As the case revolving around FTX's collapse continues to unfold, this is the first of several articles covering the diverse angles of the FTX collapse. 


Without doubt, 2022 has been a bad one for crypto. From the devastating collapse of LUNA and its algorithmic stablecoin, UST, to the demise of important firms such as 3AC, Voyager, and Celsius, it has been one bad message after another.

In what is the latest installment of the crypto bustomania, the second-largest centralized crypto exchange, FTX, officially went bust on November 11th. But what happened, and how did an exchange valued at $38 billion go to zero almost overnight?

8 Days in November: Explaining FTX’s Sudden Collapse

On Nov. 2nd — to the dismay of many in the ecosystem — CoinDesk published findings that roughly $5.8 billion out of $14.6 billion of assets on the balance sheet at Alameda Research, based on then-current valuations, were linked to FTX’s exchange token, FTT. This scoop, based on leaked internal documents from FTX, was explosive because of the very close relationship between Alameda and FTX. Both outfits were founded by Bankman-Fried, and there has been significant anxiety among industry players about the extent and nature of their fraternal dealings. The FTT token was created from thin air by FTX, inviting questions about the intrinsic, real-world, open-market value of FTT tokens held in the reserves of FTX-affiliated entities.

Negative speculation about a financial institution can be a self-fulfilling prophecy, and this one triggered withdrawals out of a sense of uncertainty, leading to the very liquidity problems that were feared. However, sometimes straightforward facts are enough to trigger an entirely justified bank run. Seemingly because of their known close ties, worries about the health of Alameda’s balance sheet translated into a rapidly accelerating mass exodus from FTX by customers. The exchange saw $6 billion in withdrawals in the 72 hours before things reached a climax on the morning of Nov. 8th.

According to data from Coinglass, that for a time left FTX with a balance of, unbelievably, just one bitcoin! That value shot up to 36 BTC eventually, compared to more than half a million BTC each held by Coinbase and Binance.

This rush to get out of the exchange reportedly led Bankman-Fried and his team to begin frantically shopping for an acquisition partner, approaching a number of potential partners before Binance entered the picture.

Events that followed have shown exactly why such a dramatic rush for the exits would have led FTX to seek its own bailout. The exchange promised users, over and over, that it would not speculate with cryptocurrencies held in their accounts. But if that policy was followed, there should have been no pause to withdrawals, nor any holes in its balance sheet to fill. The plausible explanation comes from Coinmetrics analyst Lucas Nuzzi, who has presented what he says is evidence that FTX transferred funds to Alameda in September, perhaps as a loan to backstop Alameda’s losses, in the region of $10 billion.

The crisis also validated widely held anxieties about what Alameda’s immense holdings of FTT-linked assets meant for the stability of Bankman-Fried’s empire. The market value of the token is down more than 80% over the past week. Late in the day on Nov. 8th, after the announcement of a tentative deal with Binance, FTX said it had officially suspended all crypto withdrawals.

Citing a financial infeasibility, Binance CEO, Changpeng Zhao, eventually pulled out of the deal on November 9th. Being the only centralized exchange considerably bigger than FTX, Binance’s withdrawal led FTX scrambling for investors to plug the hole in which it found itself. Unable to do so, Bankman-Fried ultimately resigned, while FTX and affiliated organizations filed for bankruptcy on November 11th.

Key Talking Points From FTX’s Collapse

The effects of FTX’s collapse cannot be overemphasized. Before its collapse, FTX was a leading driver of adoption, both on social media and off, in the most remote areas of Africa, the Caribbean and the Middle East. What are the talking points from these events?

1. IS IT FINALLY TIME TO RETURN TO THE TRUE ETHOS OF CRYPTO

Pundits are calling the collapse of the FTX exchange the end of cryptocurrency and venture capitalism that drives innovation in the space. But it’s not. Some of these pundits anointed Sam “SBF” Bankman-Fried “The King of Crypto” — and then summarily killed the king. But, in reality, crypto has never had, and can never have, a king.

In reality, the FTX collapse is merely a symptom of a deeper problem, which is traditional finance’s “profit at any cost” mentality. For all the lip service paid to FTX as a regulated entity, at the end of it all, the exchange fell to sheer greed and profit-driven fraud like so many of its traditional counterparts. The so-called ‘stain’ FTX left behind has no more to do with real crypto than Enron had to do with real oil in the ground.

That brings us to Bankman-Fried and his roots at quantitative trading firm Jane Street. SBF was a quant trader who relentlessly and repeatedly asked why anyone would ever use a decentralized exchange and then answered his own question by mishandling billions in customer funds.

However, SBF and FTX didn’t fail because of his background. Warren Buffet, no fan of crypto, has an oft-repeated line that applies here: “You only find out who is swimming naked when the tide goes out.” It turns out that SBF was swimming ferociously, trunkless, in that turquoise Bahamian water. He either miscalculated the risk he was taking or ignored it altogether, overleveraging FTT — his exchange’s own loyalty print masquerading as a $4 billion market cap store of value — and lost huge on that bet.

It’s time the crypto industry drops the 10x mentality of seeking to gain enormous profits and focus on the fundamentals that brought so many to this world. Profits may fade, but solid foundations will keep crypto till the end of time. Crypto was never about the next memecoin or the next x- or y-to-earn application, and it was absolutely not about minting your own tokens to fund risky, fraudulent business practices. It was about financial self-sovereignty and cutting out the middlemen who have alienated billions from the world’s financial system.

It’s time to get back to this ethos.

Crypto is not a game of quick, exponential gains and speculative bets. Crypto is about recapturing the 5% rent that the financial services industry exacts on businesses and consumers around the world, daily, while making payments difficult for them. Crypto is about programmability and exploring what hundreds of thousands of smart developers can create when you give them an honest-to-truth API for money.

The promise of crypto isn’t just profit, although the profit could be a plus and nothing more. It’s a system where access to financial services isn’t determined by geography, race, sexual orientation, professional gravitas, gender or creed. It was initially designed as a system free of the middlemen that siphon dollars out of our pockets at every turn, and where greedy actors can’t treat our life savings like their bankroll at the roulette table. In founding bitcoin, Satoshi Nakamoto made referencing a ‘peer-to-peer network’ the central idea. That must be the rallying cry henceforth.

Crypto as a whole can continue to be personality obsessed, or the adults in the room can finally stand up.

2. ‘NOT YOUR KEYS, NOT YOUR COINS’ CAN ONLY SUCCEED AS A MORE USER-FRIENDLY OPTION

Since FTX’s collapse, there has been an exponential upshoot in the number of overnight advisors who have parrotted the phrase ‘not your key, not your coins’, pointing to the need for crypto owners to move their assets from exchanges to self-custodied cold wallets.

But this completely misses the mark—more so for an ecosystem looking to onboard billions of the world’s uneducated. The migration to the use of cold wallets isn’t the most user-friendly option. Cold wallets cost north of $100, which puts its affordability in the spotlight. Additionally, many people who look to get into crypto already struggle with CEXs from a user-experience perspective; cold wallets might be a nightmare that could get them uninterested in a technology that cannot be easily used by the average Joe. And then what? The ecosystem is worse off for it.

The DeFi and DEXes-only crowd is way off the mark. Pure DeFi isn’t without reproach – Terra/Luna for instance qualifies to be called DeFi. Hacks and rug pulls are plentiful in DeFi. And of course DeFi users need to hold their assets in self-custody, which, while being the premise of DeFi, is a nonstarter for the vast majority of people.

The fact is, while the average user should have the ability to withdraw funds and transact with them outside of an intermediated system, many users will not choose to do that. We can admit the reality that many users will always prefer intermediation, while pushing to improve the quality of service offered by these intermediaries.

3. Let’s Actually Commit to CEX Proofs of Reserve This Time, Okay?

The fraud-driven collapse of Alameda Research and FTX is, in the author’s opinion, the worst single event in the crypto industry since its inception. Even though as a share of overall crypto market cap the impact may have been less in relative terms than Mt. Gox was in 2014, the fallout will be more significant. For one, no one really thought of Mt Gox as a particularly credible institution. It wasn't “institutional” in the way that FTX is.

Mark Karpeles, who was the CEO of Mt. Gox, didn’t go on a charm offensive, lobbying in Washington to win favor from politicians and conducting PR interviews to position his exchange as crypto’s savior. Mt. Gox didn’t sanction Super Bowl ads. Celebrities didn’t line up to endorse the exchange. And crucially, the number of users worldwide were much fewer than FTX. FTX, by contrast, served millions of users across all six continents. It catered to numerous institutions, funds, and startups. It was aggressive in promoting itself to mainstream users, being solely responsible for the onboarding of many into crypto. Sam Bankman-Fried practically lived in Washington, charming members of Congress, politicians, and financial regulators. The exchange was widely considered one of the most trusted and credible platforms in the industry. The apparent fraud and subsequent collapse was therefore particularly catastrophic, because it happened so quickly and no one expected that from the FTX.

But that’s where proof of reserve comes in. Proofs of reserve harmonize the innate transparency of blockchains with the convenience and security of centralized custodians. The procedure generally refers to a demonstration undertaken by centralized exchanges proving that they possess client assets to match outstanding liabilities.

There was a minor wave of proof-of-reserve enthusiasm in the aftermath of Mt. Gox which immediately fizzled out, and a slight renaissance starting in the summer of 2021 with BitMEX’s proof of reserves and liabilities, followed by Kraken’s effort this February. Things haven’t moved any faster since. As it appears, reform must either wait for a crisis or a regulator.

Post-FTX, a new enthusiasm for proofs of reserve has predictably emerged. A number of exchanges – Binance, KuCoin, Gate.io, Poloniex, Huobi, Bitget, OKX, Deribit and Bybit – have indicated their intention to publish proofs of reserve. A couple of exchanges such as Crypto.com, Bitfinex and Binance have taken the intermediate step of releasing wallet addresses as a crude proof of assets. But this is incomplete without corresponding liabilities for therein lies the actual problem.

The asset side of things is trivial: It can involve publishing wallet addresses or signing a transaction. The tricky part is matching the assets with the exchange’s outstanding liabilities. To achieve that, an exchange adds up all user balances, anonymizes them and publishes the data in Merkelized format. From there, depositors can verify that they are included in the liability set. If enough do this, they can have strong confidence that the exchange in question isn’t cheating by omitting liabilities. And if the process happens under the eye of an external auditor, users can gain additional assurance that no liabilities are being excluded from the publications.

4. DON’T COUNT ON SBF FACING THE CONSEQUENCES OF HIS ACTIONS

After FTX’s collapse, skeptics have questioned whether the elite — in Washington, Nassau or elsewhere — will be motivated to investigate the situation with any rigor, or even be motivated to prosecute Bankman-Fried.

There are also more serious reasons to wonder who might be interested in holding Bankman-Fried accountable — like a glowing Nov. 14 interview with SBF published by the New York Times. Noting that SBF had been “compared to titans of finance like John Pierpont Morgan and Warren Buffett,” the article says that SBF “did, however, agree with critics in the crypto community who said he had expanded his business interests too quickly across a wide swath of the industry.”

That is OK, but what about the allegation that Alameda Research used more than half of FTX’s $16 billion in customer deposits to make failed trades? “He said the size of the position was in the billions of dollars but declined to provide further details,” the Times noted before moving on to other talking points.

What about new blockchain evidence that indicates Alameda Research used advanced knowledge of which assets FTX would list in order to inform its purchases? Such “front-running” is a form of insider trading — one that a securities lawyer might argue is illegal. The Times failed to even broach the issue when interviewing a man whose actions had sent millions of customers, hundreds of startups, and a few investors in financial trouble.

Media infatuation and, in the case above, boot-licking, isn’t the only advantage SBF enjoys. As several observers — not the New York Times, but others — have noted, he also holds a degree of political influence accrued from hours spent consorting on Capitol Hill, in addition to the tens of millions he has spent on political contributions. His $5.2 million donation to President Joe Biden’s 2020 presidential campaign made him its second-largest donor. He gave away another $39.8 million to political action committees and candidates primarily affiliated with the Democratic party in 2022.

Perhaps it’s understandable that some observers are wondering whether Bankman-Fried has faced the appropriate level of regulatory scrutiny he ought to, or whether he will in the future. Lawmakers who do take aim at matters related to finance and cryptocurrency could focus on coming up with rules that prevent industry kingpins from using and abusing their customers’ funds for frivolities.

Ultimately, FTX and Sam Bankman-Fried have set crypto back by years. Will crypto recover? The answer is yes, but changes must begin in earnest to fast-track this recovery.

This article is written by Chidera Anushiem as a part of enter.blog's bounty program. Do you have an interesting topic, series or subject you think would be fitting for enter.blog? 

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