrencies do not. Their prices fluctuate wildly, and speculation can easily become heated. Users need to fully understand the high level of risk involved in cryptocurrencies.

When it was reported that FTX was having financial problems, it triggered investors to withdraw their money in one fell swoop, and the company suffered a blow to its cash flow. Another leading company in the same industry came forward with a potential bailout acquisition, but after conducting due diligence, that company withdrew from the deal.

There are suspicions that FTX had misappropriated customer assets. It is reported that the U.S. authorities have begun an investigation. The full picture must be revealed as soon as possible.

FTX also operates in Japan. The Finance Ministry’s Kanto Local Finance Bureau has issued administrative measures, including a partial business suspension order, to FTX Japan K.K., its Japanese subsidiary, calling for it to preserve customers’ assets.

FTX Japan says that clients’ assets are in 14 cryptocurrencies, including bitcoin, and these are managed separately from its own assets. The company also explained that, therefore, the entire amount of clients’ assets is protected, adding that it held about ¥19.6 billion in cash and deposits as of Nov. 10.

However, the U.S. Bankruptcy Code filing also covers Japanese subsidiaries, and some believe that it is unclear whether assets in Japan will be preserved. The Financial Services Agency should do its best to protect customers.

Cryptocurrencies became widespread in Japan in the early 2010s and became a popular investment vehicle due to expectations of increased valuations. In 2017, the FSA was the first agency in the world to introduce a registration system for exchange operators.

However, the industry’s sloppy asset management has been called into question, as evidenced by the outflow of about ¥58 billion worth of assets from an exchange operator in 2018.

The FSA has tightened controls on the industry with such steps as enforcement of the revised Payment Services Law in 2020. The failure of the cryptocurrency exchange operator should serve as an opportunity to further strengthen monitoring and supervision of the industry.

(From The Yomiuri Shimbun, Nov. 16, 2022)