Abstract
One of the things skeptics like to point out about the crypto markets is that they are notoriously unregulated, opaque, and risky. Crypto exchanges like Binance (run by Changpeng CZ Zhao) and Coinbase tend to stay on the safer side of things by doing their utmost to work with regulators. Part of the problem, however, is that regulatory agencies like the SEC are not even sure how they want to regulate the crypto space. So there is a lack of clarity and oversight in the industry overallbut that doesnt stop investors and speculators from wanting to pile into one of the hottest asset classes of the 21st century. And that means risk-on appetites can soarand when they do, charlatans and fraudsters find ways to get rich quick. Sam Bankman-Fried, co-founder of FTX, is accused of being one of the latter.
Introduction
What sets commodities or securities exchanges apart from the majority of crypto exchanges is that the former are tightly regulated and the latter are not. Some, like Coinbase, take self-regulation seriously in the hopes of winning over and working with institutional investors, such as BlackRock (which is very much happening) (Tejpaul and Tusar). Others, like FTX, project an image of professionalism to clientsbut underneath they are a shaky house of cards, over-leveraged, and (probably) using client funds in a Ponzi-type of scheme to support their own expansion, growth (and mansions in the Bahamas) (Qing). Theoretically, that kind of thing is known as commingling of fundsi.e., taking clients deposited money that they hold in their portfolios kept on an exchange like FTX and mixing it with the exchanges business funds. Thats a big no-no, and FTX is accused of having done it.
Thesis Statement
Honestly, though, the big banks all do the same thingonly they have a word for it: rehypothecationand the regulators (cronies of the big banks) allow it for the good of the system.
Body of Paper
When it comes to asset classes, none is more controversial than crypto. From the start, cryptocurrency has been a head-scratcher for most. No one really knows the original founder of Bitcoin (the crypto OG). He is called Satoshi Nakamotobut thats just a nom-de-plume. Nonetheless, Bitcoin rose up from obscurity in the wilderness when transactions were facilitated by gamers with GPUs who mined it and made it all possible. Today, the wealthiest companies in the worldlike Exxonare mining Bitcoin, and countries have begun to adopt it as legal tender. Yet few still understand it or how it works or why it has utility or even any value at all. Some still continue to see it all as one big con gamelike tulip-mania or the Dot-com bubble. They imagine it will all, in the end, go to zero.
One reason skeptics think this way is the fact that the crypto market in recent months has looked like it was on deaths door. Bitcoin, for instance, went from trading at an all-time high of $69,000 in November 2021 to a low of $15,460 one year later. Such a spectacular fall in price or fall from grace or fall from all-time highs in an over-exuberant market pumped up and priced to perfection by a punch-bowl spiking Federal Reserve and friends could only be the result of fraudso said the skeptics. And so went the crypto winterthe big bear marketthe worst year in crypto since ever. Like the crypto winter that followed the big run-up in price in 2017, the winter that hit in 2022 may still have a little while longer to goor it may be coming to close. No one knows. But the skeptics do have plenty of ammo with which to support their its all a con narrative: for instance, they have the fall of FTX.
Before we get to FTX, lets just explain what a crypto exchange is: its a place where people can buy, sell or trade crypto. Like any exchange, you can set up an account and keep funds on the exchangebut you can also move your funds off the exchange and keep them in a wallet and only use the exchange when you want to make a transaction. Some people do both. Cautious people keep their crypto in their walletsnot on exchanges.
FTX was an exchange that had the appearance of legitimacy and authenticity: after all, it sponsored the World Series; had commercials starring Tom Brady, Steph Curry, Larry David, and other A-List celebs and sports stars; and owned the naming rights for an NBA coliseum. So people trusted it. Sam Bankman-Fried, the young co-founder and face of FTX, often appeared on stage at high-profile events with people like Bill Clinton. Michael Lewis (author of The Big Short) was even (apparently) writing a book about himwhen everything suddenly went off the rails.
Actually, everything went off the rails in the crypto space prior to FTX blowing up. But it always plays out the same way: exchanges play fast and loose with risk; they have too much leverage (i.e., margin debt). They get margin called after losing clients money (unbeknownst to clients), and then the panic sets in. Dominoes fall, because so many funds and exchanges are tied at the hip all playing the same margin game (aka Ponzi scheme). Those that survive have the best balance sheets and manage their risk most effectively. Those that perish die because they were erected on a shoddy foundation of recklessness and deceit. FTX appears to be one of these. It was also one of the biggest busts in the crypto spaceby more than a few billion. Who or what was really going on with FTX? How high up did the corruption actually go? When Bankman-Fried is sharing the stage with guys like Larry Fink (BlackRock), Janet Yellen (US Treasurer, former Fed Chair), and Ben Affleck (yeah, not sure why he was there but he was there) even after his firm goes bust and people around the world are crying foultheres a good chance not all is what it seems. Heck, there has even been speculation that Ukraine was using FTX to launder funds back into the pockets of the American political class (Nelson). So this is a rabbit hole that probably goes pretty deep.
Ultimately, howeverif this is all trueBankman-Fried was really just doing the same thing banks do. The only problem was that his competitor (CZ) figured out the extent to which FTX was over-leveraged and triggered a collapse in FTXs token by tweeting about an intention to sell it all (CZ held a big stake). The token crashed and FTX (along with its trading firm on the wing Alameda) went into panic mode on Twitter, offering to buy what CZ was selling off-market to stop the bleeding. Sharks smelled blood and went in for the kill as clients pulled funds (or what was left of them). Because FTX didnt have the funds (due to bad trades under Alameda) it couldnt prop up its token (which it was using as collateral to fund its expansion). Forced to liquidate the remainder of its holdings, FTX had to declare bankruptcy. It happens. It happens to banksthink Lehman and Bear Stearns. Banks, however, are insuredand most crypto exchanges are not.
Conclusion
The bright side of all this is that crypto survived. The crypto community of miners, stakers, users, and traders remains. The bad blood of over-leveraged Ponzi-like exchanges has been let out. More bad blood may still need to be let out, but it appears for now that the bottom is in for Bitcoin and the rest of the crypto space. As always, too much leverage leads to too much risk, and too much risk inevitably leads to collapse and a washout. Case in point: Gemini and the Winkelvoss predicament currently playing out (Chafkin). Leverage has to be managed cautiously and carefully: it is why Terry Duffy, the CEO of the CME Group, laughed in Bankman-Frieds face when, at a meeting, Bankman-Fried refused to take Duffy up on his offer to run risk for FTX. Duffy knew right away that Bankman-Fried was a fraud and said so to his face (Rosen). Risk is a serious matter in the world of high finance. Speculators in crypto often forget that because they see the opportunity for big gains in a short amount of time and have a risk-on mentality that lets them swing for the fences. All is fine and gooduntil the music stops.
Potential Topics:
-how is crypto different from other asset classes
-is crypto a good or safe investment
-how do the crypto markets work and why is crypto so volatile
-is crypto a scam or not
Alternate Titles:
Another Crypto Winter Has Come
Will Crypto Survive or is Bitcoin Doomed to Die?
Why So Many Crypto Exchanges are Going Bust and What to Do About It
FTX and the Crypto Market Catastrophe
Outline:
Crypto and regulations
Not really any different from banks in terms of actions, just in terms of accountability
What is an exchange?
What happened with FTX?
What it means and why risk management mattersyes, even in crypto markets
Works Cited / Bibliography
Chafkin, Max. The Winklevii Are the Latest Crypto Founders to Blame Everybody But Themselves. Bloomberg, 2023. https://www.bloomberg.com/news/articles/2023-01-17/winklevoss-twins-deflect-blame-as-gemini-faces-lawsuit?leadSource=uverify%20wall
Nelson, Danny. Ukraine Partners With FTX, Everstake to Launch New Crypto Donation Website. CoinDesk, 2022. https://www.coindesk.com/policy/2022/03/14/ukraine-partners-with-ftx-everstake-to-launch-new-crypto-donation-website/
Rosen, Phil. ‘You’re an absolute fraud’: CME Group CEO says he called out Sam Bankman-Fried the first time he met him, months before FTX’s collapse. Business Insider, 2022. https://www.businessinsider.com/ftx-sam-bankman-fried-fraud-collapse-cme-group-duffy-crypto-2022-11
Tejpaul, Brett and Greg Tusar. TLDR: Coinbase and BlackRock to create new access points for institutional crypto adoption by connecting Coinbase Prime and Aladdin. Coinbase, 2022. https://www.coinbase.com/blog/coinbase-selected-by-blackrock-provide-aladdin-clients-access-to-crypto-trading-and-custody-via
Qing, Koh Gui. Bankman-Fried’s FTX, senior staff, parents bought Bahamas property worth $300 mln. Reuters, 2022. https://www.reuters.com/technology/exclusive-bankman-frieds-ftx-parents-bought-bahamas-property-worth-121-mln-2022-11-22/
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