By Chris LaPorta, CTFA, AFIM

Senior Portfolio Manager

What is FTX?

By now everyone has heard of the collapse of crypto exchange FTX and its founder, Sam Bankman-Fried (known in the crypto community as SBF). FTX was viewed as one of the darlings of the crypto space. It was thought to be among the most secure. SBF was even lobbying for crypto regulation. FTX was believed to be stable in an extremely volatile space. Having it collapse in the way it did is what’s really shocking. Its collapse has played a huge role in what is happening in crypto right now.

A big piece of what needs to be understood is that FTX is a centralized exchange, meaning it oversaw all transactions and set the rules and fees without regulation. Also, being centralized, it was its own custodian without regulation, and that is where the problem lies. If this sounds remotely familiar, it is similar to what was one of the central issues with Bernie Madoff. There was no third-party custodian of the assets. For perspective, the NASDAQ is a centralized exchange. However, it is heavily regulated by the SEC. It should come as no surprise for the crypto market that having an unregulated, centralized exchange performing fraudulent activity would send shock waves through the space. Every exchange in crypto is now under a microscope.

What Happened?

FTX had its own token called FTT. If you owned FTT you would get a discount on trading fees. Because it was thought to be such a successful and reputable company, there was a lot of demand for this token, and its value rose. People started trading FTT the same as you would typically trade stock or crypto. FTX was a centralized exchange without regulation and had an investing arm called Alameda. In November 2022, CoinDesk, a crypto news source, realized that Alameda’s assets were in FTT and that it owned a large share of the overall FTT tokens. If Alameda decided to sell FTT, the price would collapse, meaning that its balance sheet was worth significantly less than it claimed.

As soon as CoinDesk broke the news that Alameda was not holding enough in reserve assets, Binance, another centralized crypto exchange that also held a lot of FTT, decided that it was going to sell its FTT, and that’s when everything started collapsing for FTX, Alameda, and crypto to some degree.

Alameda also had some venture capital investments and required those firms to keep their money in FTX. FTX then lent back those assets to Alameda, which it used to invest in other projects. FTX also gave Alameda loans, and it was using client capital, not its own.

What’s Next for Crypto and Is There Opportunity?

Regulation.

What happened to FTX didn’t happen in isolation. There were a lot of cryptocurrencies and exchanges, both centralized and decentralized, that shut their doors in 2022. These types of events are going to benefit the crypto space because it is going to help speed up the process for regulation and full transparency with centralized exchanges. With strict regulation, it helps reduce fraud and Ponzi schemes, which at the end of the day is what everyone wants.

With crypto, there is still a ton of speculation and a get-rich-quick mentality amongst retail and investors. This isn’t isolated though to just crypto. There is a similar phenomenon that has happened within traditional markets as well. There are, however, a lot of great decentralized crypto projects out there where control and decision-making are transferred from a centralized entity to a distributed network. One example is Ethereum, which is considered a market leader and has a lot of use on its network (Web 3.0).

What happened with FTX is the collapse of a centralized system that should have been regulated. There was no way to know what it was doing without regulation. It is hard to blame centralized exchanges or the market in this instance. Regulators are still trying to figure out how to accomplish this oversight with crypto. What happened to FTX doesn’t mean that all centralized crypto exchanges are doing fraudulent things, but for all intents and purposes, it is still the Wild West. The two largest centralized crypto exchanges, Coinbase and Binance, have opened their hoods, so to speak, since the events at FTX. I think both would agree that regulation is needed to move crypto forward.

Cryptocurrency and blockchain technology will be around for a long time, and regulation will play an important role in making sure that it does.

If you have additional questions or concerns, please do not hesitate to reach out.