Block11 Lessons from FTX Collapse and New Capital Risk Framework

Description: The Financial Services Agency of Japan (JFSA) will conduct a presentation on Japan’s crypto asset-related regulations, mainly focusing on stablecoin legislation and the measures taken following the FTX collapse. This presentation will be followed by a Q&A session and an open discussion. In the second part of this session, a new capital risk framework for stablecoins will be presented and discussed.

In response to the presentation by Hayashi-san from JFSA with regards to the measures taken following the FTX collapse, there are some important points to address:

  1. The conflict between the Chapter 11 procedure initiated by the representative of FTX Global and the segregation required by the Japanese regulatory framework arises from the unique characteristics of the Chapter 11 court in the U.S. Under the Japanese bankruptcy procedure, it is impossible to file bankruptcy petitions without the consent of the entity controlling the bankruptcy funds. In contrast, the U.S. Chapter 11 court took jurisdiction over the funds even though the entity that controls the funds in Japan did not consent to the initiation of the Chapter 11 procedure. This issue requires international coordination among jurisdictions to determine which should take the lead in facilitating the distribution of respective funds globally. Therefore, the regulatory approach proposed by Hayashi-san faces challenges. Regulatory bodies generally do not have the authority to coordinate court jurisdiction. To address this difficulty, I suggest that JFSA continue discussions with U.S. Chapter 11 courts and deepen its understanding of bankruptcy procedures in the U.S. From a global perspective, engaging in discussions with regulators from different jurisdictions regarding bankruptcy procedures could also be beneficial.

  2. While Hayashi-san highlighted the importance of the cold wallet requirement, which is typical of the Japanese regulatory framework, the key point is not merely that customer funds are segregated in a cold wallet. The most crucial aspect is that Japan has full control over the policy engine that authorizes transactions from the wallet where customer funds are stored, as well as the backup key for the cold wallet. In FTX’s case, there was a risk that individuals on FTX’s global side might have had full control over the entire backup key of the cold wallet used for Japanese customers.
    I suggest that JFSA reconsider the internal control structure to ensure that Japanese VASPs have full control over the wallet transaction policy engine and backup key.

Thank you for your insightful comments. While I cannot ensure that JFSA will take specific action based on them, I will share your feedback internally with the Fintech Policy Office.