For the better part of the last three years the term “cryptocurrency” has stirred all sorts of emotions in people. There are three common responses to the idea of a virtual coin:
- You’re a true believer and you think cryptocurrencies are the future of money, a tool to create generational wealth for a set of young investors that hold the most minuscule amount of wealth in the country. Millenials control just 8% of wealth according to the Fed, the smallest of any previous generation by a wide margin.
- You think cryptocurrencies are nothing more than digital fool’s gold. A risky investment that can pay big, but isn’t based on or grounded in reality.
- A subset that doesn’t understand crypto, refuses to understand crypto, and wishes the whole thing would just go away.
Given the recent crypto crash and the total collapse of the digital currency exchange FTX, if you’re in that third camp you just might get your way. By now you’ve undoubtedly heard about FTX and how its founder Sam Bankman-Fried, once the super-young face of crypto and touted as possibly “The Next Warren Buffet” by Fortune Magazine, was essentially just running a Ponzi scheme. But how did a celebrated philanthropist wunderkind go from being worth an estimated $16 billion to being a disgraced alleged crook who was arrested in the Bahamas, extradited, and released on a historically high $250 million bail to live with his parents while he awaits trail, and, more importantly, what does that mean for cryptocurrencies as a whole?
We’re going to break it down, but first, we’ll explain the FTX collapse if you haven’t been following with a close eye. In truth, the FTX scandal is big and interesting enough to be a plot of a Wolf Of Wall Street or The Big Short style movie and undoubtedly will be. It’s also sure to generate a whole lot of non-fiction bestsellers. So understand that this is truncated — if we talked about all of it, you’d be reading a book, not an article.
What Is FTX?
Sam Bankman-Fried’s alias, @SBF_FTX, is nothing like the stereotypical “crypto bros.” Still, he is now the de facto leader of the crypto community.
So who exactly is he? @Fortune500 https://t.co/YcCqrySOYb pic.twitter.com/m94Beiovxw
— FORTUNE (@FortuneMagazine) August 1, 2022
FTX was a digital currency exchange that massively simplified the more technical aspects of buying and selling cryptocurrencies like Bitcoin, DogeCoin, and Ethereum. It’s important to note that FTX wasn’t just favored by small-time investors, major venture capital groups also bought in and NBC News reports that such groups invested as much as $2 billion in the company. FTX was very much seen as a legitimate business and a smart and functional way to get in on the crypto market for both small-time and large investors.
The main idea behind FTX, according to NBC News, was that people could keep their money in accounts and earn higher yields than if they kept money in traditional banks. As for the technical aspects, rather than needing to figure out how to set up an external hardware crypto wallet, FTX allowed people to easily buy and sell their digital assets via what is called a “custodial wallet.”
Custodial wallets, according to CNET, make the exchange of cryptocurrencies easier, but the major drawback is that they offer less security as the exchange — in this case, FTX — has the private keys to your cryptocurrency. That’s where things start to get shady.
In November of this year, The Wall Street Journal reported that Bankman-Fried said in an investor meeting that the trading firm Alameda Research owed the company $10 billion, loans that were extended to Alameda using money that customers had deposited on the exchange. At the time FTX had $16 billion in customer assets, meaning FTX lent more than half of its customer’s money to Alameda Research to place risky bets. Even worse than that, Alameda Research was a sister company of FTX, meaning FTX was essentially passing money to itself, gambling with its customer’s funds.
If that sounds shady it’s because it is!
What Is Alameda Research?
Alameda Research is a trading firm co-founded by Sam Bankman-Fried that specializes in cryptocurrencies and actually predates FTX by two years, first launching in 2017. The company made its money primarily via what it called “arbitrage.” According to Protos, arbitrage (in this sense) involves buying an asset on one exchange and selling it for a higher price on another exchange.
In 2017, bitcoin was valued higher in Japan, so according to Yahoo! Finance, Bankman-Fried organized a way to buy bitcoin cheaply in the US and sell it higher in Japan, wire the proceeds to the US, and repeat the process until the gap closed. In that time, as crypto experienced a crash and the price of crypto on both sides of the Pacific began to align, Bankman-Fried’s Alameda Research made about $20 million in profit. Not only was all of this legal, but it was also celebrated and helped to solidify Bankman-Fried as a young genius who made a risky bet and profited big.
Why Is All Of That A Problem?
Things started to fall apart late last year. In early November the digital currency news publication CoinDesk revealed that much of Alameda Research’s $14.6 billion in wealth at the time was tied up in a digital currency created by FTX called FTT. Meaning if the price of FTT were to drop for some reason, Alameda would be at risk of insolvency.
So in simple terms, Alameda Research, a trading firm created by Bankman-Fried was gambling with the digital currency of customers whose money was being stored on FTX, a digital currency exchange also owned by Bankman-Fried, and derived most of its value from a digital currency created by the same platform it was borrowing said money from. Without surprise, this raised red flags for anyone who had serious money invested in FTX.
How FTX Collapsed
According to NBC News, after the balance sheet was leaked, Changpeng CZ Zhao, the CEO of Binance, a major FTX rival, announced on November 6th that this company would sell all of its FTT tokens, resulting in a sharp price drop and a subsequent bank run as worried investors attempted to pull their money out of FTX before it became worthless. Only two days passed before FTX stopped allowing customers to take money out of the platform. On November 9th, The Wall Street Journal cited anonymous sources that said Bankman-Fried told investors that FTX needed $8 billion to cover the gap between what was owed and what it could pay out to customers looking to withdraw.
On November 11th, a disgraced Bankman-Fried stepped down as the CEO of FTX, and all the companies he oversaw filed for Chapter 11 bankruptcy. But it doesn’t end there, according to CoinDesk between November 11th and the early hours of November 12, $400 million mysteriously flowed out of FTX accounts due to an alleged hack. Many blockchain experts have pointed to several clues that the hacker was an FTX insider.
What Happened to Sam Bankman-Fried?
In December, Sam Bankman-Fried was arrested in the Bahamas and charged by Federal prosecutors with wire fraud, securities fraud, money laundering, and other financial crimes. The Securities and Exchange Commission also separately charged Bankman-Fried for allegedly defrauding FTX investors. Bankman-Fried has since been extradited to the US and released from jail on a $250 million bond. Vox reports that Caroline Ellison and Gary Wang, two former top executives at Alameda Research and FTX respectively, have since pleaded guilty to several fraud charges and are cooperating with federal prosecutors in the investigation.
On January 3rd, 2023, Sam Bankman-Fried plead not guilty to federal charges, his trial will begin on October 2nd.
So What Does This All Mean For Crypto?
It’s not looking good. Bitcoin, arguably the most trusted and safest digital currency peaked in 2021 — during FTX’s reign — reaching a value of above $65,000 per coin and crashed during the summer of 2022 dropping to $21,000, and dropping again to around $15,000 after the FTX collapse. Today, as of this writing, the digital currency sits around $23,000. Is this the end of Bitcoin and cryptocurrencies as a whole? Far from it, but what was once touted as the ‘future of money’ is seeming riskier than ever.
But with risk comes reward, and while a lot of small retail investors who put a lot of money into a belief that crypto would fundamentally change their lives have lost a lot of money, this downturn can be an opportunity for those willing to take a risk. And true believers in crypto haven’t lost faith. We spoke with Glauber Contessoto aka the “Dogecoin Millionaire” about how the FTX fallout would affect crypto in the long haul and he gave us some interesting insight and revealed that this larger downward trend predates FTX, he sent along the following:
It first started with the Celsius collapse, then the Voyager and the Luna/UST collapse which ultimately saw the FTX collapse. These are all setbacks that push crypto down more than it already is given the overall larger bear market and crypto winter currently happening. Everything is cyclical and crypto will come roaring back in the bull market. Typically we’re looking at a 4-year cycle in crypto so given our last bull run being in 2021 our next should be 2025 or 2024 at the earliest. (I also feel like these cycles will shorten as crypto becomes more widely accepted) Having said that I expect this year to remain bearish and it’ll probably be the best time to invest. This is not financial advice and I am not a financial advisor.
It should be noted that Contessoto, who made an initial investment of $180,000 in Dogecoin and grew his money to over $1M and never sold, isn’t an on-paper millionaire anymore. But considering Contessoto was bringing in a yearly income of $36,000 from a regular paying job, grew up poor, and made a risky investment that paid big, he represents exactly the sort of investor that FTX targetted and became a sort of folk-hero amongst the Reddit investment crowd. Does Contessoto think he should’ve sold some of that coin when it was hot? Absolutely, and he now focuses his investments on safer digital currencies like Bitcoin and Ethereum.
When asked how the same mistakes made with FTX can be avoided in the future, and whether crypto needs more government regulation, Contessoto responded with the following:
I feel like government regulation is something that will inevitably happen in the near future given the popularity of crypto as it moves into eventual mass adoption. I do believe there are a lot of scams, pump-and-dump schemes and rug pulls that need to be regulated and there should be some type of governance over this so people don’t continuously lose money investing in projects that aren’t real or get abandoned soon after launch. I think it should also pattern itself after Wall Street in a way but not as rigid. There should just be more accountability and transparency when it comes to the people launching projects in the space so if they do end up being scams these people get jail time and not just rinse and repeat these over and over. As far as SBF, crypto can’t be run like the traditional banking system. They shouldn’t be allowed to loan out customer funds ever and everything should always be backed 1-1 and there should be transparency on where these funds are held.
So should you start investing in digital currencies like Bitcoin and Ethereum while they’re valued at historic lows so you can flip some a bit of cash into a whole lot? To borrow from Contessoto, we’re not financial advisors and this is not financial advice: hell no. Just kidding, we honestly, have no f*cking clue! THAT. IS. THE. LESSON. OF. FTX. — very few people can predict how these markets operate. But one thing is for certain, digital currencies and the people who believe in them, aren’t going anywhere, regardless of what happens to Bankman-Fried.