The Rise And Fall of FTX

Brief History of FTX

Before we dive deeper into the demise of FTX, it’s good to know where the company was coming from. This will help us better understand the reasons for its collapse. Let’s recap the FTX story briefly from the early days to the current situation.
 

The Beginning

Though it may now be a thing of the past, ironically, the meaning of the abbreviation FTX is Future Exchange. It was founded by Sam Bankman-Fried and Zixiao Wang in 2019. The company’s first seeds were planted in 2017 when Bankman-Fried, Wang, and Caroline Ellison started Alameda Research, a company that would play a big role in FTX’s demise a couple of years later.

Only six months after the FTX was launched, Binance frontman Changpeng Zhao bought a 20% piece of the company for $100 million. That’s when things started to get big. Not too long after that, the company made its first major acquisition, buying the crypto portfolio tracker Blockfolio for $150 million.

In July 2021, only a bit over two years after the company’s journey had started, FTX raised more than 900 million from major investors such as Softbank and Sequoia. At the time, the company was valued at $18 billion.
 

How Did FTX Grow so Fast

FTX growth started to roll faster and harder after the first round of funding. The company moved to the Bahamas, and in January 2022 it was valued at $32 billion after raising $400 million in new funding. Changpeng Zhao, one of the company’s biggest investors, was bought out at the same time.

The company continued to make acquisitions, buying BlockFi for 240 million as well as its bankrupt competitor Voyager Digital for roughly $1.42 billion. The going was fast and furious, but it would soon come to an abrupt halt.
 

The End of FTX?

The relationship between Alameda Research and FTX caught the attention of Bloomberg reporters in September 2022. There were major issues in the connection between the two that would never have been allowed in traditional financial corporations.

A couple of months after the Bloomberg report, CoinDesk reported that a large portion of Alameda’s assets was, in fact, locked in FTX-issued cryptocurrency FTT. Only a few days after the report, Changpeng Zhao tweeted that Binance was about to sell all of its FTT holdings, as he had lost faith in Bankman-Fried’s operation.

This started a snowball effect, when masses of FTT holders tried to get rid of their tokens. Over three days, there were withdrawal requests for over $6 billion made, and this sent FTX into a liquidity crisis, since they simply did not have the money to pay their clients.
 

New Industry, Old Habits

One of the fundamental principles of Bitcoin was to create a new financial system, one without the ability for big players to abuse the system – to avoid catastrophic failures like the Lehman Brothers fall in 2018. At this point, it looks like not much has been learned, as the industry has been riddled with the failures of big players.

Starting from Mt.Gox in 2014, there have been several other cases where the reckless behavior of a few bad apples has made the whole industry look bad. Although these incidents are good in the sense that they help get rid of the rotten eggs, how many of these blows can the industry take?

The idea of Bitcoin was to create a system where trust wouldn’t be an issue since everything could – and should – be verified. Maybe one thing to learn from this is not to trust any exchange too much, no matter how big – when it comes to crypto, it seems the ‘too big to fail’ rule simply doesn’t apply.
 

You Should Be Cautious With Exchanges’ Own Currencies

One of the most interesting things about the whole FTX show is FTT, the cryptocurrency issued by the exchange itself. FTT is the native token of FTX. One of its biggest features for FTX users was commission discounts: holders of FTT could get up to 60% off their usual trading commissions. The token was also designed to make leveraged investments easier. FTT hit its all-time high of $85 in September 2021, but the value has plunged over 98% due to the recent crisis.

This puts pressure on other tokens issued by the exchanges that deal in them, such as Binance Coin and Crypto.com’s Cronos.

In the short term, these tokens could take a hit, since many investors might shy away from these centralized assets. Then again, at the same time, some consider it the right time to buy, as long as the technology and idea behind the token are sound.
 

Decentralizing the Power

As many commentators have noticed, the crypto world is not as decentralized as it would like to be. This might seem odd at first, given that decentralization is one of the key selling points of many cryptocurrencies, but there are valid reasons why that is.

The biggest issue with decentralization is the fact that scaling is much more difficult than with centralized exchanges. Centralized exchanges are simply able to create more buzz, meaning more transactions and lower transaction costs.

Even though decentralized exchanges might be more cost-effective, scaling is so much more difficult than with centralized exchanges. While centralized exchanges are more effective and easier to maneuver than decentralized ones, the centralization of power can also be an issue. The whole FTX crisis proves this point.

Too much power in the wrong hands can lead to poor decision-making, and when the poor decisions start to escalate, the results can be shocking. One thing we learned from the FTX collapse is that favoring decentralized exchanges might be something to consider, at least for some of your assets.
 

Choose a More Transparent Exchange

Ever since the FTX crisis started to gain more attention, some other big exchanges have rushed to make changes to their practices and inform their clients that their money is safe. Binance announced they would be launching a Proof-of-Reserves system, and Crypto.com also published some information on their reserves.

It seems obvious now that this kind of information should be made available to the public, and it’s easy to say the clients should have demanded some transparency from FTX as well. But is simply giving information on a company’s reserves and client funds enough?

As long as the information is not verified, there is no way of knowing with absolute certainty that these reserves really are what the companies claim they are. One thing that would raise any exchange’s trustworthiness through the roof would be using an external auditor.

Thanks to the FTX implosion, we are fairly confident that from here on out, everyone who wants to get invested in cryptocurrencies will choose a more transparent exchange.
 

More Regulation To Follow

We don’t yet know the ultimate outcome, and it will likely take months, if not years, for the dust to settle after the FTX crisis. Arguably one of the saddest things about the whole incident is the fact that this was not the first time the crypto industry has faced a serious crisis mainly caused by one person, and it’s likely not the last.

While the things a single investor can do are limited, some takeaways can help you in the future. You might not be able to avoid all issues, but at least you will be in more shallow waters should all hell break loose again. Here are a few things to keep in mind:

• Diversify and use several exchanges

• Only use transparent exchanges

• Be wary of exchange-issued tokens

• Trust no one.

It looks likely that the whole industry will be under more scrutiny in the future, and there is surely more regulation to follow. What type of regulation and how it will affect the industry remains to be seen, but more eyes on the big shots of the industry are not necessarily bad – at least for investors.