The FTX scandal explained: what happened?
The FTX scandal explained: what happened?
Crypto

The FTX scandal explained: what happened?

By Lexia Avvocati - 26 Nov 2022

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The sudden scandal of FTX – the world’s third-largest cryptocurrency exchange by volume – has unleashed a scandal in the crypto world that to many is reminiscent of the financial crisis that began in 2008 in terms of related dynamics: here it is explained.

Some have even gone so far as to compare FTX to Lehman Brothers in terms of the significance and potential implications of its collapse for the financial system. What brought a platform valued at $32 billion to the brink of bankruptcy?

The scandal of FTX explained

On 2 November CoinDesk reported that FTX was effectively insolvent. The report stemmed from the apparently murky relationship between FTX and the trading firm Alameda Research, both led by Sam Bankman-Fried. In particular, Alameda Research appeared to be heavily exposed to the FTT token, a cryptocurrency issued by FTX and usable on the platform’s ecosystem. Following the recent crypto market compression, the value of FTT declined, leading to heavy losses for Alameda Research, which was unable to meet its commitments to its investors. 

The situation looked as if it could be resolved through the intervention of competitor Binance, which was in negotiations to buy FTX’s holdings. 

Following due diligence on FTX’s books, Changpeng Zhao, CEO of Binance, officially declined to proceed with the transaction, confirming the issues already identified by CoinDesk. 

The consequence was a tsunami that hit investors: withdrawals of the FTT token were halted and the venture capital firm Sequoia Capital itself, which had invested some $213 million in FTX, officially reported a 100% loss on its investment. 

Small investors holding the FTT token also suffered heavy losses. The value of BTC, and thus the crypto market, suddenly collapsed.  

The intervention of regulators

Developments in recent days have triggered strong reactions from regulators in several countries around the world. 

Authorities in the Bahamas, where FTX and Alameda Research are headquartered, have frozen some of FTX’s assets after appointing a liquidator to determine whether or not to initiate bankruptcy proceedings. 

FTX itself is under investigation on charges of illegally diverting user funds and using them to fund Alameda Research.

FTX’s activities have also been blocked in several other states, such as Japan and Australia. 

In addition, US authorities, primarily the SEC, have launched investigative activities to determine possible violations by FTX of financial regulations. 

What are the implications for the future of the crypto market?

The collapse of FTX and its aftermath mark an important moment for the entire crypto market. The affair comes after a year of market downturn, a contraction of NFT trading, and crisis episodes such as the Luna token case. There are those who argue that this is the beginning of the end and those who believe that regulation can finally bring order to what is still a fledgling industry anyway.

It is apparent how urgent it is to outline regulation for exchanges that can foster market growth and technological innovation while protecting the consumer and preventing fraudulent schemes from being implemented.

To date, the efforts of regulators have mainly focused on anti-money laundering aspects, perhaps placing too much emphasis on the risks associated with the use of cryptocurrencies for criminal purposes and forgetting, as the FTX case also demonstrates, how much more important it is to ensure the soundness and reliability of the entities operating in the sector and their protocols.

The approval and entry into force of the Markets in Crypto Asset (MiCA) regulation will enable a significant step forward in this direction. According to the drafts circulating to date, the regulation will introduce important transparency obligations to consumers, including duties of disclosure regarding assets earmarked for reserve.

Establishing a clear and balanced regulatory framework will also be a key to regaining trust from those who today see the crypto market as highly dangerous due to the absence of any consumer protection measures.

 

Lexia Avvocati

Lexia is an Italian multi-practice law firm specialised in Fintech, Cryptoassets, Tech and Financial Services. The firm regularly assists Fintech and Cryptoassets service providers in the setting-up of their Italian platforms.

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