The FTX Collapse: Cryptocurrency Market Vulnerability and Regulatory Implications
FTX is a cryptocurrency exchange situated in the Bahamas that was founded in 2018 by former Jane Street Capital international exchange-traded funds (ETFs) trader Sam Bankman-Fried and had over 1 million members at its height in 2021, making it the world’s third-largest crypto exchange by volume. It offers a variety of trading products, including derivatives, options, volatility products, and tokens with leverage. FTX, on the other hand, has been in bankruptcy since November 11, 2022, having borrowed heavily and misused its clients’ funds in a likely and remarkable fraud.
What Happened to FTX?
The collapse of FTX occurred over ten days in November 2022. The cause was a Nov. 2 report by crypto news site CoinDesk, which revealed that Bankman-Fried’s quantitative trading firm, Alameda Research, maintained a $5 billion position in FTT, the native token of FTX.
According to the report, Alameda’s investment foundation was also invested in FTT, the token created by its sister firm, rather than a fiat currency or cryptocurrency. Concerns were raised throughout the digital currency sector over Bankman-Fried’s companies’ unreported leverage and solvency.
The following day, FTX was having a liquidity issue. Bankman-Fried attempted to reassure FTX investors that their assets were secure, but consumers demanded $6 billion in withdrawals following the CoinDesk revelation. Bankman-Fried sought additional funding from venture capitalists before turning to competitor Binance. In two days, the value of FTT plunged by more than 80%.
Timeline for FTX Collapse—2022
• November 2: Allegations and worries about the balance sheet of Alameda Research, a crypto hedge fund affiliated with FTX founder Sam Bankman-Fried (SBF), surfaced. Alameda has a large number of FTT tokens.
• November 4: Subsequent allegations and doubts about Alameda Research’s financial health and affiliation with FTX were published on Substack, a newsletter platform.
• November 6: Binance CEO Changpeng Zhao (CZ) stated that the company planned to liquidate its FTT holdings due to “recent revelations.” Binance was a previous investment in FTX, and this announcement significantly impacted the value of FTT.
• November 8: In an unexpected change of events, Changpeng Zhao (CZ) revealed that Binance would buy FTX to help with a liquidity crisis. This seems to be an attempt to save FTX.
• November 9: CZ and FTX’s Sam Bankman-Fried appeared to have agreed on the acquisition deal to work together.
• November 10: The situation worsened when Binance opted not to proceed with the acquisition after doing due diligence.
• November 11: FTX filed for Chapter 11 bankruptcy protection in the United States, affecting its platform and Alameda. SBF was replaced as CEO by John Ray III, a restructuring lawyer. CZ compared the situation to the financial crisis of 2008.
• November 18: The Bahamas controls the FTX assets stored there.
• December 12: Bankman-Fried is captured by Bahamian authorities. He was later extradited to the United States.
• December 22: A federal judge releases Bankman-Fried on a $250 million bond, the largest in history.
Lawsuit Filed Against FTX And CEO Sam Bankman-Fried:
On Nov. 16, a class-action lawsuit was filed in a federal court in Florida, alleging that Bankman-Fried devised a fraudulent cryptocurrency scheme to take advantage of inexperienced investors from throughout the country. Other celebrities and professional sportsmen mentioned in the complaint include Steph Curry, Shaquille O’Neal, Shohei Ohtani, Naomi Osaka, Larry David, and Kevin O’Leary, who allegedly assisted Bankman-Fried in carrying out the scheme.
On December 12, 2022, Bahamian officials detained and imprisoned Bankman-Fried in connection with several FTX fraud allegations, including those beginning from a charge filed by the United States Attorney for the Southern District of New York. When announcing the accusations against the former CEO Bankman-Fried , U.S. Attorney Damian Williams stated that it was one of the greatest financial crimes in American history. On December 13, the new FTX CEO Ray told a U.S. House committee that the company had “no bookkeeping.” He said, “It was just old-fashioned embezzlement.”
Bankman-Fried was brought back to the United States and subsequently charged with eight charges of securities fraud and money laundering in U.S. District Court in Manhattan. Following a court hearing on December 22, a federal judge decided to release Bankman-Fried after his attorneys and federal prosecutors agreed to the biggest bond in history of $250 million. The 30-year-old former crypto CEO will be confined to Northern California, live with his Stanford law professor parents in Palo Alto, and wear an electronic monitoring bracelet.
Binance’s Involvement in the FTX Collapse:
When FTX, one of the world’s largest cryptocurrency exchanges, was hit by a serious financial crisis, it raised concerns about its previous investment in Binance and the potential consequences of the collapse. The plot revolves around two key figures in the cryptocurrency industry: Sam Bankman-Fried (SBF), the founder of FTX, and Changpeng Zhao (CZ), the CEO of Binance. They had created two of the most important digital currency exchanges, but their origins and paths to success were very different.
FTX experienced significant financial difficulties as a result of its own cryptocurrency, FTT, being used as collateral by Alameda Research, a crypto hedge fund controlled by Sam Bankman-Fried. This put FTX at risk because a decline in FTT’s value would affect both companies due to their joint ownership.
Binance, which earlier invested in FTX and obtained a part of the company, later decided to sell its FTT holdings, which accounted for around 5% of the total. This move had a tremendous impact on the price of FTT and created anxiety in the crypto market. The situation deepened as Bankman-Fried and Zhao engaged in public social media exchanges. Bankman-Fried claimed a competitor was circulating false allegations regarding FTX’s financial condition, but did not name the competitor. He approached Zhao for help and cooperation.
In an unexpected change of events, Zhao declared that Binance would fully acquire FTX in order to help it recover from its liquidity issue. This seemingly peaceful arrangement gave both corporations and their customers hope.
The deal, however, fell through after Binance performed due diligence and discovered obstacles outside its control that hindered the acquisition. Zhao expressed disappointment, and the future of FTX appeared to be doubtful.
The Controversial Repurchase:
During a court hearing, it was revealed that FTX, a cryptocurrency exchange that declared bankruptcy in November 2022, used customer money to repurchase its shares from competitor Binance. Binance CEO Changpeng Zhao stated in November 2022 that his company had received roughly $2.1 billion in Binance USD (BUSD) stablecoins and FTX’s FTT tokens as part of this deal.
The disclosure has sparked considerable investigation and legal action, with the US Department of Justice hiring an accounting professor from the University of Notre Dame, Peter Easton, to trace the transfer of billions of dollars between Alameda, FTX’s parent company, and the exchange. Professor Easton acknowledged that customer deposits were diverted for a variety of reasons, including company and real estate reinvestment, political donations , and contributions to charities.
The most shocking publication, however, was that more than a billion dollars for the share repurchase came directly from FTX customer funds. This has raised concerns regarding the exchange’s financial operations and customer asset protection.
Will FTX Users Receive Their Crypto back?
If FTX fails, its consumers would most likely suffer the most. According to the Federal Deposit Insurance Corporation, FTX is not protected in the same way that traditional banks are. The disruptions of cryptocurrency exchanges are upsetting for investors since they are likely to have an impact on their hard-earned money. If your money is involved in the solvency of your crypto exchange, your crypto assets are likely to be in the wind.
During a bankruptcy case, the court determines the amount to be repaid to customers, the repayment period, and the repayment priority order. Customers are usually informed when they will be paid and how much of their money will be paid back. Although not all crypto projects require users to meet know-your-customer (KYC) standards when registering on their platforms, it is sometimes required to stay afloat in the event of bankruptcy. A customer’s interest can be efficiently maintained by providing accurate information.
In the event of bankruptcy, the failing cryptocurrency company would most likely contact its customers to notify them of the situation and provide them with the necessary information or processes to recover their funds. You do not want to be excluded because you did not fulfill the KYC standards, as most organisations would distribute funds to clients using their approach.
Customers of FTX may have greeted the proposed settlement with cautious hope. The prospect of getting more than 90% of their assets by the end of the second quarter of 2024 is likely to be viewed positively, providing hope of getting back their investments. Customers who withdrew more than $250,000 from FTX within the first nine days of the bankruptcy may be concerned about the 15% claim reduction. This part of the settlement may cause conflict among larger account holders.
The FTX collapse and subsequent bankruptcy highlight the cryptocurrency industry’s vulnerabilities. With over 1 million users at its peak, FTX’s demise highlighted the dangers of an unregulated digital asset market. While the proposed settlement gives clients hope of recovering funds, problems such as clawbacks for larger withdrawals remain. This case highlights the critical importance of aggressive regulatory actions in the cryptocurrency sector to safeguard investors and ensure market stability. As financial frauds and scandals become more common, authorities must react to protect investors by ensuring clear disclosure of risks and benefits. The cost of poor protection is obvious, requiring immediate regulatory reform.