Understand the shock in the cryptocurrency sector caused by the failure of the billionaire FTX

November 2022 will be a month that investors, especially cryptocurrency investors, will never forget. And the worst could be yet to come.

Over the past two weeks, the digital asset industry has been in terror as it has watched FTX, the multi-billion dollar crypto exchange created by one of the industry’s biggest and brightest stars, Sam Bankman-Fried, collapse.

FTX’s failure shook the pillars of the entire ecosystem. Token prices plummeted as investors rushed out of risky positions. What followed was contagion.

In the panic, customers rushed to withdraw their money from various cryptocurrency platforms, forcing creditors to suspend withdrawals — what one industry observer described as an imminent “death bed”.

Overnight, Bankman-Fried went from hero to villain. How did we get to this point? And will cryptocurrencies survive? The saga is far from over, and if you just found out, see all the details below.

brief retrospective

On Nov. 2, an article by cryptocurrency news site Coindesk cited a leaked financial document that raised questions about the relationship between FTX and Bankman-Fried’s exchange, Alameda. On paper, they were two separate companies owned by the same man. But the Coindesk article said that Alameda “is built on a foundation made up largely of a coin that its sister company invented.”

A few days later, the director of FTX’s biggest rival, Binance, said the company would liquidate $580 million (about R$ 3.1 billion) in FTT, FTX’s internal token. This unleashed a storm of withdrawals that FTX lacked the funds to facilitate.

Panic spread, triggering the devaluation of not only FTT but also more mainstream cryptos including bitcoin, ethereum and solana.

FTX was facing a huge liquidity crisis. The company was in need of a rescue and, momentarily, it looked like it could be rescued by none other than Binance, its rival, whose departure exacerbated the crisis. But Binance pulled out of the bailout plan less than a day after the announcement, explaining that FTX’s problems were “beyond our control or ability to help.”

On November 11, FTX and Alameda filed for bankruptcy, and Bankman-Fried resigned as CEO of the exchange. “I f***ed up,” Bankman-Fried wrote in a lengthy apology on Twitter.

2) I’m really sorry, again, that we ended up here.

Hopefully things can find a way to recover. Hopefully this can bring some amount of transparency, trust, and governance to them.

Ultimately hopefully it can be better for customers.

— SBF (@SBF_FTX) November 11, 2022

house of cards

FTX named a restructuring expert, John J. Ray III, as CEO to steer what’s left of the company through bankruptcy. That means taking a good look at the company’s finances and finding out exactly how much it holds in assets and liabilities.

It’s only been a week, and Ray has already declared that this is the biggest mess he’s ever seen. This coming from an executive who made his name overseeing the liquidation of Enron, the largest bankruptcy reorganization plan in US history.

“Never in my career have I seen such a failure of corporate controls and a complete absence of reliable financial information as happened here,” Ray wrote in a petition Thursday.

The document contains evidence of massive mismanagement and possible fraud under Bankman-Fried’s leadership. Bankman-Fried has not been charged with any crime. His lawyer did not respond to requests for comment from the CNN Business 🇧🇷

crypto contagion

The entire crypto industry is on edge, waiting for the next dominoes to fall. In the immediate aftermath of the FTX crash, cryptocurrency companies were flooded with requests from customers looking to get their money back — the digital equivalent of a run on the bank. Several companies were forced to suspend withdrawals while they sorted out their liquidity problems.

“In the world of cryptocurrencies, the minute you hear a company announce ‘we are temporarily suspending withdrawals’ – jeez,” said Daniel Roberts, senior editor at Decrypt Media, a crypto news outlet. “You kind of put them on their deathbed… It’s not common for someone to say ‘we’re suspending withdrawals’ and then say, ‘Okay, withdrawals are open, we’re fine’”.

Among the firms at risk is lender BlockFi, which said it has “significant exposure” to FTX. BlockFi has suspended most of its operations. According to The Wall Street Journal, the company is preparing for a possible bankruptcy filing.

Suffering is not restricted to the crypto world. The venture capital company Sequoia reduced its investment in FTX from US$ 210 million (R$ 1.1 billion at current quotations) to zero. Likewise, the Ontario Teachers Pension Fund, in Canada (Ontario Teachers), which invested US$ 95 million (about R$ 511 million), believes that now the investment is useless. As many as 1 million other investors may have lost all the money they put into FTX.

Binance, however, is emerging as a potential lifeline for companies hit hard by the FTX meltdown. Its CEO, Changpeng Zhao, announced on Monday (14) his team would create “an industry recovery fund”, for projects facing a liquidity crisis. Binance and other players have rushed to try to distinguish themselves from FTX, assuring customers and investors that their finances are sound.

Zhao, who goes by CZ, told CNN’s Anna Stewart that an FTX-style collapse is not a risk for Binance. Asked what he would say if all his customers wanted to withdraw at once, CZ replied: “Yes, no problem… We’ve always been profitable.”

An eccentric genius turned outcast

At the heart of the whole saga is an enigmatic 30-year-old who, with his charm, managed to penetrate powerful circles dominated by celebrities, legislators and investors with “deepest pockets”.

In recent years, SBF (as he is known online) has graced the cover of Forbes and Fortune magazines, hailed as the Warren Buffett of the cryptocurrency world. He amassed a vast personal fortune, estimated at US$26 billion (about R$140 billion) at his peak earlier this year.

All of that went up in smoke when FTX crashed. His fortune disappeared, and now his companies are under investigation by federal prosecutors in New York, according to a person familiar with the matter.

SBF had also become a regular in Washington (US capital), where he traveled regularly to pressure lawmakers for greater regulatory clarity for the crypto industry. But since he lost his companies, SBF has been tweeting at random, and he told a Vox reporter that all his trips to the American capital were not much more than posing as a good guy.

“F****** the regulators”, he raged in the interview with Vox, which was done through direct messages on Twitter. “They make everything worse.”

Investigations and regulatory control

FTX said this week that its representatives have contacted “dozens” of federal, state and international regulatory agencies.

In addition to the investigation conducted by the Court for the Southern District of New York, FTX is reportedly being investigated by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). , according to several news outlets.

Authorities in the Bahamas, where FTX is headquartered, opened a criminal investigation shortly after the company filed for bankruptcy.

On Friday, a powerful U.S. House of Representatives subcommittee said it was seeking internal documents and communications from Bankman-Fried and FTX to understand how the cryptocurrency exchange crashed so suddenly and what is being done to recover. customer funds.

Will cryptos survive?

In a word, yes. But there will still be a lot of suffering. “In the short term, the FTX meltdown undermined confidence,” said Matt Hougan, CIO of Bitwise, a crypto asset manager. “The marginal investor in cryptocurrencies will now think twice before opening an account, and many institutional investors will be on the back foot waiting for the worst to happen.”

Many observers have compared cryptocurrencies to the DotCom Bubble of the late 1990s — many companies failed, but those that survived, like Amazon, emerged to become mainstays of the tech industry.

Another historical comparison was with the collapse of Lehman Brothers in 2008, which triggered a global financial crisis. Crypto-optimists might be quick to point out that Lehman didn’t take all of Wall Street with it when it went bankrupt.

Skeptics might disagree, claiming that this only didn’t happen because the US government intervened — a very unlikely outcome in the highly deregulated world of cryptocurrencies.

“There are attempts to turn this issue into something about cryptos and poor regulation, but this disaster has nothing to do with cryptocurrencies per se,” said economist Pete Earle of the American Institute for Economic Research. “It’s a question of fraud and the power of the moral lesson.”

He added: “This scandal, far from destroying cryptocurrencies, pretty much guarantees that they are here to stay for a long, long time.”