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The Rise and Fall of the FTX Empire
Nov 21 2022
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By
Artem DubasThe cryptocurrency market has been thrown into turmoil over the last few weeks as FTX, one of the largest exchanges, collapsed.
Though relatively small compared to traditional asset classes, cryptocurrencies are quite widely held. At its peak last year, the global market of cryptocurrencies surged to almost $3tn. Today it is estimated to be around $850bn, around 70% down. Despite its democratisation over the last few years, the recent developments are a harsh reminder that the crypto space has a long way to go.
The FTX exchange was founded by Sam Bankman-Fried (aka SBF) who, until recently, was the company’s CEO. Before starting the exchange, he was involved in high-frequency trading and quickly rose to prominence in the crypto domain. In Washington he was the accepted face of crypto, communing with lawmakers and bankrolling efforts to influence its regulation.
SBF’s timing in establishing FTX could not have been better. The pandemic environment of 2020 saw cheap money with ultra-low interest rates, bullish sentiment towards tech and innovation, and many start-ups commanding ever-higher valuations. FTX was a huge beneficiary of this movement as some of the biggest and most sophisticated investors lined up to invest and within three years of its founding, the company had amassed roughly $2bn in venture funding and accrued a $32bn valuation.
Over those three years, SBF became one of the richest people in the world under the age of 30 with a net worth estimated to be $16bn at its peak. In the eyes of the Democrats, he was one of the largest donors and to venture capitalists, he was the financial genius who could do no wrong.
However, when you look at someone through rose-tinted glasses, red flags can be ignored and last week it all came crashing down. It started when CoinDesk, a news site specialising in crypto assets, called into question FTX’s liquidity of clients’ funds. The CEO of Binance, arguably FTX’s main and bigger rival, then liquidated their entire stake in the platform to protect themselves.
This set off a chain reaction and as the news spread, customers rushed to withdraw their funds. In the end, the exchange had to stop customer withdrawals before eventually filing for Chapter 11 bankruptcy in the US. Even after the filing, hundreds of millions of dollars mysteriously flowed out of the company’s accounts.
Sequoia, a California-based venture capital firm; Temasek, a Singaporean sovereign-wealth fund; and the Ontario Teachers’ Pension Plan were among FTX’s backers. All have suffered financial losses, but none have been catastrophic.
The more information that emerges about FTX’s demise, the more shocking the story becomes. Out of the $14bn in customer funds, FTX reportedly lent $8bn to Alameda Research, a trading firm also owned by SBF. In exchange, it accepted as collateral its own digital tokens created out of thin air. Unsurprisingly, the regulators are now probing FTX over whether it mishandled customer assets.
Clearly, investors in FTX got carried away with SBFs short but impressive track record and did not conduct the appropriate due diligence. Few, if any, appeared to push for SBF to set up suitable compliance measures at FTX, such as a third-party review of transactions or an international standard, which should have prevented this. Even a modicum of diligence could have uncovered those liabilities.
Though it is not clear what the longer-term impact of this saga will be, in the short term, prices of crypto assets have responded aggressively. Major cryptocurrencies have fallen in value with Bitcoin, one of the largest currencies, falling 25% in just a matter of days. These fresh losses come off the back of a difficult year for crypto assets which were already down by 50%.
The longer-term impacts are less clear. However, it is likely that the industry will be treated with more scepticism going forwards. Due diligence will be more robust, and institutions will moderate their willingness to allocate capital to this space. With prices depressed, lower investment, and a lack of opportunity, those working in crypto, some of whom are the world’s brightest minds, might begin to have thoughts about leaving the industry.
Regardless of whether you are a proponent of cryptocurrency and believe it is the future of modern finance, it is still susceptible to the fallacies of human nature. Speculation is as old as the hills and the only impact of innovation and technology so far has been the speed and size at which it builds.
Written by Artem Dubas
General Disclosures: This article is based on current public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates and forecasts contained herein are as of the date hereof and are subject to change without prior notification. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. The price and value of investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.Cornwall
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