Home Business Why the FTX collapse has plunged the crypto world into upheaval

Why the FTX collapse has plunged the crypto world into upheaval

Why the FTX collapse has plunged the crypto world into upheaval

The cryptocurrency world was plunged into chaos this week with the stunning fall of FTX, a crypto exchange once valued near $32 billion that on Friday announced it would file for bankruptcy and the resignation of its chief executive.

Days earlier, industry leader Binance had backed out of a planned buyout of the troubled exchange on Wednesday after disclosing that a review of FTX's books had unearthed "mishandled customer funds" and amid news reports that U.S. regulatory agencies were circling the smaller exchange.

The sudden collapse is being referred to as the crypto industry's "Lehman Brothers" moment – a reference to the once-mighty investment bank whose implosion helped spark the 2008 financial crisis. One expert even described it as nearly "apocalyptic" for the sector.

Here's what you need to know about the failed deal, the key players and what it means for consumers:

What is FTX?

Cryptocurrency exchanges function as online marketplaces where anyone can buy digital currencies such as bitcoin and ethereum. FTX is one of the largest such exchanges in the world, along with the much larger Binance. A funding round at the beginning of 2022 put its valuation near $32 billion.

It was a darling of Wall Street, with major financial companies, including venture capital firm Sequoia Capital, among its investors. Sports leagues and franchises also entered multimillion-dollar contracts with the company. Those included a $135 million deal to rename the Miami Heat's stadium the FTX Arena and an ad with NFL star Tom Brady.

Who are Sam Bankman-Fried and Changpeng Zhao?

Sam Bankman-Fried, often referred to as SBF, is the 30-year-old founder and chief executive of FTX. This election cycle, he was the second-largest Democratic donor and a major lobbying force in Washington for crypto regulation. Before this week's turmoil, Bankman-Fried drew comparisons to legendary banker J.P. Morgan for bailing out other troubled exchanges. Bankman-Fried also owns cryptocurrency trader Alameda Research, which is technically separate from FTX.

Changpeng Zhao is the chief executive of Binance, the world's largest crypto exchange and FTX's main rival. Zhao and Bankman-Fried were once close, and Binance made an early investment in FTX.

But tensions emerged between the two as Bankman-Fried lobbied Washington for more regulation and Zhao publicly objected to those efforts.

"We won't pretend to make love after divorce," Zhao, also known as CZ, tweeted this past weekend of Bankman-Fried. "We won't support people who lobby against other industry players behind their backs."

What happened?

Last week, CoinDesk published a report, citing a private document, that raised questions about whether FTX and Alameda Research were more interconnected than previously disclosed. Alameda reportedly had a large portion of its balance sheet tied up in an FTX-issued cryptocurrency called FTT, raising questions about whether Bankman-Fried's companies could survive a major drop in FTT's value.

Zhao, who held a large stake in FTT, announced Sunday that Binance would sell about $530 million of FTT – depleting the value of the token and prompting FTX customers to start pulling out their investments. Despite Bankman-Fried's efforts to calm customers, on Monday they withdrew some $654 million from FTX.

On Tuesday, Zhao announced that he was swooping in to buy out the troubled exchange. But in an about-face, he walked away from the deal the next day after a review of FTX's books revealed that the company "mishandled customer funds."

On Friday morning, FTX announced it will file for Chapter 11 protection, along with Alameda and other affiliated companies. The company said that Bankman-Fried had resigned as chief executive but would "remain to assist in an orderly transition."

Why does this matter?

The crumbling of FTX, which had cast itself as the poster child for cryptocurrency reliability, has raised major concerns about an industry that has gone largely unregulated, experts said. This week's chaos has rattled retail investors who put faith in FTX, and the crypto market and they may lose money, said Reena Aggarwal, director of Georgetown University's Psaros Center for Financial Markets and Policy.

"It really shakes up confidence in the whole system," Aggarwal told The Post on Thursday.

Also worrying are the possible ripple effects of the FTX collapse, she said. After Binance walked away from the buyout, bitcoin dropped 15 percent – although the popular cryptocurrency was on the rise Thursday, along with other major cryptocurrencies.

Is this the death of cryptocurrency?

Not necessarily. There have been other events – such as a crash this year – during which observers feared a collapse of the market. But Yesha Yadav, a law professor at Vanderbilt University who closely follows cryptocurrency and financial markets, characterized the most recent situation as "close to apocalypse."

FTX's collapse "means not only a kind of normal chaos for the industry, but also a lot of worries about the credibility of the industry and its ability to actually run itself," Yadav told The Post on Wednesday.

"Existential questions have raised about how this is going to exist afterwards – what it's going to look like, what the standards are going to look like, who's going to be allowed to be here, what kind of rules we need for that to happen safely," she said.

Yadav called the collapse an "inflection point" that may prompt a harder regulatory push and "restore credibility to this very broken industry."

Who are the biggest losers?

Bankman-Fried and FTX may be the biggest losers. This week Bankman-Fried was seeking as much as $8 billion to bail out his company, the Financial Times reported. FTX is also being investigated by the Justice Department and federal regulators, The Post reported.

Aside from the industry's credibility, Yadav said the biggest losers will be FTX's customers – it's unclear if they'll get their money back. Other losers included large institutional investors such as Sequoia, which is believed to have invested about $210 million in FTX.

In a letter to partners on Wednesday, the firm said it was marking its investment down to zero.

Will FTX customers get their money back?

FTX paused withdrawals as customers sought to pull funds out of the exchange this week, and some of them have begun to worry their money is lost. A recent precedent in the digital finance world isn't encouraging: Since the embattled bank Celsius Network filed for bankruptcy in July, many of its customers still cannot access their funds.

If FTX has money to repay its customers, they may be able to recover funds through bankruptcy proceedings, said Barry Adler, a law professor at New York University. But they probably won't get anything if the exchange lost that money through its dealings with other companies, Adler said.

"You can't get blood from a stone," he said.

WASHINGTON POST

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