FTX Scandal: What Just Happened to Cryptocurrency, and Does It Affect Blockchain?

In March 2022, the White House formally accepted blockchain and crypto as valid innovations with strong use cases, important for U.S. technological progress. But any commercial innovation has to be balanced with consumer protection. And it can’t come soon enough.

A (formerly) $32 billion cryptocurrency company just plunged into bankruptcy, its founder now being questioned by law enforcement officers in the growing crypto haven in the Bahamas.

Here, we take stock of what we know about the FTX implosion (details are emerging), how it affects the market, and whether or not any part of this mess changes the game for blockchain.

What Is FTX, and Where Did It Go Wrong?

FTX, a cryptocurrency exchange, was co-founded by the now 30-year-old Sam Bankman-Fried (who’s often just called “SBF”). Within a brief three years, as SBF became a multi-billionaire, the crypto exchange swelled into a $32 billion company. The Miami Heat’s stadium is named after it; but the FTX Arena will soon have to change its name.

Forbes once featured Bankman-Fried on its cover. Now, the magazine is reviewing some red flags that ought to have been obvious all along.

For example, Forbes recalls:

Talking to David Rubenstein, one of the founders of the Carlyle Group and a Bloomberg TV host, Bankman-Fried explained why he created FTX…out of the frustrations he was experiencing at Alameda Research, his crypto-focused proprietary trading firm.

What were those frustrations?

Venture capital wasn’t lining up to fork over cash to 20-something traders regardless of their purported 100% annualized returns…

So SBF set out to create a crypto exchange that would work in symbiosis with his private trading firm, Alameda. The trading firm would keep the FTX token strong while allegedly using it as investment collateral.

SBF did indeed attract big investors, like Sequoia Capital (whose representative, Forbes says, “only found out later that Bankman-Fried was playing video games throughout the pitch meeting”).

SBF was a vocal fan of leverage. His companies appear to have lacked enough insurance to cover the risks. In April 2022, Bloomberg Odd Lots podcaster Matt Levine had SBF on to talk about manufacturing value through digital tokens, “and how much potential profit there is for the taking.”

FTX Enjoyed Relationships With Renowned Financial Firms.

Out of the 500+ crypto trading platforms, FTX stood out. Sam Bankman-Fried spoke in front of Congress more than once about crypto legislation. FTX enjoyed relationships with some of the biggest financial firms in the world. Deloitte, Stripe, Sullivan & Cromwell… the list goes on.

Bankman-Fried donated tens of millions to political candidates, too. He claimed to run FTX in order to accrue a great deal of wealth which he could then give to noble causes.

Those aspirations came to an end on November 11, 2022. On that date, FTX filed for Chapter 11 bankruptcy. SBF has stepped down as CEO.

Retail investors are reeling. Sequoia Capital wrote down its $214 million investment to… zero. And the Ontario, Canada Teachers’ Pension Plan, which invested $95 million in FTX and FTX.US, now has a major gap on its books. This is notable especially with the recently introduced U.S. Responsible Financial Innovation Act poised to guide digital currency investments in retirement accounts.

Enough Is Enough. Where’s the Crypto Regulation?

Already, rules laid out by the U.S. Securities and Exchange Commission (SEC) do cover many digital currencies. The Responsible Financial Innovation Act is a bipartisan bill to regulate monetized blockchain technology more comprehensively. It would treat Bitcoin and Ethereum as commodities. All other crypto products — like the ones involved in the FTX debacle — would be regulated by the SEC as securities.

Well, let’s get it on — before more of these companies play with their clients’ funds as though the whole thing were a video game.

Hester Pierce of the SEC said, “The questions around lack of jurisdictional clarity are partly our fault.” So we’d best believe the FTX fiasco will change the course of U.S. regulation.

Watch for the regulators to compel exchanges to be adequately insured, to avoid leverage, to prove they have reserves to cover client losses, and to keep their books open for inspection. Of paramount concern is customers’ access to clear information about their rights and risks. Clearly, that assurance will come too late for FTX customers.

What’s the Impact on Blockchain Itself?

This fiasco has nothing to do with Bitcoin, Ethereum, or the blockchain. Centralized exchanges that introduce proprietary tokens (securities) are the issue here.

Exchanges are centralized. That is, they are led by founders or founding groups. They profit from the trading that happens on their platforms. These companies can harm the public if they don’t have to follow disclosure rules and if left to their own devices.

While Bitcoin is not impaired in any way by the FTX mess, though, it cannot escape the reputational cloud that’s formed over the world of cryptocurrency in recent days. And the fallout from FTX will inevitably change the “crypto space” forever.

Please note:  While we strive to keep our readers informed, our articles are not investment advice. Readers should do their own research and discuss potential investment decisions with a financial adviser.

Supporting References

Brandon Kochkodin for Forbes: The Red Flags on FTX We All Seemed to Miss (Nov. 11, 2022).

Javier Paz, Nina Bambysheva and Emily Mason for Forbes: Stripe, Deloitte, Sullivan & Cromwell Are Among 53 FTX Advisors, Vendors And Bankers Weathering Exchange’s Collapse (Nov. 10, 2022).

Deeds.com: New Regulation for Digital Assets (Jun. 21, 2022).

Tracy Alloway and Joe Weisenthal for Bloomberg Odd Lots: Sam Bankman-Fried and Matt Levine on How to Make Money in Crypto (Apr. 25, 2022).

And as linked.

Photo credit: Christoph Scholz, via Flickr, cropped. Licensed: CC by-SA 2.0.