Crypto’s Lehman Brothers moment – and what happens after the fall of FTX

A 30-year-old MIT graduate who went from billionaire to bust, a note of caution from the White House, and lakhs of customers with their money stuck – the past week has arguably been one of the most dramatic in the world of cryptocurrency. The events could pave the way for stricter regulations in an industry that is now seen as playing fast and loose with customers’ funds.

So what happened this past week?

FTX, the world’s second biggest crypto exchange (used to buy and sell cryptocurrency like Bitcoin), went bankrupt, affecting an estimated 10 lakh-plus people who were barred from withdrawing funds. Think of this as a stock broker suddenly declaring you cannot sell your holdings or withdraw your money. The FTX collapse predictably shook investors’ confidence and prompted a fresh selloff in cryptocurrencies – for instance, Bitcoin, which is already down over 70% this past year, plummeted another 12% in just five days.

It also led to fresh concerns about how safe customer funds really are, since crypto exchanges lack the gatekeeping mechanisms that apply to other financial institutions like banks. In a recent briefing, White House Press Secretary Karine Jean-Pierre said: “The administration has consistently maintained that, without proper oversight of cryptocurrencies, they risk harming everyday Americans.”

Many have compared this to the crypto industry’s Lehman Brothers moment – referring to the bankruptcy of the investment bank that precipitated the 2008 global financial crisis.

How exactly did FTX collapse?

Here’s where things get complicated. FTX founder Sam Bankman Fried, popularly known as SBM, had also founded a trading firm called Alameda Research. While these were supposed to be two different businesses, two reports – by Coindesk (a website that reports on cryptocurrency) and The Wall Street Journal – suggested otherwise.

WSJ reported that FTX had extended loans to Alameda using money that customers had deposited on the exchange. Coindesk reported that a significant part of Alameda’s assets were in the form of a cryptocurrency called FTT – a token that FTX issued, and that it could hypothetically keep producing indefinitely.

Following the Coindesk report, Binance – the world’s largest crypto exchange firm, run by Changpeng Zhao – said it was planning to sell all its FTT tokens “due to recent revelations”. This spooked investors, who rushed to do the same, leading to the token crashing 78% in value in a single day.

But FTX, it turns out, lacked the money to handle so many withdrawals – an estimated $6 billion over three days – all at once, and paused the ability for customers to pull their own money out.

What happened next?

On November 8, Binance said it planned to bail out FTX by buying the company. Simultaneously, SBM tweeted that the deal would protect customers, who would once again be able to withdraw their funds. But the hope was short lived – the next day, Binance announced it would no longer buy FTX “as a result of corporate due diligence”.

Interestingly, Zhao and SBM have long been rivals, and many speculate it was Binance’s announcement of selling FTT tokens that led to the downfall of its closest competitor.

And what happened to SBM?

As rumours swirled that he was planning to flee to Argentina, SBM told Reuters he was still in the Bahamas, where FTX is headquartered. It is also where his inner circle lives. In one report, Coindesk quoted a person familiar with the company as saying: “The whole operation was run by a gang of kids in the Bahamas.” The report also claimed that the 10-odd key people are, or have been, entangled in romantic relationships with each other.

Wasn’t SBM also somewhat of a celebrity?

The 30-year-old had cultivated an image of being an altruistic billionaire, relying heavily on influential YouTubers to amplify this message. FTX was also known for its advertisement blitzkriegs – among its celebrity endorsers were supermodel Gisele Bündchen, NFL star Tom Brady, and Seinfeld creator Larry David. The company had its name on a basketball arena, sponsored F1 teams and, according to the Financial Times, SBM was the second-largest donor to the Democrats after George Soros.

How does this fiasco impact the crypto industry?

This year alone has seen at least three crypto exchanges pause client withdrawals – Vauld, FTX and BlockFi – shaking investor confidence both in India and abroad.

With FTX filing for bankruptcy, founders of Indian crypto exchanges rushed to reassure users that their funds were safe. Ashish Singhal, co-founder of CoinSwitchKuber, tweeted that his exchange “holds user assets 1:1. The funds you deposit and the crypto invest in are fully held against your name. They are not reinvested or reused by us. You can access them at any time”.

Sumit Gupta, co-founder and CEO of CoinDCX, tweeted: “What happened with FTX is very unfortunate! At @CoinDCX, user safety and the investors’ best interest has always been our #1 priority.” He added that they “never expose user funds to price and credit risk” and “do not have a native token”.

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