"FTX Collapse is not a Crypto Failure. It's a failure of centralized finance and a failure of Sam Bankman-Fried." — Rep. Tom Emmer (Minnesota)
"This is really just old fashioned embezzlement. This is just taking money from customers and using it for your own purpose. Not sophisticated at all." — John J. Ray, (curent FTX CEO in a testimony to the House Financial Services Committee)
Summary
Following a report suggesting potential leverage and solvency concerns, the exchange faced a liquidity crisis and tried to negotiate a bailout by rival Binance that quickly fell through. Its CEO was later arrested, extradited to the U.S., released on a $250 bond, and he now faces trial in October 2023.
This article explains what happened and provides insight into why it was risky from the start and how to avoid being a victim of these situations.
The Indictment
Prosecutors allege in the indictment that Sam Bankman-Fried was engaging in criminal activity that began as far back as 2019 — in that he deliberately and knowingly “agreed with others to defraud customers of FTX.com by misappropriating those customers’ deposits and using those deposits to pay expenses and debts of Alameda Research,” the indictment alleges.
It also accuses Bankman-Fried of conspiring with others to defraud FTX’s lenders “by providing false and misleading information to those lenders regarding Alameda Research’s financial condition.”
The SEC indictment asserts that Sam Bankman-Fried improperly diverted customer assets to his privately-held crypto hedge fund, Alameda Research LLC, and then used those customer funds to make undisclosed venture investments, lavish real estate purchases, and large political donations.
When prices of crypto assets plummeted in May 2022, Alameda’s lenders demanded repayment on billions of dollars of loans. Despite the fact that Alameda had, by this point, already taken billions of dollars of FTX customer assets, it was unable to satisfy its loan obligations.
In response, Sam Bankman-Fried allegedly instructed FTX to divert billions in investors’ assets to Alameda to sustain its lending relationships and cash flow from lenders and investors. Finally, the SEC claims that, despite becoming clear that the platforms were unable to make customers whole, Sam Bankman-Fried continued to move millions to Alameda, using the misappropriated assets to finance other investments and ‘loans’ to himself and other FTX executives.
The U.S. Attorneys Office for the Southern District of New York charged Sam Bankman-Fried with eight criminal counts: conspiracy to commit wire fraud and securities fraud, individual charges of securities fraud and wire fraud, money laundering and conspiracy to avoid campaign finance regulations. His court date is set for October 2, 2023.
The History
FTX, which was launched inn 2019, was initially well-received by the cryptocurrency community, as it offered a wide range of features and a strong user interface. It quickly gained popularity and had a high daily trading volume. However, the platform was eventually hit with a series of mismanagement issues that led to its decline and eventual collapse.
The first issue was the fact that the platform was not properly regulated. As a result, there was an absence of oversight, which allowed for a number of potential issues to arise. In addition, the platform was not properly secured, which allowed for hackers to access user funds.
Another issue was the fact that the platform had a number of issues with liquidity. This meant that users could not always access the assets they wanted to trade, which caused a lot of frustration. Furthermore, the platform had a number of technical issues that hindered its usability.
In February of 2020, FTX, a rapidly growing cryptocurrency exchange, was accused of using its customer’s cryptocurrency to fund a new venture, Alameda Research, without their customer’s knowledge. This allegation was made public in a blog post from Alameda Research’s CEO, Sam Bankman-Fried, who admitted that FTX had used its customer’s cryptocurrency to fund the venture.
The controversy began when Bankman-Fried revealed that FTX had taken cryptocurrency from its customers and used it to fund Alameda without their consent. According to the blog post, FTX had taken a “small percentage” of customer funds from its exchange to “invest in Alameda”. Bankman-Fried also clarified that the funds were taken from customer accounts that were in “good standing” and that the funds were used to “support Alameda’s research and development”.
The revelation quickly caused backlash from the cryptocurrency community, with many customers feeling betrayed and outraged that their funds had been taken without their permission. Some customers even threatened to take legal action against FTX.
In response to the controversy, FTX issued an apology and clarified that while it had taken customer funds to fund Alameda, it had done so in an effort to “benefit all of its customers”. The exchange explained that the funds taken were a “small percentage” of customer funds that were “not actively being used for trading” and that the funds were used to “help the development of Alameda and its growth”.
Furthermore, FTX also pledged to reimburse any customer whose funds were taken without their knowledge. The exchange also promised to be more transparent in the future and to “actively engage with customers” before taking any action that affects them.
In the end, many customers were still not satisfied with FTX’s response and some even chose to move their funds to other exchanges.
Is Cryptocurrency at Risk?
What happened with FTX did not invalidate cryptocurrency, nor did it make it more or less risky to invest in cryptocurrency.
The problem is that a lot of investors are just looking for quick returns. They often do not know how to distinguish between decentralized and centralized projects, and they don’t do the due diligence to understand what is behind the coins. They can’t answer what value a specific token holds or whether they believe that it is going to create and sustain some kind of value.
Here are some topics that can help you understand how to avoid an FTX scenario. However, before investing in any cryptocurrency, it’s important to research the technology and its potential applications. Understand the risks associated with the asset before investing.
Don't trust, validate! You'll need to choose a crypto exchange to buy and sell your coins. And, while there are many exchanges available, you need to research them to determine which one is the best fit for you. Prefer decentralized exchanges over a centralized ones, and avoid exchanges that have direct access to your private keys.
Centralized vs. Decentralized Exchanges
FTX is a centralized exchange that allows users to trade cryptocurrencies with each other. FTX acts as the intermediary between the buyer and seller, taking a fee for each transaction. This is different from decentralized exchanges, which do not have a centralized point of control and instead operate on a peer-to-peer system.
Centralized and decentralized networks are two types of networks that are used for communication and data transfer. Centralized networks are typically owned and operated by a single entity, while decentralized networks are owned and operated by multiple entities. Each type of network has its own advantages and disadvantages, depending on the application.
Centralized Networks: Centralized networks are typically owned and operated by a single organization. This organization controls the resources and data of the network and is responsible for its security and reliability. In a centralized network, the central authority has full control over the network's resources, data, and communications. This allows the organization to monitor and control the network and its users. One of the main advantages of centralized networks is that they are easier to manage and secure. However, they can also be vulnerable to single points of failure and can be subject to malicious attacks.
Decentralized Networks: Decentralized networks are owned and operated by multiple entities. These entities share the resources, data, and communications of the network. This creates a more secure network as there is no single point of failure. In addition, decentralized networks are usually more resilient to malicious attacks as the data is distributed across multiple entities. Furthermore, decentralized networks are often more efficient as they can better manage resources and data.
Centralized exchanges are the most popular way for people to buy, sell and trade digital assets. Despite the convenience of these exchanges, they come with a number of risks that should be considered before investing.
One of the most significant risks of centralized exchanges is the potential for hacking. As these exchanges have become increasingly popular, they have become a prime target for malicious actors. Hackers can access user data, steal funds, and even manipulate the exchange’s order books. This has led to the loss of millions of dollars worth of cryptocurrency, and has caused many users to lose faith in these exchanges.
Another major risk of centralized exchanges is that they are subject to the regulations of the government or jurisdiction in which they are based. This means that the exchange can be shut down or have trading halted at any time, leaving users unable to access their funds. In addition, governments can impose rules and restrictions on the types of digital assets that can be traded, making it difficult for users to access certain coins or tokens.
Finally, centralized exchanges are subject to the “exit scam”, where the exchange’s operators suddenly disappear with the funds of their users. This can leave customers with no way to recover their money, and can cause them to lose a significant portion of their investments.
Decentralized exchanges, on the other hand, are platforms that allow users to trade digital currencies without relying on a third-party intermediary. These exchanges use a peer-to-peer network to connect buyers and sellers directly, allowing users to trade without having to submit personal information or complete a KYC process. Decentralized exchanges also tend to have lower fees, as users are not required to pay the fees associated with a centralized exchange. Additionally, since the funds are not held by a third-party, users have more control over their funds and are less likely to experience losses due to hacking or other malicious activities.
In conclusion, centralized exchanges are a convenient way to buy, sell, and trade digital assets, but they come with a number of risks that should be considered before investing. Users should be aware of the potential for hacking, government regulations, and exit scams in order to minimize their losses.
The Risks of Custodian Exchanges
When we’re talking about whether an exchange is custodial or non-custodial, what’s actually being taken custody of isn’t the funds in a crypto user’s account, it’s the private key needed to gain access their crypto assets. FTX had control of their customers' private keys; which means the user does not have direct control over the funds and their security. While these exchanges provide investors with an easy way to access the cryptocurrency market, there are some risks associated with entrusting a third-party with your funds.
The most significant risk with these types of exchanges is that your coins are held in the exchange’s wallet, meaning that the exchange has control and custody of your funds. This can create a single point of failure that could lead to your coins being irrevocably lost or stolen if the exchange is hacked or otherwise fails.
In addition to the risk of your coins being lost or stolen, these exchanges also have the potential to become insolvent. This could result in investors not being able to access their funds, as the exchange would have control over them.
Furthermore, cryptocurrency exchanges are not regulated in the same manner as traditional stock exchanges, meaning that there is no guarantee that the exchange will remain solvent or that your coins will remain safe. If the exchange is hacked or otherwise compromised, the user's funds could be lost or stolen. This is why the term "not your wallet, not your coins" is important - it emphasizes the need for users to take responsibility for their own funds and not rely on third parties for security.
Protecting Your Cryptocurrency
The most important way to protect your cryptocurrency is to use a secure wallet. You should also make sure to use a secure connection when sending or receiving cryptocurrency. Additionally, it’s important to keep your passwords and private keys secure, and to never share them with anyone. You should also use two-factor authentication when available and be sure to only transact with trusted parties. Lastly, you should diversify your holdings, spread your coins among different wallets, and keep your coins off of exchanges as much as possible.
What's in your wallet?
A cryptocurrency wallet is a digital wallet used to store, send, and receive cryptocurrencies. It stores public and private keys, which are used to access the cryptocurrency stored in the wallet.
Public keys are like a bank account number, allowing anyone to send cryptocurrency to the wallet. Private keys are like a password, allowing only the owner of the wallet to send cryptocurrency from it. The private key must be kept secure and is used to digitally sign transactions, providing mathematical proof that the transaction has come from the owner of the wallet.
What's the best wallet to use?
When it comes to storing digital currencies, there are two main types of wallets: hot wallets and cold wallets. Hot wallets are those that are connected to the internet, while cold wallets are those that are not connected to the internet. Both types of wallets have their advantages and disadvantages, and it is important to understand the differences between them before choosing which wallet to use.
Hot wallets, also known as online wallets, provide users with the convenience of instantly accessing their digital currency. These wallets are connected to the internet, so users can easily view their balances, send and receive funds, and manage their accounts. These wallets are also easier to use, as they usually have a more user-friendly interface. However, hot wallets have some major security risks. Since they are connected to the internet, they are vulnerable to hackers and other malicious actors.
Cold wallets, on the other hand, are wallets that are kept offline. These wallets are not connected to the internet, which makes them much more secure than hot wallets. Cold wallets provide users with the peace of mind that their digital funds are secure, as they are not vulnerable to hacking or other malicious attacks. However, cold wallets are not as convenient as hot wallets, as users cannot access their funds without first connecting the wallet to the internet.
In conclusion, both hot and cold wallets have their advantages and disadvantages. Thus, the decision of which wallet to use will depend on the user’s needs and preferences.
- Hot wallets offer the convenience of instantly accessing funds, but are vulnerable to hacks and other malicious attacks.
- Hot wallets are great for day-to-day spending.
- Cold wallets are much more secure, but they are not as convenient as hot wallets.
- Cold wallets are better suited for long-term storage of large amounts of coins and tokens.
Conclusion
The collapse of FTX will have a short-term negative impact on cryptocurrency prices as traders and investors may be concerned about the safety of their funds on the exchange. However, it is important to note that FTX is not the only cryptocurrency exchange, and many other exchanges are still operating normally. In the long-term, the impact of the FTX collapse is likely to be minimal.
Moreover, the cryptocurrency market is likely to remain resilient and has shown strong growth in the past year despite several negative events.
While the collapse of FTX did not make cryptocurrency more or less risky, it does highlight the need to