January 5, 2023
In November 2022, FTX, once a leading cryptocurrency exchange, collapsed. The company had been founded in 2019 and, at its peak, had over one million users. The platform also held a valuation of over $32 billion, but by November 11th it had plunged into the depths of Chapter 11 bankruptcy in just a matter of days.

What happened?

The controversy started when articles began to appear alleging that FTX was mismanaging funds relating to its partner firm, Almeda Research (it would be suggested by anonymous sources soon after that FTX secretly lent $10 billion of customer assets to Almeda).

Soon, rival exchange Binance (led by CEO Changpeng Zhao) announced its plans to sell FTX’s associated FTT token (which FTX had used as collateral in the loans to Almeda, creating a vicious cycle of risk), leading to panicked hordes of customers seeking withdrawals. Binance also offered to buy out FTX, which was later abandoned after further due diligence work.

FTX was now facing a serious liquidity crisis, which founder Sam Bankman-Friedman attributed on Twitter to a lack of consistent internal accounting processes, leading him to believe the company was sitting on more capital than it actually was. Many customers were now unable to withdraw their funds, and the world looked on as one of the most well-respected crypto organisations crumbled to the ground.

The importance of public image

Sam Bankman-Fried, the company’s founder, had developed a real cult following. On the one hand, he was a laid-back, late-20s tech entrepreneur with a net worth of over $10 billion, but still living in a shared home with his friends and sleeping on beanbags – he appeared to fit the inspired genius Zuckerberg mould perfectly.

On the other, his background in more traditional financial institutions (e.g. as an intern-turned-full-time-employee at Jane Street Capital, a proprietary trading firm) gave investors confidence in his ability to manage FTX properly and position himself as the acceptable face of crypto (in December 2021 he worked with the Committee on Financial Services in a discussion around crypto regulation). By successfully walking such a tightrope, Bankman-Fried enabled FTX to appeal to both sides.

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How will regulators react?

Regulators were already known to harbour apprehension towards cryptocurrencies, and Bankman-Fried was seen as the best of an already questionable bunch. The downfall of FTX, and specifically the allegations of financial mismanagement within the company, will almost certainly encourage regulators like the SEC (US Securities and Exchange Commission) to take a tougher stance on crypto.

Much of this predicted regulation was already in development internationally – for example in October the Council of the European Union approved plans for increased crypto regulation (the MiCA proposal) – a process which will likely increase in pace now.

There is a great deal of debate over whether regulators should tighten on crypto – some have suggested that such a move would discourage innovation and bring crypto closer towards a traditional financial institution, which is the exact opposite of its appeal for many. Regardless, regulators will be following this rapidly developing story closely.

How will investors react?

The downfall of FTX has left many retail investors scrambling to recover their hard-earned capital, and the platform’s inability to comply with those requests is likely to result in a wave of class-action lawsuits.

However, FTX was also trusted by a great number of institutional investors – for instance, BlackRock (the world’s largest asset manager) participated in a $420 million FTX financing scheme in October 2021. The collapse of FTX is likely to increase fears among large corporate organisations regarding the reliability of crypto investments.

In particular, the extent to which such investors carry out due diligence on potential investments in the crypto space is likely to increase dramatically. Although a great deal of pension plans and other traditionally risk-averse organisations have gradually become more comfortable with crypto investment, their holdings in such blockchain-related firms are usually, percentage-wise, relatively low in the context of whole portfolios – the collapse of organisations like Terra, Celsius and now FTX are likely to feed into the bearish attitude of such investors.

FTT is, at the time of writing, down more than 80% over the last five days – but more interestingly, Bitcoin and Ethereum are down 17% and 18%, respectively, too. The impact that this story could have on crypto markets as a whole cannot be understated.

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