Lessons from FTX Collapse and the Future of Capital Risk Management

One year since the FTX Collapse and Capital Risk Framework BGIN Block #11

Key Takeaways:

• Japan's regulatory framework enabled the successful return of customer assets from FTX Japan.

• Asset segregation and local regulatory compliance were crucial factors in protecting Japanese users.

• Circle introduced a new risk-based capital framework for stablecoin issuers.

• Bankruptcy segregation and global system risks emerged as key challenges

• The incident highlighted the importance of business continuity planning in crypto firms

  

The JFSA Response

The session opened with insights from Japan's Financial Services Agency (JFSA) on how their regulatory framework, developed since 2016, helped protect local customers during the FTX collapse. As one JFSA representative explained:

"FTX Japan became the first FTX entity to allow users to withdraw crypto assets and cash, thanks to Japan's asset segregation requirements."

Key Protective Measures

Japan's regulatory framework included:

• Mandatory registration for crypto asset service providers

• Strict asset segregation requirements

• 95% cold wallet storage requirement

• Regular external audits

• Comprehensive KYC protocols

Lessons Learned

Three critical insights emerged from the FTX collapse:

1. Bankruptcy Segregation

   • Parent company bankruptcy laws can obstruct timely asset return

   • Local regulatory frameworks need independence

2. Global System Risks

   • Shared systems across entities can delay asset access

   • Need for operational independence in emergencies

3. User Understanding

   • Confusion about protection under different entities

   • Importance of clear communication about regulatory coverage

Circle's New Capital Framework

Circle presented a forward-looking approach to capital risk management with five main risk categories:

1. Financial risk

2. Concentration risk

3. Operational risk

4. Liquidity risk

5. Governance risk

The Issuer Balance Sheet Model

Key components include:

• Asset side: Liquid reserves

• Liability side: Customer obligations

• Loss-absorbing capital

• Dynamic risk assessment

• Quarterly evaluations

As Circle's representative noted: "The reserve capital should be in cash or highly liquid assets, not in assets like Bitcoin or other tokenized assets."

Operational Resilience

The framework emphasizes:

• Value-at-risk models for long-tail risk

• Regular stress testing

• Blockchain infrastructure risk assessment

• Dynamic capital requirements

Regulatory Evolution

The incident has sparked regulatory changes:

• Enhanced guidelines for crypto asset service providers

• Stronger focus on business continuity planning

• Improved asset segregation requirements

• Cross-border cooperation frameworks

Looking Forward

Key recommendations for the industry:

1. Implement robust asset segregation

2. Maintain operational independence

3. Develop comprehensive business continuity plans

4. Ensure clear customer communication

5. Regular stress testing of systems and procedures

BGIN's Role

BGIN is working to:

• Document lessons learned

• Develop best practices

• Create educational resources

• Foster international cooperation

Join the Conversation

The industry needs continued dialogue and collaboration to prevent future crises. BGIN invites stakeholders to contribute to developing more robust frameworks for capital risk management in the crypto space.

---

This blog post is based on discussions from BGIN Block #11, Washington DC, October 21, 2024.

For more information about BGIN and upcoming events, visit BGIN

Join the conversation on our forum & Working Group Calls