On November 11, the second largest cryptocurrency exchange in the world, FTX, filed for bankruptcy. Reports emerged that FTX had no liquidity and was propped up solely by the trust the market had in its currency. When the news broke, investors began scrambling to sell off their tokens and pull money out of FTX, ultimately leading to the demise of the company. With its collapse, billions of dollars in customer funds are now lost and further billions in sponsorship money have also disappeared. The collapse of FTX rocked the cryptocurrency world and reinvigorated discussions around regulation. How could such a large exchange escape scrutiny for so long? We explore the collapse of FTX and the effects of the collapse on wider markets.
What was FTX?
FTX was the world’s second largest exchange. Headquartered in the Bahamas, the company was valued at $32 billion in its latest funding round. It was founded and led by “crypto-King ” Sam Bankman-Fried. Bankman-Fried is a 30-year-old whiz-kid and who was dubbed the Warren Buffett of cryptocurrency after becoming one of the youngest billionaires in the world, worth $17 billion.
After founding FTX in 2019, it shot to prominence exponentially. Its aggressive marketing and offer of low fees drew in significant interest. The exchange secured backing from huge investment conglomerates including BlackRock and SoftBank. FTX was a huge donor of the US Democratic Party and received endorsements from celebrities such as Tom Brady and Steph Curry. It became one of the first cryptocurrency firms to advertise during the NFL Super Bowl and had even bought the naming rights for NBA team Miami Heat’s arena.
Why did it collapse?
A cryptocurrency news publisher, Coindesk, reported that FTX was propped up by the Alameda hedge fund, owned by Bankman-Fried. The majority of Alameda’s $14 billion of assets, however, were FTX’s cryptocurrency, FTT. Crucially, this cryptocurrency had been used as collateral in Alameda’s loans. This was a huge proble as if FTT crashed for any reason, then Alameda’s collateral would be worth less and it would not be able to service its debt. If it cannot service its debt, Alameda would collapse. If Alameda collapses, so does FTX.
Competitor exchange Binance reacted to this news and sold off roughly $500 million of its FTT. The situation then spiralled out of control and investors sought to sell off their assets. Around $6 billion worth of FTT tokens were withdrawn over a three-day period, roughly 100 times more than usual. There appeared to be a way out when Binance offered to buy the company. A few days later however, Binance pulled out, claiming there were issues beyond their ability to help. In total, FTX was $8 billion short and filed for bankruptcy along with Alameda Research. Bankman-Fried stepped down as CEO, acknowledging that he “f-ed up”.
The bankruptcy filings and a report by the new CEO showed the scale of mismanagement. The report in particular showed a complete lack of corporate controls. Records of communications, decision making and financials were not kept with any sort of consistency. Board meetings were never held. Employees used customers’ funds to buy real estate in their own names. FTX, a $32 billion company, did not even have an accounting department. The failures at the company were staggering.
Fraud
There have also been allegations of fraud as a huge $1.7 billion has gone missing from FTX. Bankman-Fried secretly transferred $10 billions of customer funds from FTX to Alameda Research. Bankman-Fried used a “backdoor” in the bookkeeping system to transfer the funds without triggering a compliance alert. Of this $10 billion as much as $2 billion has now disappeared. Bankman-Fried denies the characterisation of the transfer as secret and gave no comment on the missing funds. A US Federal investigation is now under way.
Fallout
The main and most severe impact of FTX’s collapse is on its creditors and investors. In its bankruptcy filing it noted 100,000 creditors but recognised this could be up to 1 million. Investors who deposited funds and currency with FTX have collectively lost $8 billion. Individual customers lost thousands of dollars, in some cases over $100,000. These funds are trapped in FTX’s ecosystem, and they were unable to withdraw them before the collapse. Even those invested in unrelated cryptocurrencies saw their assets tumble in price as major tokens sank by 20% following FTX’s collapse.
The celebrities who endorsed FTX have also been sued by investors. Tom Brady, Steph Curry and Larry David are all named in lawsuits over their endorsement of FTX. The class action accuses the celebrities of promoting unregistered securities and breaching Florida’s Securities and Investor Protection Act and the Deceptive and Unfair Trade Practices Act.
On a broader scale, the collapse has led to louder calls for regulation of cryptocurrency markets. US treasury secretary, Janet Yellen, expressed the view cryptocurrency needs “very careful regulation”. Regulators in the UK are also monitoring the situation. The investigations are likely to pile up in the coming months as the dust settles.
Summary
FTX’s collapse is a result of gross negligence at best, but potentially outright fraud at worst. By basing their HQ in the Bahamas and obfuscating their corporate structure with a web of over 100 companies, FTX and Alameda have evaded scrutiny since their inception. As soon as a light was shone on their practices, the house of cards tumbled dramatically. Mismanagement and negligence of this scale should not have been allowed to happen.
With a seemingly unrecoverable $8 billion black hole, investors, creditors and the wider cryptocurrency market will be reeling from FTX’s collapse for months to come. For those individuals who lost chunks of their lives’ savings, the recovery could take decades. Regulators across the world have already been moving to regulate digital asset service firms but FTX’s collapse will undoubtedly expedite this process. If cryptocurrencies are to become truly mainstream financial assets, then such bad actors within the market must be weeded out.
