The volatility of the crypto industry was laid bare for all to see earlier this month when FTX went from being one of the top three cryptocurrency exchanges to filing for bankruptcy within the space of just 7 days.
The rapid downfall of FTX came as the company found itself embroiled in a liquidity crisis and pleaded for help from its industry rivals. It agreed to sell itself to its rival Binance – the world’s biggest crypto exchange – only for that deal to fall through within less than 24 hours. Binance said FTX’s problems were just too big to fix, leading to customers fleeing the exchange while they still could.
FTX CEO Sam Bankman-Fried warned investors earlier in the week that, unless the company received a cash infusion of $8 billion, he would have no choice but to file for bankruptcy. The cash never materialized, and Bankman-Fried promptly followed through.
So how did FTX go from being one of the biggest and most successful crypto firms to bust in such a short space of time?
FTX was established by Bankman-Fried in 2019 as a Bahamas-based cryptocurrency exchange, and it very quickly became one of the biggest in the business. Through its exchange, customers could buy, sell and trade Bitcoin, Ethereum, and other digital assets.
The company reported earning more than $388 million in net income in 2021 at a time when interest in crypto was surging and the price of assets like Bitcoin hit new all-time highs. Around that time, Bankman-Fried became one of the most prominent names in crypto, spending millions of dollars to lobby for crypto-friendly regulations in the U.S. For a time, he was hailed as the J.P. Morgan of the crypto business, as he made deals to buy out rivals and grow FTX s presence. Meanwhile, his net worth reportedly soared above ten billion dollars.
FTX’s and Bankman-Fried’s downfall followed what, at the time, seemed like a fairly innocuous report from the crypto-centric news website Coindesk on Nov. 2. The report revealed how an FTX affiliate – Alameda Research – held a significant portion of its assets in FTT, which is the native token of FTX. The main benefit of FTT was that holders were able to receive a discount on trading fees with FTX.
While most ignored the report at first, for those in the know it suggested that FTX was simply manipulating the prices of FTT. Nic Carter, a partner at startup funding firm Castle Island Ventures, told Inside Bitcoin that FTX essentially “created this token out of thin air, gave it some value, and then Alameda utilized it as collateral.”
Speculation mounted and pressure quickly began to bear. In light of the report, investors in FTT – notably Binance – began selling off their FTT holdings, causing the token’s price to fall to an unsustainable level. In turn, that led to fears that FTX may not have sufficient assets to pay out to all of its users. What followed was a bank-style run as more people learned of FTX’s potential troubles, and the exchange’s users began racing to withdraw their assets from the platform while they still could.
FTX was forced to put a halt to withdrawals on Nov 9. One day prior, it announced that it had agreed on a non-binding deal for Binance to acquire it. However, shortly after FTX halted withdrawals, Binance announced it was pulling out of the deal – saying it did so amid concerns that FTX had mishandled customers’ funds.
Bankman-Fried’s last-ditch attempts to secure a rescue deal with other crypto exchanges, such as Kraken, came to nothing, and he was forced to file for chapter 11 bankruptcy on Nov. 11. Shortly afterward, Bankman-Fried announced he was resigning his position as FTX’s CEO.
Centralization Caused This Mess
At present, it’s still not clear as to how FTX managed to find itself in this position, but one thing we do know is the why – because FTX was a centralized exchange (CEX), it was able to keep its business dealings under the table, away from the scrutiny of its users. There was no way for anyone to sound the alarm in the event it mishandled its customer’s funds.
FTX is just the latest in a long line of CEXs that have bitten the dust. Names like Celsius Finance, BlockFi, Voyager Digital and Mt. Gox – they were all CEXs and their business models were as old as those of the banks they say they’re trying to displace. CEXs are money-making businesses and like many of the banks that collapsed in 2008, they have an economic incentive to under-collateralize and take risks with their user’s funds. In the case of FTX, it’s alleged that it used customers’ money to make all kinds of dodgy investments.
The dodgy practices of CEXs like FTX goes against the very ethos of cryptocurrency. When Satoshi Nakamoto created Bitcoin, he inscribed the words “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.” within its genesis block, sending a powerful message around his intentions. With Bitcoin, people would finally be able to participate in an alternative, permissionless financial system governed by code rather than profit-hungry bankers, where the rules are transparent and public, and apply to everyone equally.
Bitcoin was later followed by Ethereum and smart contracts, which gave rise to the idea of decentralized finance, or DeFi, which provides an array of modern banking services without the need for banks.
The latest debacle around FTX and CEXs shows us that DeFi and decentralized exchanges may finally be ready for prime time. With DeFi, every single transaction is transparent and publicly viewable on the blockchain. The middleman is made redundant, thereby eliminating the opportunity for mischief and under-the-table deals that seek to speculate with customers’ funds.
The collapse of FTX is bad news for its many customers, who will surely lose most, if not all of their funds. But at the same time, it may well serve as the catalyst DeFi needs to finally take off. The industry is evolving fast. Today, we no longer need to rely on outdated and buggy platforms like Ethereum, which suffer from network congestion, high fees, and constant hacks. The next-generation DeFi platform Radix enables low-cost transactions in real-time while eliminating the risk of vulnerabilities creeping into its code through its novel use of components and blueprints, which act like Lego building blocks for all manner of DeFi applications.
DeFi’s advantage is already clear. Despite the mass selloffs of crypto and the declining value of Bitcoin and other cryptocurrencies, it has been business as usual at DEXs like Uniswap, Balancer, and Curv. With those platforms, users remain free to enter and exit positions as normal and cash out at any time. There’s no danger of investors one day waking up and being unable to access their funds. No single entity controls these DEXs, so no one can arbitrarily put a stop to customers’ withdrawals. In this way, these DEXs are the epitome of consumer protection.
Modern DeFi platforms like Radix come with all of the benefits first introduced by Bitcoin – they’re permissionless, transparent, censorship-resistant, and enable self-custody of user’s assets. For anyone who’s determined to remain in control of their finances, DeFi should be the new focus of their economic activity. It’s the only true way for someone to be able to safeguard their assets.
The dangers of CEXs were highlighted by Bankman-Fried’s attempts to lavishly court U.S. government regulators. He was notably one of the main backers behind the proposed Digital Commodities Consumer Protection Act (DCCP), which is a piece of legislation that aims to legitimize CEXs at the expense of DeFi. Bankman-Fried even went on record to say that DeFi needed greater consumer protections while he continued to play loose with his customer’s funds.
A CEX like FTX of course sees DeFi as a major competitor to its own interests. What Bankman-Fried wanted was not so much consumer protection, but rather an opportunity to entrench his own interests by making it more difficult for DeFi to prosper.
So if there is a silver lining to the FTX debacle, it’s that it serves as yet another reminder as to why we should embrace decentralization. FTX’s failure was a failure of centralization, and the smart investors, developers, and users will do well to take notice of that and instead look to a fully decentralized future.
Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice
