Michael Krebs
Founded in May 2019 by Sam Bankman-Fried, FTX is a cryptocurrency exchange based in the Bahamas whose past month has been anything but a breeze. As the story continues to unfold, regulators point to the warning signs and regulators, investors and industry leaders reflect on what lessons can be learned.
First, some terminology. A cryptocurrency exchange is an online marketplace where investors may buy, sell, or trade cryptocurrencies. These exchanges take investors’ money and lend them out or make investments of their own, much like a bank. Many cryptocurrency exchanges, including FTX, also sell their own cryptocurrency on the exchange. FTX’s currency is known as “FTT.” FTX founder Sam Bankman-Fried also founded and controlled Alameda Research, a cryptocurrency trading firm, which according to reports may have borrowed substantially from FTX and indirectly from FTX’s clients.
On Nov. 6, Binance, the world’s largest exchange in terms of daily trading volume of cryptocurrencies and an early investor in FTX, announced that it planned to liquidate its entire FTT position, totaling $529 million. Binance’s announcement came on the heels of a November 2 CoinDesk report that revealed previously undisclosed details about Alameda’s financial condition that spooked investors. Over the next 72 hours following Binance’s Nov. 6 announcement, FTT’s value began to crater, losing more than 80 percent of its worth and eventually forcing it into the largest crypto-related bankruptcy ever filed.
Tim Rennie
FTX’s new CEO, John J. Ray, has over 40 years of legal and restructuring experience, including helping recover billions of dollars for creditors of Enron and Nortel Networks. In a Nov. 17 bankruptcy filing on the matter, Ray states, “[n]ever in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.”
Warning Signs
Since the advent of cryptocurrencies, and as further discussed in our October 2022 Banker & Tradesman article, regulators, legislators and other industry leaders have warned investors of the potential harm of high-risk investments, or even fraud, that is inherently possible in the crypto space.
Addressing the risks of the crypto space has been on the Biden administration’s radar since the beginning. The SEC has repeatedly cautioned investors about crypto currencies generally and crypto exchanges specifically, often noting how investors can be enticed by the allure of high returns in a new investment space or how investors may let their guard down when assessing something novel, new and cutting-edge.
Likewise, the Commodity Futures Trading Commission (CFTC) has frequently warned investors of the operational risks, cybersecurity risks, market risks and fraud risks that come hand in hand with cryptocurrency investments. The Treasury Department just two months ago, on Sept. 8, issued a detailed report about implications for consumers, investors and businesses in connection with increased involvement with cryptocurrency.
The fact that the unregulated crypto industry is unraveling is not a surprise to regulators. The SEC, CFTC, Treasury Secretary Janet Yellen and others have been encouraging Congress to implement some form of a regulatory framework for an industry devoid of exactly that.
What’s to Come?
As the dust settles, regulators, consumers and the crypto community continue to grapple with the fallout of FTX’s meteoric crash. In a Nov. 10 interview, SEC Chairman Gary Gensler outlined critical paths that must be considered: additional investor education, registration of crypto exchanges and lending platforms and enforcement. On Nov.14, CFTC Chair Rostin Behnam warned that there is no longer the luxury of time on deciding what action to take.
“If we wait, we’re just going to be waiting for the next crisis. I don’t know how big or small it’s going to be and what the impact will be. But I don’t think that’s a risk that anyone in this room wants to take or should want to take, and I hope Congress will recognize that and move quickly,” said Behnam.
Cryptocurrency investors, many of whom were FTX customers when it filed for bankruptcy, are left wondering how far-ranging the impacts to FTX’s downfall will be and whether the contagion that began with the collapse of Terra in May 2022 will continue to spread. The anxiety surrounding FTX is especially acute among its retail customers, who relied on FTX’s marketing that the trading platform was a safe-for-beginners cryptocurrency exchange (remember the Super Bowl ad featuring Larry David?), are wondering how much, if any, of their money they can expect to get back at the end of the bankruptcy proceeding. Given the complexity and unprecedented nature of this bankruptcy, there is no telling how long FTX’s customers will be waiting to see if there will be anything left for them at the end of this process.
Even leaders in the crypto community are reckoning with the lessons of FTX’s implosion.
Marcelo Claure, a former SoftBank executive who helped lead investments in FTX tweeted, “I have been reflecting personally on the whole FTX fiasco and it taught me one more time that we should NEVER invest because of FOMO and we should always 100% understand what we are investing in. I totally failed here on both.”
Michael K. Krebs and Timothy J. Rennie are a partner and associate, respectively, in Nutter’s corporate and transactions department. Both are members of the firm’s banking and financial services group.
