In the fast-paced realm of cryptocurrency, vast sums of cash can be created or lost in the blink of the eye. At the begining of November 2023, the second-largest cryptocurrency exchange, FTX, was worth more than US$30 billion. By Nov. 14, FTX was in bankruptcy proceedings together with more than 100 companies connected to it. D. Brian Blank and Brandy Hadley are professors who study finance, investing and fintech. They let you know that and why this incredible collapse happened, what effect it might have on the traditional financial sector and whether you need to care if you do not own any cryptocurrency.
1. What happened?
In 2023, Sam Bankman-Fried founded FTX, a business that ran among the largest cryptocurrency exchanges.
FTX is where many crypto investors trade and hold their cryptocurrency, like the New York Stock Exchange for stocks. Bankman-Fried can also be the founder of Alameda Research, a hedge fund that trades and invests in cryptocurrencies and crypto companies.
Within the standard financial sector, both of these companies would be separate firms entirely or at least have divisions and firewalls in position together. But in early November 2023, news outlets reported that the significant proportion of Alameda's assets were a type of cryptocurrency released by FTX itself.
A couple of days later, news broke that FTX had allegedly been loaning customer assets to Alameda for risky trades without the consent of the customers and also issuing its own FTX cryptocurrency for Alameda to use as collateral. As a result, criminal and regulatory investigators began scrutinizing FTX for potentially violating securities law.
These two pieces of news basically led to a bank run on FTX.
Large crypto investors, like FTX's competitor Binance, as well as individuals, began to sell cryptocurrency held on FTX's exchange. FTX quickly lost its ability to meet customer withdrawals and halted trading. On Nov. 14, FTX seemed to be hit by an apparent insider hack and lost $600 million worth of cryptocurrency.
That same day, FTX, Alameda Research and 130 other affiliated companies founded by Bankman-Fried declared bankruptcy. This action may leave more than a million suppliers, employees and investors who bought cryptocurrencies with the exchange or committed to these companies with no way to get their money back.
Among the particular groups and people who held currency around the FTX platform were many of the normal players in the crypto world, but numerous more traditional investment firms also held assets within FTX. Sequoia Capital, a venture capital firm, as well as the Ontario Teacher's Pension, are estimated to possess held millions of dollars of the domain portfolios in ownership stake of FTX. They've both already wiped off these investments with FTX as lost.
2. Did a lack of oversight may play a role?
In traditional markets, corporations generally limit the risk they expose themselves to by preserve liquidity and solvency. Liquidity may be the ability of the firm to market assets quickly without those assets losing much value. Solvency may be the idea that a company's assets are worth a lot more than what that company owes to debtors and customers.
But the crypto world has generally operated with a smaller amount caution than the traditional financial sector, and FTX is no exception. About two-thirds of the money that FTX owed to folks who held cryptocurrency on its exchange – roughly $11.3 billion of $16 billion owed – was backed by illiquid coins developed by FTX. FTX was taking its customers' money, passing on to Alameda to make risky investments and then creating its own currency, known as FTT, as a replacement – cryptocurrency it's unable to sell at a sufficient price when it required to.
In addition, nearly 40% of Alameda's assets were in FTX's own cryptocurrency – and don't forget, both companies were founded by the same person.
This all came to a head when investors chose to sell their coins around the exchange. FTX did not have enough liquid assets to meet those demands. This in turn drove the need for FTT from over $26 a coin at the beginning of November to under $2 by Nov. 13. By this point, FTX owed more money to its customers of computer was worth.
In regulated exchanges, investing with customer funds is against the law. Additionally, auditors validate financial statements, and firms must publish how much money they hold in reserve that's available to finance customer withdrawals. As well as if things go wrong, the Securities Investor Protection Corporation – or SIPC – protects depositors against the lack of investments from an exchange failure or financially troubled broker. None of these guardrails have established yourself inside the crypto world.
3. Why is this an issue in crypto?
As a direct result this meltdown, the company Binance has become considering creating a business recovery fund – akin to a private form of SIPC insurance – to avoid future failures of crypto exchanges.
But as the collapse of FTX and Alameda – worth more than $30 billion and today essentially worth nothing – is dramatic, the bigger implication is simply the potential lost rely upon crypto. Bank runs are rare in traditional banking institutions, but they are increasingly common within the crypto space. Given that Bankman-Fried and FTX were seen as some of the biggest, most trusted figures in crypto, these events often leads more investors to think twice about putting profit crypto.
4. If I don't own crypto, must i care?
Though investment in cryptocurrencies is continuing to grow rapidly, the entire crypto market – worth over $3 trillion at its peak – is much small compared to the $120 trillion traditional stock exchange.
While investors and regulators continue to be evaluating the consequences of the fall, the impact on any person who doesn't personally own crypto is going to be minuscule. It is a fact that lots of larger investment funds, like BlackRock and the Ontario Teachers Pension, held investments in FTX, but the estimated $95 million the Ontario Teachers Pension lost with the collapse of FTX is just 0.05% of the entire fund's investments.
The takeaway for many individuals is not to purchase unregulated markets without understanding the risks. In high-risk environments like crypto, it's possible to lose everything – a lesson investors in FTX are understanding the hard way.
This article is republished in the Conversation. Browse the original article.
