The sudden demise of cryptocurrency exchange FTX, which filed for bankruptcy on Friday, has stunned the crypto world – and its effects are already rippling through traditional financial markets.
In less than two weeks, the world’s fourth largest exchange by volume collapsed, and its founder and CEO, Sam Bankman-Fried – arguably the face of cryptocurrency in the United States – resigned.
The startling developments will almost certainly lead to further regulatory scrutiny of the industry. The collapse is also likely to reset the growing investment and interest in crypto from investment banks, pension plans, and other players in traditional finance. Investors in FTX included Ontario Teachers’ Pension Plan, Japanese conglomerate SoftBank and US venture capital firm Sequoia Capital.
The question now is how far things go. The Securities and Exchange Commission is investigating the matter and regulators in the Bahamas have frozen the assets of FTX Digital Markets, a key FTX subsidiary based there.
“You have asset managers, investment funds, and other entities that have investments in crypto companies and crypto-related companies that run down those assets,” said Howard Fischer, former senior counsel at the SEC and a partner at the law firm Moses and Singer. “Investors in these companies have seen their assets dwindle, and there is a potential ripple effect that will cause many people, businesses, and investors to liquidate other assets to make up for the shortfall in FTX.”
The first sign of trouble at FTX came on November 2, when CoinDesk announced that Alameda Research, a trading company also run by Bankman-Fried, held large amounts of an FTX-created coin on its balance sheet. These large and previously undisclosed financial ties between the companies made investors uncomfortable and sparked a sell-off of FTX’s own cryptocurrency, FTT, which quickly turned into a bank on FTX.
On Tuesday this week, FTX had halted client withdrawals.
The beginning of the end came on Thursday, when even bigger crypto exchange Binance decided not to bail out its rival after signing a letter of intent to buy the company on Tuesday, pending due diligence. within reason. Binance scrapped the deal after reviewing FTX’s balance sheets to determine if the exchange’s overall value outweighed the $6 billion hole on its balance sheets.
The relationship between FTX and Alameda has been murky for years. But on Thursday, the Wall Street Journal reported that Alameda had borrowed $10 billion in funds from FTX clients and invested them in risky propositions, creating the liquidity crunch revealed by the recent bank run on FTX.
Unlike a traditional commercial or savings bank, FTX was not insured by the Federal Deposit Insurance Corporation – a layer of protection created in response to widespread banking runs during the Great Depression. For FTX customers, this meant that there was never any guarantee that the exchange would have funds to withdraw when those customers wanted it.
FTX investors have lost millions and clients are selling their frozen account balances for pennies on the dollar – and some may never see their funds again, despite assurances from Bankman-Fried that all funds are safe.
Besides Sequoia Capital, other major financial firms such as Galaxy Digital, Amber Group, Tiger Global and Genesis Global Trading have all lost funds or frozen them on the stock market. Edward Moya, senior market analyst at OANDA, an online platform for multi-asset trading, currency data and analysis services, said that before the FTX crisis, cryptocurrencies were on the path to legitimacy – and were becoming a standard part of trading portfolios.
A reset on the horizon?
Now everything is falling apart.
“It’s becoming clear that there wasn’t enough regulation put in place,” Moya said. “The shutdown appears to be motivated by risky bets with customers’ money. And that story isn’t going away anytime soon.
The collapse of FTX could set the crypto industry back years, he added, and reshape the way traditional financial firms view the industry.
“I’m not saying everything ain’t like a Lehman [Brothers] time for everyone, but for crypto it is,” Moya said, referring to the shocking collapse of the longtime financial services company during the 2008 subprime mortgage crisis.
Fischer said the full effects won’t be known for some time, as the FTX situation is far from settled. “There is going to be downward pressure on the prices of these other assets, and it could be crypto assets or non-crypto assets,” he said.
For Howard, one of the ironies of all of this is that it will likely accelerate tighter regulation of the cryptocurrency industry.
“If this was a regulated product and this industry was treated like other financial services industries, then regulators could have gone into the books, looked at risk, looked at assets and liabilities and been in able to determine that there was a problem long before it became a disaster,” he said.
FTX’s bankruptcy filing lists a total of 134 separate corporate securities, illustrating how many fingers FTX had in the proverbial pie and how far shockwaves could spread.
“I’m curious how many of the 134 companies filing for bankruptcy knew they were doing so,” Nikhilesh De, CoinDesk’s editor for global policy and regulation, said in a Grid Twitter Space on Friday about the news of FTX’s bankruptcy.
Thanks to Lillian Barkley for writing this article.