The FTX scandal explained

published on 30 December 2022

Everyone is talking about SBF, Alameida, FTX, Binance, and you have no idea what is going on? We got you covered.


What is FTX?

FTX was a cryptocurrency exchange platform. Investors would come to buy and sell all sorts of coins. It was one of the two biggest exchange platforms with Binance. Until recently, the platform was worth $32 billion valuation, reflecting its importance in the cryptocurrency space and its promising future prospects.

FTX was founded by Sam Bankman-Fried (aka SBF), a figure that soon became one of the most prominent figures in the industry. You could see him hanging out with Gisele Bundchen or testifying in front of Congress to make crypto more respectful.

On top of his FTX business, SBF was also the founder of Alameda Research, a quantitative trading firm focusing also on crypto. Alameda specialized in trading arbitrage for crypto. This meant they look for small differences in the price in the market and pocket the difference (an example of arbitrage is someone finding that apples are sold for $1 in Brooklyn and $2 in Manhattan. This person buys the apple in Brooklyn, sells it in Manhattan, and pocket the $1 difference). For arbitrage to generate returns, you need a lot of money to invest upfront. 

This is where it got tricky.

What happened with the FTX scandal?

Usually, trading platforms are not allowed to lend the securities that the investors hold on their platforms (there are exceptions, but it is heavily regulated). This means that if you hold an Apple stock, the platform will hold this stock in a “vault” until you decide to sell it.

Cryptocurrencies exchange such as FTX are not regulated this way. FTX took the cryptocurrencies stored on its platform by the investors and lent them to Alameda. People's crypto was not stored in their vaults any more. Alameda could take all the cryptocurrencies and bet with them. Such moves were easy to cover in normal times: FTX was getting more and more money on its platform, and individuals were not withdrawing money in large volumes.

This got trickier on November 6 when Binance, the major FTX competitor, announced it would liquidate its FTX holdings in a tweet. 

Investors on the platform lost their confidence and asked to withdraw the money. But it was not there.

Alameda was playing with the money and was losing big, leaving an $8bn hole to reimburse to investors.

Why it matters?

First, it highlights the governance failures of those that invested in FTX itself. Many prominent VCs, attracted by huge gains potential, invested in FTX without any or very little diligence. The board of FTX was only SBF, the CEO, and Jonathan Cheesman, one of his friends.

This lack of scrutiny led to reckless behaviors such as SBF buying Bahamas property worth $300 mn for him and his family on the company account.

The new CEO mandated to clean up the mess called this situation unprecedented. And he was the one that managed the Enron collapse, the now second-biggest corporate scandal of the century.

Second, it highlights the importance of regulation and transparency in the crypto industry. The collapse of FTX created a snowball effect with other companies on the brink of bankruptcy. Some investors might never see their money back, although they thought they picked a safe and reliable platform. 

There is a reason why the financial industry is one of the most regulated. It protects you and your investments from the irrational and reckless behaviors of some irresponsible players.

If you still did not get it, the Onion explains it even better.

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