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 like Bitcoin or Ethereum, for 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 their 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 prohibited in the United States. Sam Bankman-Fried, the ex-CEO and founder of FTX, gained fame as a prominent figure in the world of cryptocurrency. At just 30 years old, he was a rising star in the industry and well-known for his generous donations to the Democratic Party, and multiple media outlets labelled him as the next Warren Buffet. Additionally, the vegan Bankman-Fried was a strong advocate for the concept of effective altruism, which encourages individuals to donate their wealth in the most effective and logical ways possible.

The rapid downfall 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 big 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 being in FTT, a coin issued by FTX. 

Alameda representatives said that the leaked document didn't show their full financial picture, and they actually had over $10 billion in assets not reflected in the leaked balance sheet. However, investors were still worried because FTT was being used as collateral on FTX's balance sheet and FTX had borrowed billions of dollars from Silicon Valley. This meant Alameda's assets were tied to a risky and volatile coin. It also contradicted Bankman-Fried's previous 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.

However, when Zhao expressed concerns about FTX's financial stability, it sparked panic among investors, who began withdrawing their funds in large numbers. That left FTX owing customers $8 billion. Despite Binance's offer of a loan, FTX ultimately 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 like Sequoia Capital, SoftBank, and BlackRock, but the lack of oversight and disclosure regarding the company's relationship with Alameda Research led Sequoia to apologise 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 acquire FTX since it was facing financial troubles. The deal was intended to protect customers and allow FTX to process their withdrawals, but Binance reserved the right to pull out at any time. However, the next day, Binance decided not to go through with the acquisition, citing regulatory investigations and concerns about mishandled funds. Binance stated that the crypto industry would become more resilient over time, and those who misuse 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 in search of quick and substantial returns, often neglecting to consider the potential risks involved. However, as with any previous market crash, 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, wire 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 tied 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 feel empathy towards him and fear economic fallout for the island if he and other cryptocurrency investors do not return. Bankman-Fried was working to diversify the Bahamian economy beyond tourism, and his associates were known for being generous employers. FTX's new CEO has accused Bahamian authorities of withdrawing $100 million from the cryptocurrency exchange before its collapse, but the securities regulator for the Bahamas denied this.

The collapse of FTX has had significant repercussions for the cryptocurrency industry, as it has amplified concerns about the trustworthiness of the industry among regulators, investors, and the public. Investigations by the Justice Department and the Securities and Exchange Commission have been launched to probe whether FTX improperly used customer 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 plummeted more than 90% since November 8th, while the price of Bitcoin is down about 19% this month and Ether is down about 24%.

FTX's fall has also had ripple effects throughout the industry, as lenders like BlockFi and Genesis announced pauses in operations. Days after that announcement, BlockFi, a cryptocurrency lender that targeted small investors, filed for bankruptcy due to its financial ties to FTX, the troubled exchange that has shaken the cryptocurrency industry. BlockFi had offered loans backed by cryptocurrency and accounts that paid high interest on crypto deposits, claiming to have over 450,000 retail clients. 

After a market panic in the spring, the lender struck a deal with FTX in June, which gave it a $400 million credit line. However, when FTX filed for bankruptcy, BlockFi was unable to fulfil customer withdrawals due to its financial entanglement with FTX. BlockFi filed for Chapter 11 protection in New Jersey on Monday and stated 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 safety of exchanges and the security of users' cryptocurrencies. As a result, many individuals are opting to sell their cryptocurrencies and invest in other assets, such as stocks or bonds, while others are choosing to move their cryptocurrencies to a secure offline wallet known as a cold wallet or hardware wallet. However, the selling 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 could cause further defaults in the future. 

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

In our view, the recent cryptocurrency turmoil resulting from the FTX fallout can be likened to the Lehman Brothers collapse in September 2008, with the primary distinction 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 it). Two years after the Lehman Brothers' downfall, the world returned to a state of normalcy, and people went back 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 per se but rather the unethical practices of the people managing the exchanges. Similarly, the 2008 financial crisis was not the result of inherent flaws in money itself but rather the inefficient performance of those managing the banks. 

History has shown us that human greed knows no bounds, and unfortunately, these types of events will persist as long as humans control these organisations. Cryptocurrencies may have their pros and cons, and only time will tell whether they are truly beneficial, but condemning them solely based on human avarice 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 doctoral 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 opinions and views of The Business Standard.