FTX and Crypto Fallout

Future Exchanges (FTX) was a major player in the world of cryptocurrency exchanges, offering users the ability to trade digital currencies such as Bitcoin or Ethereum, against other digital currencies and traditional money. It was the third largest cryptocurrency exchange by volume and had over one million users. The exchange also had its own cryptocurrency called FTT, and unfortunately the company has since gone bankrupt.

FTX was based in the Bahamas and their success was largely due to the availability of risky trading options that are banned in the US. Sam Bankman-Fried, the former CEO and founder of FTX, rose to fame as a prominent figure in the cryptocurrency world. At just 30 years old, he was a rising star in the industry and known for his generous donations to the Democratic Party, with several media outlets labeling him as the next Warren Buffet. In addition, the vegan Bankman-Fried was a strong proponent of the concept of effective altruism, which encourages individuals to donate their wealth in the most efficient and logical ways possible.

The rapid demise of FTX, one of the world’s largest cryptocurrency exchanges, has become a cautionary tale for investors in the volatile world of digital currencies. On November 2, 2022, CoinDesk, a news agency focused on cryptocurrency, released a report that had a major impact on the crypto industry. The report stated that Alameda, a company in the industry, had assets worth $14.6 billion as of June 30, 2022, with most of it in FTT, a coin issued by FTX.

Representatives for Alameda said the leaked document did not show the full financial picture, and they actually had over $10 billion in assets that were not reflected in the leaked balance sheet. However, investors were still concerned because FTT was used as collateral on FTX’s balance sheet and FTX had borrowed billions of dollars from Silicon Valley. This meant that Alameda’s assets were tied to a risky and volatile coin. It also contradicted Bankman-Fried’s earlier claims that Alameda and FTX were separate entities. But what actually triggered FTX’s fallout was a transaction between FTX founder Sam Bankman-Fried and Binance CEO Changpeng Zhao, in which Zhao sold his stake in FTX for FTT tokens.

But when Zhao expressed concern about FTX’s financial stability, it sparked panic among investors, who began withdrawing their money in large numbers. That left FTX owing customers $8 billion. Despite Binance’s offer of a loan, FTX eventually filed for bankruptcy, triggering investigations by the SEC and DOJ. FTX’s former CEO resigned, and the company’s bankruptcy case now involves more than 100 companies and over a million creditors, with a significant amount of assets missing or stolen.

FTX’s investors included well-known firms such as Sequoia Capital, SoftBank and BlackRock, but the lack of oversight and disclosure regarding the company’s relationship with Alameda Research led Sequoia to apologize to its limited partners for its investment in FTX, which it now values ​​at zero. dollars. John Jay Ray III, a veteran of corporate turnarounds, has replaced Bankman-Fried as FTX’s CEO and described the “complete failure of corporate control” at FTX as unprecedented.

In early November, Binance announced plans to buy FTX as it was facing financial problems. The agreement was meant to protect customers and allow FTX to process their withdrawals, but Binance reserved the right to withdraw at any time. But the next day, Binance decided not to go through with the acquisition, citing regulatory investigations and concerns about misused funds. Binance stated that the crypto industry would become more robust over time and those who abuse user funds would eventually be removed from the market.

The collapse of FTX, along with the involvement of Binance, serves as a warning about the risks of the rapidly changing world of cryptocurrency. Investors often dive into the cryptocurrency market looking for quick and substantial returns, often failing to consider the potential risks involved. But as with all past market crashes, this experience should serve as a valuable lesson for future investors.

The situation was further complicated by a leaked document suggesting that FTX had improperly used customer funds to support Alameda Research. Sam Bankman-Fried was charged with securities fraud, bank fraud and several conspiracy counts, including money laundering and campaign finance violations. The charges stem from the scheme that began in 2019 to defraud FTX crypto exchange customers and lenders to Alameda Research, which was closely linked to FTX.

The indictment also alleges that Bankman-Fried committed wire fraud by obtaining large loans and providing false and misleading information to lenders about Alameda’s financial condition. Sam Bankman-Fried, who lived in the Bahamas for a year and donated millions of dollars to Bahamian charities and government entities, was arrested and extradited to the United States to face the charges previously mentioned.

Despite his alleged crimes, many Bahamians empathize with him and fear economic fallout for the island if he and other cryptocurrency investors do not return. Bankman-Fried worked to diversify the Bahamian economy beyond tourism, and his associates were known to be generous employers. FTX’s new CEO has accused Bahamian authorities of withdrawing $100 million from the cryptocurrency exchange before it collapsed, but the Securities and Exchange Commission of the Bahamas denied this.

The collapse of FTX has had significant implications for the cryptocurrency industry, as it has heightened concerns about the industry’s reliability among regulators, investors and the public. Investigations by the Justice Department and the Securities and Exchange Commission have been launched into whether FTX improperly used client funds to prop up Alameda Research, the trading firm co-founded by Bankman-Fried. Additionally, the price of FTT, a native cryptocurrency token for FTX, has fallen more than 90% since November 8, while the price of Bitcoin is down around 19% this month and Ether is down around 24%.

FTX’s downfall has also had ripple effects throughout the industry, as lenders such as BlockFi and Genesis announced pauses in operations. Days after that announcement, BlockFi, a cryptocurrency lender targeting retail investors, filed for bankruptcy over its financial ties to FTX, the troubled exchange that has rocked the cryptocurrency industry. BlockFi had offered loans backed by cryptocurrency and accounts that paid high interest on crypto deposits, and claimed to have over 450,000 retail customers.

After a market panic this spring, the lender struck a deal with FTX in June, giving it a $400 million credit line. However, when FTX filed for bankruptcy, BlockFi was unable to fulfill customer withdrawals due to its financial entanglement with FTX. BlockFi filed for Chapter 11 protection in New Jersey on Monday, stating that it has more than 100,000 creditors and $10 billion in assets and liabilities.

The recent FTX incident has had a significant impact on the cryptocurrency community, causing concern about the security of exchanges and the security of users’ cryptocurrencies. As a result, many individuals choose to sell their cryptocurrencies and invest in other assets, such as stocks or bonds, while others choose to move their cryptocurrencies to a secure offline wallet known as a cold wallet or hardware wallet. However, the sale of cryptocurrencies has led to a decline in their prices, and the withdrawal of assets from exchanges has resulted in a decrease in liquidity, which may lead to further defaults in the future.

Despite the potential utility of the technology behind some cryptocurrencies, many investors view them as speculative assets and hold them solely for the purpose of making money through buying and selling. The aftermath of the FTX incident does not bode well for the future of these assets. Until people start seeing them as potentially valuable assets rather than just speculative investments, they are unlikely to gain wider acceptance and use.

In our view, the recent cryptocurrency turmoil resulting from the FTX fallout can be compared to the September 2008 Lehman Brothers collapse, with the primary difference being the underlying asset involved (cryptocurrencies versus fiat money). Just as people continued to trust and use fiat currency after the 2008 crisis, we should maintain our faith in cryptocurrencies despite the FTX incident (in case we ever had one). Two years after the fall of Lehman Brothers, the world returned to a normal state and people returned to their daily routines without dwelling too much on the past.

It is crucial to understand that the root cause of this disaster is not cryptocurrencies themselves, but rather the unethical practices of the people who manage the exchanges. Likewise, the financial crisis of 2008 was not the result of inherent flaws in money itself, but rather the inefficient performance of those who manage the banks.

History has shown us that human greed knows no bounds, and unfortunately these types of events will continue as long as humans control these organizations. Cryptocurrencies may have their pros and cons, and only time will tell if they are truly beneficial, but condemning them based solely on human greed seems foolish to us.

M. Kabir Hassan is a professor of finance at the University of New Orleans. José Antonio Pérez Amuedo is a PhD student at the University of New Orleans.

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views and opinions of The Business Standard.