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FTX, one of the world’s biggest crypto exchanges, has collapsed

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Crypto exchange founder Sam Bankman-Fried has been arrested

FTX – one of the world’s largest cryptocurrency exchanges – filed for bankruptcy last week. It followed revelations about its financial structure, which triggered a collapse in confidence.

CEO Sam Bankman-Fried, a prominent figure in crypto, has since resigned and declared he “fucked up”. It’s unclear whether customers who held money in the exchange will be paid back, and authorities are investigating possible illegal activity.

What went wrong?

First, the basics

Cryptocurrencies (like Bitcoin) are digital money. Transactions are recorded by a network of computers.

Advocates say they offer protection against theft and fraud, and a way to transact free from the control of governments and traditional banking.

Critics say cryptocurrencies are riskier than traditional currencies (e.g. the U.S. dollar) because they do not have the backing of a government.

The total value of crypto investments hit almost $US1 trillion this year.

Crypto exchanges

Cryptocurrency exchanges allow people to trade traditional currencies for cryptocurrencies, and to trade between different types of cryptocurrencies.

FTX and its main rival Binance are two of the largest exchanges. FTX was founded by 30-year-old Sam Bankman-Fried (‘SBF’), a prominent crypto personality who has donated to political campaigns, partnered with celebrities and promised to give away most of his wealth to charitable causes. Binance is run by Changpeng Zhao (‘CZ’), another prominent industry player.

What went wrong?

Traditionally, exchanges don’t do much more than what their name suggests: exchange money, and profit by charging transaction fees.

In the U.S, there are strict rules restricting currency exchanges from ‘leveraging’ customers’ money (using it to borrow and invest more money).

However, these rules don’t neatly apply to crypto exchanges. They are often based outside the U.S. (FTX is primarily based in the Bahamas) to reduce regulator oversight, and relatively little is known about their financial structures.

On 2 November, a report by crypto news site CoinDesk, and since partially confirmed by SBF, claimed FTX was taking risks with its customers’ money.

The report said a company owned by SBF, Alameda Research, was holding billions worth of FTX’s customers’ money (in the form of FTX’s own cryptocurrency FTT). Alameda used that to borrow and invest in risky projects.

This raised fears about whether FTX could afford to pay back all its customers if something went wrong and the value of FTT fell.

Last week, those fears became a reality very quickly.

On 6 November, rival exchange Binance announced it was selling all the FTT it owned, implying it lacked confidence in FTX.

Then on 8 November, Binance said it would save FTX by acquiring it. The next day, it cancelled that plan, suggesting FTX’s financial problems were too big for it to fix.

That triggered a panic. In the space of a few days, customers tried to pull out billions from FTX, but FTX didn’t have enough ‘liquidity’ (access to funds) to meet this demand. On Friday, it filed for bankruptcy, a legal status which gives it more time to figure out how to pay its debts.

SBF resigned a short time after he had sought to assure customers and investors that FTX’s U.S. arm was “fine”. In a Twitter thread, he said he “fucked up, and should have done better”.

What happens now?

It’s unclear whether FTX’s customers or its investors will get their money back. A new CEO, who has experience dealing with companies in financial turmoil, has been appointed to oversee the bankruptcy process.

Authorities in the U.S. and the Bahamas are investigating whether any of FTX’s behaviour violated laws. SBF’s whereabouts are uncertain, but he told news agency Reuters he was still in the Bahamas.

Broader implications

There are fears FTX’s collapse will lead to a broader loss of confidence in crypto companies.

Rival companies Binance, Robinhood, and Coinbase have received more funds in the short-term as customers moved away from FTX. However, Binance’s CEO CZ warned it should not be viewed as a “win”.

“User confidence is severely shaken. Regulators will scrutinise exchanges ever more,” he said. He also denied Binance’s actions throughout the week were part of a “master plan” to destroy its competitor.

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