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Seven Answers to Questions about the Collapse of FTX— and the Future of Crypto.


Crypto exchange FTX went from soaring success to filing for Chapter 11 bankruptcy last month. What had been a $32 billion company in January was left with an $8 billion shortfall after customers began withdrawing their digital assets. FTX’s demise quickly caused a chain reaction within the crypto industry, with some players finding their own value sinking fast and others questioning the future of digital assets more broadly.


Precisely what happened—and how the downfall of FTX might affect banks and credit unions that either allow or might soon allow customers to buy, sell, or hold cryptocurrency or those that bank crypto providers—can be difficult to understand. Below are a few common questions with some answers (at least according to what’s known now).


1. What is cryptocurrency anyway?


Cryptocurrency—often called “crypto,” for short—is money that can be traded in a digital form. Records of trades are kept on a shared and decentralized ledger that is secured through cryptography; the transparency provided by this decentralized ledger is designed to keep crypto safe from being traded multiple times and even from being hacked.


2. What Is FTX?


FTX is a Bahamas-based cryptocurrency exchange where users can buy, sell, and store digital assets; the company operates a separate exchange—FTX.US—for residents of the United States. FTX also created its own virtual currency in the form of tokens known as “FTT.”


Founded by 30-year-old Sam Bankman-Fried, who was until quite recently a billionaire and gained a reputation for being active in the effective altruism movement, FTX was once the fourth largest crypto exchange by volume, according to an article in NerdWallet[1].


Here is why the demise of FTX is getting so much attention, according to a November 16th article in USA Today: “FTX is one of the biggest exchanges where trading… digital assets took place, and was touted by regulators and market watchers as one of the most transparent crypto operations[2].”


3. What started the crypto run on FTX in early November?


On November 6th, rival crypto exchange Binance announced that it would be selling its FTT tokens. The announcement came via a tweet by Binance CEO and founder Changpeng Zhao, who wrote: “Due to recent revelations that have come to light, we have decided to liquidate any remaining FTT on our books[3].”


Zhao is believed to have acted following a report by CoinDesk that revealed FTX’s sister company -- Alameda Research-- had a balance sheet heavily weighted with FTT.


When FTX couldn’t immediately fulfill requests for withdrawals, Bankman-Fried apologized for FTX’s liquidity issues on Twitter. As news spread, customers made a run on the exchange, spurring it to announce that trading might soon be halted.


The exchange also seems to have fallen victim to a $600 million hack on users’ wallets[4].


4. Why is the collapse of FTX affecting the whole crypto industry?


Here’s the explanation offered by the New York Times on November 10th: “The cryptocurrency industry has long struggled to convince regulators, investors and ordinary customers that it is trustworthy. The fall of FTX, which seemed more stable than other companies, and the pullout by Binance have jolted the market[5].”


What’s more, the FTX crash meant that the value of FTT dropped sharply. Along with losses to FTT came losses to other crypto coins, such as Ethereum, Bitcoin, and Solana.


Other exchanges also had exposure to FTT or FTX, and as a result, are dealing with their own financial woes. For instance, cryptocurrency exchange BlockFi has been reported to have frozen withdrawals and has filed for bankruptcy because of its exposure to FTX[6].


5. Will the undoing of FTX lead to more crypto regulation?


Quite possibly.


In prepared testimony, Michael Barr, the Federal Reserve’s vice chair for supervision, said that recent events in the crypto market have “highlighted the risks to investors and consumers associated with new and novel asset classes and activities when not accompanied by strong guardrails[7].”


6. What actions are the Justice Departments and the SEC pursuing right now?


The U.S. government is said to be investigating whether FTX CEO Bankman-Fried improperly used billions of dollars of customer funds to help out another of his companies: Alameda Research.


In addition, there have been news reports that much of the money transferred out of FTX in its final hours has disappeared, according to the USA Today article mentioned above.


7. Will crypto-banking pick up steam if the existing crypto exchanges are perceived as risky?


Perhaps.


A November 15th article in American Banker says that “some bank executives… see a silver lining: Investors and crypto businesses are likely to want to work with more heavily regulated players like banks, they say[8].”


Continue to follow RiskScout for up to date information on the crypto market and what you need-to-know as a financial services professional. Subscribe to our blogs here to stay up to date.

[1]https://www.nerdwallet.com/article/investing/ftx-crash [2]https://www.usatoday.com/story/money/2022/11/16/ftx-bankman-frieds-crypto-bankruptcy/10710734002/ [3]https://twitter.com/cz_binance/status/1589283421704290306 [4]https://www.nerdwallet.com/article/investing/ftx-crash [5]https://www.nytimes.com/2022/11/10/technology/ftx-binance-crypto-explained.html?name=styln-ftx&region=TOP_BANNER&block=storyline_menu_recirc&action=click&pgtype=Article&variant=show&is_new=false [6]https://www.nerdwallet.com/article/investing/ftx-crash [7]https://fortune.com/2022/11/14/fed-banking-regulator-to-congress-ftx-crypto-regulation/ [8]https://www.americanbanker.com/news/flight-to-safety-crypto-friendly-banks-could-capitalize-on-ftx-meltdown

 

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