In the fast-paced world of cryptocurrency, vast sums of money can be made or lost in the blink of an eye. In early November 2022, the crypto exchange FTX was valued at more than US$30 billion. By the middle of that month, FTX was in bankruptcy proceedings. Less than a year later, on Nov. 3, 2023, its founder, Sam Bankman-Fried, was found guilty of seven counts of money laundering and fraud, following a trial that featured less than a month of testimony and only about four hours of jury deliberation.
D. Brian Blank and Brandy Hadley are professors who study finance, executives, firm governance, and fintech. They explain how and why this incredible collapse happened, what effect it might have on the traditional financial sector, and whether you should care.
What Happened?
Sam Bankman-Fried founded FTX, a crypto exchange, in 2019. FTX quickly became one of the largest crypto exchanges in the world. Bankman-Fried also founded Alameda Research, a hedge fund that invested in cryptocurrencies and crypto companies. In traditional financial markets, exchanges, and hedge funds are typically separate entities. This is to avoid conflicts of interest, such as the exchange giving its own customers’ assets to the hedge fund for risky trades without the customer’s consent. However, FTX and Alameda Research were not separate entities. They were both controlled by Bankman-Fried.
In early November 2022, news outlets reported that Alameda Research had borrowed a significant amount of money from FTX without the customer’s consent. They also reported that Alameda Research had used FTX’s own cryptocurrency, FTT, as collateral for these loans.
This news led to a bank run on FTX. Customers rushed to withdraw their assets from the exchange. However, FTX did not have enough liquid assets to meet these demands. As a result, FTX filed for bankruptcy.
Did a Lack of Oversight Play a Role?
Yes, a lack of oversight played a significant role in the collapse of FTX. Unlike traditional financial markets, the crypto market is largely unregulated. This means that there are no government agencies that oversee crypto exchanges and hedge funds.
This lack of oversight allowed Bankman-Fried to engage in risky and unethical behavior without fear of consequences. For example, he was able to borrow his customers’ assets without their consent and use them to make risky investments. He was also able to use FTX’s own cryptocurrency as collateral for these loans.
Why is This a Big Deal in Crypto?
The collapse of FTX is a big deal in crypto because it has damaged the reputation of the industry. FTX was one of the largest and most respected crypto exchanges. Its collapse has shown that crypto exchanges are not risk-free and that investors need to be careful when investing in cryptocurrencies.
If I Don’t Own Crypto, Should I Care?
Even if you don’t own crypto, you should care about the collapse of FTX. The crypto market is becoming increasingly interconnected with the traditional financial system. This means that a collapse in the crypto market could have a ripple effect on the traditional financial system.
The collapse of FTX is a cautionary tale for investors in cryptocurrencies. It shows that crypto exchanges are not risk-free and that investors need to be careful when investing in cryptocurrencies. It also shows that the crypto market is still largely unregulated, which means that there is a greater risk of fraud and other unethical behavior.
