Uncovering the implications of FTX for crypto custody with Anchorage Digital’s Diogo Monica

What started as a Twitter war between two crypto billionaires has turned into an unending saga with telenovela plot twists for the crypto industry. The rivalry between CZ of Binance, and SBF of FTX, came to a head in early November, with FTX Trading Limited exchange experiencing a bank run and filing for chapter 11 bankruptcy in the state of Delaware. 

Soon after, its Bahamian subsidiary FTX Digital Markets Limited filed for chapter 15 bankruptcy in New York. And since then, media outlets have been caught up in a whirlwind of rumors, speculations, and accusations. The facts or folklore surrounding the $32 billion empire collapse are so bizarre that Amazon pre-ordered an 8-part series covering the scandal. That was in November.

Early in December, just when we thought the situation was safely tucked away in the capable hands of John J Ray III, Sam Bankman-Fried emerged with a sudden urge to come clean and “do his best to help” FTX customers. Against the advice of legal counsel, SBF conducted a ferocious series of interviews appearing on Bloomberg, The New York Times, and even Twitter Spaces, to name a few.  

Amid all this drama, the bottom line is that FTX investors are billions of dollars out of pocket because of entrusting custody of their crypto to a centralized exchange. Wading through the sensational revelations, Tearsheet reached out to crypto custody expert Diogo Monica of Anchorage for commentary on the issue. 

“Without segregated custody, there are insufficient controls in place for a crypto exchange to hold custody of customer assets without the ability to spend them. That’s a major problem,” says Monica. 

Monica believes that moving forward, a clear distinction between custody and exchange is essential for promoting a fairer crypto market structure, and that is the safest way to carry out proper consumer protection. “Until we have a regulatory regime that wholly eliminates counterparty custody risks — making the commingling of funds structurally impossible — the industry will continue to face problems caused by misaligned interests,” he added.

Traditional finance has long held that exchanges and custodians should be structurally different. Case in point, even though FTX’s terms and conditions strictly forbid using customers’ funds, the current debacle is based on Bankman-Fried allegedly transferring funds between Alameda, FTX’s trading company, and the FTX exchange. 

While reeling from their FTX losses, hedge funds are looking to Wall Street for solutions. However, Anchorage Digital launched an industry-first custody exchange network in June 2022.

The network was solely created to separate custodianship from exchanges, allowing customers to maintain control of their digital assets until trade settlement. Aimed as a solution for the crypto community, the initial launch of the network included partnerships with Binance.US and commitments from CoinList, Blockchain.com, Strix Leviathan, and Wintermute.

“The FTX crisis highlights the urgent need for crypto market structure reform. The industry and regulators need to ensure that crypto is held to the same high standards as traditional finance,” says Monica. 

As the co-founder and president of America’s first federally chartered digital asset bank, Monica believes that exchange and custody functions should be separated, and customer funds should never be commingled with firm assets. He is hopeful that lawmakers will move fast to pass workable crypto regulation that follows traditional finance’s playbook while improving upon it.

“As recent events have highlighted, a regulatory regime that has a clear distinction between custody and exchange is an important guardrail for consumer protections,” said Monica. 

Looking ahead, Anchorage Digital will engage with lawmakers and regulators to pave a path forward for a safer crypto market structure. The firm also believes that stablecoins have the potential to bolster and upgrade the US dollar for the digital age, and is closely watching for any legislative movement on stablecoin regulation, like the Waters-McHenry draft stablecoin bill. 

As the DOJ and SEC continue their investigations of FTX, and the contagion continues to unfold in what Janet Yellen calls the “Lehman moment within crypto,” hopefully, common law and sense will prevail over the 'smartest guy in the room syndrome.'