Billions of dollars of customer assets are reported to have evaporated along with the altruistic image of its founder, Sam Bankman-Fried, who built up a huge empire within a short period of time by luring innocent investors with promises of high yields vis-à-vis banks to park their funds, that too, without the hassle of setting up a crypto wallet. Even major venture capital companies are no exception to this greed: they are also reported to have invested around $2 bn in the company.
It is of course, not yet clear exactly what went wrong at FTX—an exchange that was valued in January at $32 bn and being, neither a trading firm nor a lender, theoretically must always have at its command, funds equivalent to its clients’ deposits—that led it to a humiliating bankruptcy.
It all started with the publication of the balance sheet of Alameda Research, a crypto-investing firm owned by Bankman-Fried which showed a large chunk of digital currency created by FTX called FTT. These FTTs, which are like Bitcoins but minted by FTX to encourage people to use them like stock in the platform. Though FTX uses blockchain technology, their transactions are less transparent than Bitcoins, and hence it is difficult to track how many tokens had been created. Investors can, of course, buy and sell FTTs, but trading is relatively limited. These tokens are also held by other platforms.
As the news about Alameda owning FTTs leaked, the CEO of Binance, a rival crypto platform, announced in the first week of November that his company would sell off all its FTT tokens. This resulted in a sharp fall in the price of FTT. As the price dropped, many customers rushed to withdraw their assets from the FTX platform. This rush for withdrawals indeed resembled a classic bank run, though by then the extent of the relationship between Alameda Research Company and FTX was not quite known to the investors. On November 8, FTX stopped allowing customers to withdraw money from the platform. Following this stoppage of withdrawals by FTX, the relationship between Alameda and FTX began to become clearer to everyone. Ultimately, Bankman-Fried admitted in an interview that FTX ‘accidentally’ lost $8 bn of customer deposits but reassured investors that the company hopes to tide over the liquidity crisis.
But as Bankman-Fried's efforts to sell FTX to Binance fell through, it became clear that FTX lent customers’ funds to Alameda Research, a Bankman-Fried-controlled crypto-investing company that was hit hard earlier by the failures of Three Arrows Capital, a crypto hedge fund and Voyager, a crypto broker. Ironically, the crypto technology was supposed to improve the transparency of financial transactions, but FTX, as stated by John Ray III, the veteran insolvency professional brought in to run the business, stated in the bankruptcy filing, used “software to conceal the misuse of customer funds.”
Thus, the opacity of FTX and Alameda, their complex corporate structure, the use of tokens minted by FTX to boost the balance sheet of its sister concern, Alameda, the intercorporate transfer of customers’ funds, the resulting liquidity crisis, and the typical rush for withdrawal of funds by the depositors well before the company became insolvent did sound all too familiar for anyone who has studied the financial and banking crises of the past. Indeed, it was not the technology but the governance that supervised its operation, which led to the collapse of FTX. And, importantly, it also shows the lack of effective regulatory supervision.
Obviously,
this calls for making the crypto ecosystem safer for investors. But there is a
caveat here. The pain of the current FTX crisis just confined to its customers;
it did not spread to the broader economy, for crypto is not integrated with the
traditional financial system. There is a fear that any legislation that
legitimizes crypto might eliminate this barrier. Secondly, such legitimization
of crypto might even tempt the normal financial system to park its assets on
the block chain, the open-source software that is maintained by unidentified
and unaccountable developers, which is tantamount to placing the financial
system on a shaky foundation. So, any legislation to regulate the crypto
ecosystem must be attempted with due diligence.
Even if it is not legitimized can we take that this debacle has not affected the broader economy? is it not good money turned into bad money ? that much of wealth would have been channeled for national prosperity!
ReplyDeleteThanks for the visit/comment. Here, what I mean to say is: If a bank collapses, its contagion risk is likely to adversely affect other banks. But in the instant case, as cryptos are not integrated into the traditional financial system, no such crisis is noticed. The loss is thus just confined to the investors of FTX alone. Coming to your next observation –“that much wealth would have been channeled for national prosperity”, well, that is the enigma, perhaps. Wealth is still in existence, only changed hands, Isn’t it?
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