The collapse of FTX, one of the world’s largest cryptocurrency exchanges, has unleashed another bout of volatility in the highly speculative market for digital assets. The fortune of FTX founder Sam Bankman-Fried went from nearly $16 billion to zero within days when his crypto empire filed for bankruptcy protection in the United States on November 11. Here we answer some of your questions about the story so far.
How was FTX structured and what was its business model?
In corporate terms, FTX was a chaotic web of more than 100 different companies, all united under the common ownership of Bankman-Fried and his co-founders, Gary Wang and Nishad Singh. In a bankruptcy filing, John Ray III – an American bankruptcy specialist who previously oversaw Enron’s collapse – described it as four main “silos”: a venture capital arm, which invested in other companies; a hedge fund, which traded crypto for profit; and two exchanges, one presumably ring-fenced and regulated for the American public, and an international exchange where the rules were much looser.
The revenue streams were as diverse as the business, but the core of the group was the exchange. Most people buy cryptocurrency by transferring money (“fiat”) to an exchange like FTX, which acts as an exchange agency and trades currency pairs at a floating exchange rate. FTX’s regulated exchange offered that service, and the company took a cut of each transaction, but the big money was in the much more aggressive trading on the international exchange, where traders would try to profit from swings in crypto-asset prices and borrow money to increase their potential earnings (or losses). The more complex the trade, the larger the average.
Why did it collapse?
In the short term, because of a token called FTT. This was effectively a stake in FTX, which the company itself issued and promised to buy back with a portion of the profits. But documents leaked to news site CoinDesk suggested that Alameda, the group’s hedge fund, used FTT to make risky loans – which are actually traded using corporate junk. The revelation prompted a major holder of FTT, rival exchange Binance, to declare that it was selling its holdings, leading to a spread on the exchange as other customers tried to withdraw their funds.
In the medium term, it collapsed due to deeper problems to do with the connection between FTX and Alameda. The exchange did not have the ability to accept wire transfers, so customers would send money to Alameda and FTX would credit their accounts. But the actual money was never advanced: three years later, Alameda had held, traded, and often lost, $8 billion in FTX client funds. When the run on the stock market started, FTX couldn’t find the money it thought it had because it had never taken it.
In the long run, FTX failed because the company was a mess. “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of reliable financial information as occurred here,” said Ray, the bankruptcy specialist.
What does FTX’s fate tell us about cryptocurrencies?
Within the sector, different conclusions have been drawn. Some have argued that the collapse is a triumph for “decentralized finance,” or DeFi, which uses computer code to build versions of financial services that don’t rely on trust or a central party. The head of a DeFi exchange can’t buy a $40 million penthouse with client funds because there is no head.
But outside the sector, the conclusion is clear. Cryptocurrencies are a bet on the idea that a world where government power over money and finance ends would be better: the collapse of FTX is perfect proof that actually government regulation over finance is quite useful.
Will people get their money back?
Some people will get some money back, but no one will get all of it. Even Bankman-Fried is convinced that it would take an $8 billion capital injection to make every depositor whole. But the accounts that Ray presents make it clear that this is wishful thinking. There isn’t even a single document detailing all of the company’s depositors, he says, and while the balance sheet suggests a healthy mix of assets and liabilities, “I don’t have confidence in it and the information in it may not be accurate as of the date indicated.”
Robert Frenchman, a partner at New York law firm Mukasey Frenchman, said FTX customers in the US whose money is trapped in the failed business will have to join a queue of creditors because there are no special protections for customers of unregistered crypto firms that FTX.
“There is no backstop here for US clients, unlike bank or brokerage account holders. Clients will have to fight it out with everyone else because they have no special protections. They go into this process as individual creditors, or as a group of creditors if they band together, who must fight against legions of other creditors, large and small.”
Meanwhile, the U.S. Attorney’s Office for the Southern District of New York is investigating the case, and U.S. Treasury Secretary Janet Yellen has said crypto markets need more robust oversight.
Could there be contagion within the crypto markets?
There have already been signs of a spillover effect. BlockFi, a crypto lender that was bailed out by FTX this summer, has paused customer withdrawals and admitted it has “significant exposure to FTX”. On Wednesday, crypto exchange Genesis made “the difficult decision to temporarily suspend redemptions” from the company’s lending business following a series of withdrawals from the service.
This week, the CEO of Singapore-based crypto exchange Crypto.com said his company would prove wrong anyone who said the platform was in trouble, adding that it had a robust balance sheet and was not taking any risks. Kris Marszalek made the statement after investors questioned the transfer of $400 million worth of ether tokens from Crypto.com to another exchange called Gate.io on October 21. Marszalek said the transfer was a mistake and the ether tokens had been returned to the exchange.
Crypto market watchers expect more volatility, although the central crypto asset, bitcoin, has held its own this week by staying largely unchanged at around $16,700.
Teunis Brosens, head of regulatory analysis at Dutch bank ING, said the crisis would “certainly deepen” the recent crypto winter, which has seen the value of the crypto market fall from $3tn last year to less than $1tn now.
“In terms of prices, we saw bitcoin fairly stable around $19,000-$20,000 for months. I would consider it likely that we will now seek stability at lower levels – but first the storm has to settle, and we are definitely not there yet .”
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