The collapse of FTX, one of the largest cryptocurrency exchanges in the world, has unleashed another bout of volatility in the highly speculative digital asset market. FTX founder Sam Bankman-Fried’s fortune went from about $16 billion to zero in a matter of days as his cryptocurrency 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 is FTX structured and what is its business model?
On the corporate side, FTX was a chaotic network of more than 100 different companies, all united under the joint 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 the collapse of Enron—described it as four major “silos”: the venture capital arm, which invested in other businesses; a hedge fund that trades cryptocurrencies for profit; and two exchanges, one supposedly boxed in and regulated for the American public, and another an international exchange where the rules were freer.
The sources of revenue were as diverse as the business, but the core of the group was exchange. Most people buy cryptocurrencies by transferring money (“fiat currencies”) to an exchange like FTX, which operates like an exchange bureau, trading currency pairs at a floating exchange rate. FTX’s regulated exchange provided that service, and the company took a cut of every transaction, but the big bucks were in more aggressive trading on the international exchange, where traders would try to take advantage of fluctuations in crypto-asset prices, borrowing money to increase their potential profits (or losses). The more complex the trade, the higher the cut.
Why did it collapse?
In the short term, because of a code called FTT. This was effectively a stake in FTX, which the company issued itself and promised to buy back using a portion of its profits. But documents leaked to news site CoinDesk indicated that Alameda, the group’s hedge fund, was using FTT to make risky loans — effectively trading using the company’s stock. The revelation prompted a major owner of FTT, a rival trading platform Binance, to announce the sale of his holdings, prompting a decline on the exchange as other clients scrambled to withdraw their funds.
In the medium term, it collapsed due to deeper issues related to the link 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 never got through: Three years later, Alameda held $8 billion in FTX clients’ money, traded it, and often lost it. When the stock market crash started, FTX couldn’t find the money it thought it had, because it never took it.
In the long run, FTX failed because the company was in shambles. “Never in my professional life have I seen such a complete failure of corporate controls and such complete absence of trustworthy financial information as here,” said Ray, the bankruptcy specialist.
What does the fate of FTX tell us about cryptocurrency?
Within the sector, different conclusions have been drawn. Some have argued that the crash is a victory for “decentralized finance,” or DeFi, which uses computer code to build versions of financial services that don’t rely on a centralized trust or party. The head of a DeFi exchange cannot buy a $40 million penthouse with customer money because there is no head.
But the conclusion is clear outside this sector. Cryptocurrencies are a bet on the idea that a world where government power over money and finance ends will be better: the collapse of FTX is perfect proof that government regulations on finance are actually very beneficial.
Will people get their money back?
Some people will get some money back, but no one will get everything. Even Bankman-Fried is convinced it will take $8 billion in capital for each depositor to complete. But the accounts Ray gives 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 indicates a healthy mix of assets and liabilities, “I don’t trust it and the information in it may not be correct as of the date stated.”
Robert Frenchman, a partner at the New York law firm Mukasey Frenchman, said US FTX clients whose money is trapped in failed businesses will have to join a waiting list of creditors because there are no special protections for clients of unregistered crypto firms like FTX.
“There is no support here for clients in the US, unlike with bank or brokerage account holders. Clients will have to fight it out with everyone else because they have no special protection. They go into this process as individual creditors, or as a group of creditors if they come together, who They must contend with hordes of other creditors, large and small.”
Meanwhile, the US Attorney’s Office for the Southern District of New York is reportedly looking into the case and US Treasury Secretary Janet Yellen said cryptocurrency markets need more robust oversight.
Could there be infection within the cryptocurrency markets?
There were already signs of a spillover effect. BlockFi, the crypto lender that FTX bailed out in the summer, has paused customer withdrawals, admitting it has “significant exposure to FTX.” On Wednesday, cryptocurrency exchange Genesis made the “difficult decision to temporarily suspend redemptions” from the company’s lending business after a series of withdrawals from the service.
The CEO of Singapore-based crypto exchange Crypto.com said this week that his company would prove wrong all those who said the platform was in trouble, adding that it had a strong balance sheet and took no risks. Chris Marsalek made the statement after investors questioned the October 21 transfer of $400 million worth of ether tokens from Crypto.com to another exchange called Gate.io. Marszalek said that the transfer was a mistake and that the ether tokens have been returned to the exchange.
Cryptocurrency market watchers expect more instability, though the primary cryptocurrency asset, bitcoin, has held up this week by remaining broadly flat around $16,700.
Teunis Brosens, head of regulatory analysis at Dutch bank ING, said the crisis would “certainly deepen” the recent crypto winter, which sent the value of the crypto market down from $3 trillion last year to less than $1 trillion now.
In terms of prices, we have seen bitcoin quite stable around $19,000-$20,000 for months. I think it’s likely that we will now seek to stabilize at lower levels – but first, the storm has to calm, and we’re certainly not there yet. “
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