FTX and the Crypto Market Catastrophe Essay

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AbstractOne of the things skeptics like to point out about the crypto markets is that they are notoriously unregulated, opaque, and risky. Crypto exchanges like Binance (run by Changpeng “CZ” Zhao) and Coinbase tend to stay on the “safer” side of things by doing their utmost to work with regulators. Part of the problem, however, is that regulatory agencies like the SEC are not even sure how they want to regulate the crypto space. So there is a lack of clarity and oversight in the industry overall—but that doesn’t stop investors and speculators from wanting to pile into one of the hottest asset classes of the 21st century. And that means risk-on appetites can soar—and when they do, charlatans and fraudsters find ways to get rich quick. Sam Bankman-Fried, co-founder of FTX, is accused of being one of the latter.IntroductionWhat sets commodities or securities exchanges apart from the majority of crypto exchanges is that the former are tightly regulated and the latter are not. Some, like Coinbase, take self-regulation seriously in the hopes of winning over and working with institutional investors, such as BlackRock (which is very much happening) (Tejpaul and Tusar). Others, like FTX, project an image of professionalism to clients—but underneath they are a shaky house of cards, over-leveraged, and (probably) using client funds in a Ponzi-type of scheme to support their own expansion, growth (and mansions in the Bahamas) (Qing). Theoretically, that kind of thing is known as commingling of funds—i.e., taking clients’ deposited money that they hold in their portfolios kept on an exchange like FTX and mixing it with the exchange’s business funds. That’s a big no-no, and FTX is accused of having done it.Thesis StatementHonestly, though, the big banks all do the same thing—only they have a word for it: rehypothecation—and the regulators (cronies of the big banks) allow it for the “good” of the system.Body of PaperWhen it comes to asset classes, none is more controversial than crypto. From the start, cryptocurrency has been a head-scratcher for most. No one really knows the original founder of Bitcoin (the crypto OG). He is called Satoshi Nakamoto—but that’s just a nom-de-plume. Nonetheless, Bitcoin rose up from obscurity in the wilderness when transactions were facilitated by gamers with GPUs who “mined” it and made it all possible. Today, the wealthiest companies in the world—like Exxon—are mining Bitcoin, and countries have begun to adopt it as legal tender.

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Yet few still understand it or how it works or why it has utility or even any value at all. Some still continue to see it all as one big con game—like tulip-mania or the Dot-com bubble. They imagine it will all, in the end, go to zero.One reason skeptics think this way is the fact that the crypto market in recent months has looked…

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…his competitor (CZ) figured out the extent to which FTX was over-leveraged and triggered a collapse in FTX’s token by tweeting about an intention to sell it all (CZ held a big stake). The token crashed and FTX (along with its trading firm on the wing Alameda) went into panic mode on Twitter, offering to buy what CZ was selling off-market to stop the bleeding. Sharks smelled blood and went in for the kill as clients pulled funds (or what was left of them). Because FTX didn’t have the funds (due to bad trades under Alameda) it couldn’t prop up its token (which it was using as collateral to fund its expansion). Forced to liquidate the remainder of its holdings, FTX had to declare bankruptcy. It happens. It happens to banks—think Lehman and Bear Stearns. Banks, however, are insured—and most crypto exchanges are not.ConclusionThe bright side of all this is that crypto survived. The crypto community of miners, stakers, users, and traders remains. The bad blood of over-leveraged Ponzi-like exchanges has been let out. More bad blood may still need to be let out, but it appears for now that the bottom is in for Bitcoin and the rest of the crypto space. As always, too much leverage leads to too much risk, and too much risk inevitably leads to collapse and a washout. Case in point: Gemini and the Winkelvoss predicament currently playing out….....

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