Why the FTX Collapse Matters Even If You Don’t Own Bitcoin

On November 11, 2022, the world’s second-largest cryptocurrency exchange FTX filed for bankruptcy. Earlier that year, the company was estimated to be worth approximately $32 billion. Their 30-year-old CEO and co-founder, Sam Bankman-Fried (also commonly known as SBF) also saw his personal net worth plummet from an estimated $15.2 billion to $991.5 million.

So, what happened here exactly? And more importantly, why should this matter – even to people who don’t own Bitcoin or care about cryptocurrency? In this post, we’ll explore how the worlds of finance, crypto, and greed are more alike than many people realize.

What Happened to FTX?

In the week leading up to FTX’s bankruptcy announcement, the exchange experienced a major liquidity crisis after thousands of its users tried to sell off a specific crypto token called FTT. FTT was a digital currency made by FTX, and it’s a fairly common practice for crypto exchanges to create these so-called “stablecoins” and use them as intermediaries for going between paper dollars and cryptocurrencies.

Normally, these stablecoins are equal to one U.S. dollar and supposed to be backed by actual physical assets. However, the dark truth is that there’s no real way of knowing whether they are or not (since crypto is unregulated). This means two things:

  • The exchange can theoretically issue as many of these stablecoins as they want
  • The tokens are truly only valuable on their native exchange

And that’s where the problem begins …

SBF not only owned FTX, but he also had another company called Alameda Research, a venture-capital and trading firm. In leaked documents to CoinDesk, it was revealed that the majority of Alameda’s balance sheet was these FTT tokens that had been printed out of thin air. To make matters worse, these FTT tokens were also being used as collateral for physical loans. Essentially, Alameda was misrepresenting itself by claiming to be worth billions when in fact its true value was much, much less.

As this situation was coming to light, CZ (Changpeng Zhao) the co-founder and CEO of the world’s largest crypto exchange Binance, announced on Twitter that his company was selling hundreds of millions of dollars worth of FTT. This quickly escalated into thousands of other users doing the same causing an old-fashioned bank run that resulted in the bankruptcy of FTX.

Thousands of FTX users who had just seen the company endorsed by big-name celebrities during the last Super Bowl now have their accounts frozen. To make matters worse, the fall of FTX has also caused a chain reaction throughout the cryptocurrency industry. Other exchanges like BlockFi, Gemini, and Genesis have all paused withdrawals. Some are even rumored to be considering potential bankruptcy. 

Democrat U.S. Senator Elizabeth Warren tweeted that the implosion of FTX was a wake-up call for Congress and regulators to hold the industry and its executives accountable.  She stated, “Too much of the crypto industry is smoke and mirrors. It’s time for stronger rules and stronger enforcement to protect ordinary people.”

How the Fall of FTX Could Affect You

Even if you don’t own Bitcoin or pay attention to cryptocurrency, you can’t ignore the significance of this event.

Impact on Traditional Financial Markets

Given the recent surge in popularity of Bitcoin and the entire cryptocurrency industry over the last 10 years, there has been a tremendous amount of demand from consumers causing many traditional brokerages to enter into this space. As an example, in the weeks leading up to the FTX implosion, Fidelity, one of the world’s most well-known and reputable financial institutions, announced they were going to soon offer crypto services. This would have opened the door to billions of dollars in retirement funds to potentially be invested in this market.

Just to be clear, nothing was wrong with Bitcoin or any other crypto. The demise of FTX was due to gross mismanagement of the business. Yet, as you might guess, this turmoil has pushed the already battered crypto markets even further to new lows for the year. If Fidelity had gotten into the crypto space a year ago and these events unfolded, there would be a lot of very upset investors and retirees right now.

You may or may not realize this, but it’s fairly common for many mutual funds and ETFs that are made up primarily of stocks and bonds to have some small portion of their holdings devoted to “other” assets, This small sliver could sometimes be something simple like cash, or could be more exotic and risky investments like options or futures. Could you imagine the fear right now if cryptocurrency was further along and some portion of these funds was invested in these tokens? 

Despite all the progress that cryptocurrencies have made over the last few years to become considered a legitimate asset, this situation highlights just how speculative they still are. This event shook the confidence of many, and after all – what good is an investment if no one believes in it?

More Bad Characters

It’s not often, but every few years when bad actors come to light, investors get a reminder of why we have so much government oversight in this industry. Back in the early 2000s, energy company Enron filed for bankruptcy after it was found that they were manipulating their accounting system. A few years after that, the former chairman of the NASDAQ stock exchange Bernie Madoff was exposed for conducting one of the largest Ponzi Schemes in history worth almost $65 billion.

Unfortunately, a lot of people really believed that SBF was going to be a positive force for the cryptocurrency industry. He often advocated for more government regulation which would have helped to legitimize it in the traditional finance arena. However, as it turns out, he was nothing more than just another fraudster. Sadly, history is always doomed to repeat itself, and so we can expect that this will likely happen again with whatever new trend investors become attracted to.

Lack of Investor Protection

This situation also highlights another risk that many investors often take for granted – the possibility of the brokerage going into bankruptcy. Unlike traditional providers where the SIPC covers up to $500,000 per account ($250,000 of which can be in cash), there are no such protections for users of cryptocurrency exchanges.

Anyone who’s still invested in crypto needs to beware of this possibility. If the world’s second-largest cryptocurrency can essentially collapse overnight, then it’s reasonable to wonder about the integrity of the others …

Remember to Invest with Caution

The situation with FTX is unfortunate, especially for those who held any FTT tokens or kept their crypto on FTX. However, this wasn’t the first time something like this happened, and it certainly won’t be the last. As investors, we always need to be ready to brace for the full scope of risk – anything that could potentially separate you from your money. 

Whether you’ve recently started investing or have been doing it for years, some of the best things you can do for yourself are to diversify your holdings and monitor your accounts regularly. If you’d like one convenient place to see all of your investments across multiple platforms, then consider using the Buxfer Investments feature. This will give you the ability to always have a real-time report of your whole portfolio and know that your financial future is well on track for success.

Featured image credit: Pexels

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