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Reflections on FTX Bankruptcy

Things move fast in crypto, but the past week has been particularly dramatic. Sam Bankman-Fried, who has been the public face of the crypto industry for a couple of months, announced bankruptcy of FTX shortly after being criticized and “rug-pulled” by its competitor. The sudden collapse of the third-largest crypto exchange by volume with more than one million users left many lenders, investors, and customers in shock. Allegedly more than 10 billion customer funds were lost.

An Exchange War

FTX was founded by Sam Bankman-Fried, aka SBF, in May 2019. Changpeng Zhao, aka CZ, the founder of the largest crypto exchange named Binance, is one of the early investors and owned a 20% stake. Even though FTX was incubated by Binance, SBF and CZ soon became rivals. In 2021, CZ sold his shares at FTX in exchange for roughly USD 2.1 billion equivalent in cash BUSD and FTT, which are tokens issued by Binance and FTX respectively, marking Binance’s exit from FTX. As it is revealed today, this deal planted the seeds of FTX’s implosion.

In September 2022, Bloomberg reported on the relationship between FTX and Alameda Research, a trading firm that SBF has close affiliation with, which brought this open secret to the public. Two months later, Coindesk further revealed that Alameda Research held the majority of the FTT tokens in circulation, raising skepticism on the health of FTX’s balance sheet.

On November 6th, CZ said on Twitter that Binance would sell off all its holdings in FTT “due to recent revelations that have come to light”, which immediately triggered a bank run on FTX. The two giants seemingly reached a truce as Binance looked into a potential acquisition of FTX on November 8th, but the deal did not go through. Although Binance stopped selling FTT tokens at this point, it was all too late. FTX and its US branch, along with Alameda Research filed for bankruptcy on November 11th.

FTX stopped processing withdrawals two days before the bankruptcy, leaving billions of customer funds in danger. Just when the entire crypto market was brought down by this incident and panic was spreading among the investors, the situation was worsened furthermore by a mysterious “hack” on the same day as the bankruptcy was filed, where at least $515 million of funds were transferred out of FTX to unknown addresses. As of today, FTX’s website and mobile apps are no longer accessible. SBF pledged to do whatever he can to “do right by the customers”. However, the whereabouts of himself and other key persons remain unknown.

The Lack of Regulation

Although it has been 14 years since the invention of Bitcoin, and at least 10 years since it became a popular asset, regulation in the crypto space is still largely missing. As Bloomberg’s report pointed out, the such close affiliation between Alameda Research and FTX would have been impossible in the traditional finance industry in the first place. The arbitrary issuing and listing of new coins, price manipulations, over-leveraging, etc are not new problems to humankind yet still common in the crypto world. Ironically, SBF has been advocating for more government regulations in this space for months. He spent millions of dollars lobbying and donating to both the Republican and Democratic parties.

Crypto regulation in the US has been progressing slowly and has been criticized for “regulation by enforcement” rather than providing clear guidelines beforehand. As a result, more than 95% of crypto trading activities happen on overseas exchanges. For instance, FTX is based in the Bahamas, an island country with little regulation.

Many crypto believers do not like regulations, some even go as far as to say, “regulation cannot guarantee safety, only code can”. We think the industry cannot grow in the long run without sensible regulations. Firstly, regular users are usually less informed, and the protocols alone can never protect users from such schemes as in the FTX incident. Regulators may not be perfect, but they can at least scrutinize the big players before giving them the green light. Secondly, unless a decentralized cryptocurrency that is out of governments’ control can be widely accepted yet completely decoupled with fiats, which to be honest is unlikely in the foreseeable future, there will always be a need to exchange crypto for cash or cash equivalents. This by its nature calls for government overseeing. Lastly, criminal activities have to be prosecuted in the real world anyway, why not put regulations in place before it is too late?

The Future

As CZ and his millions of followers say, crypto is here to stay. After witnessing the collapse of Terra Luna, and the insolvency of 3AC, Celsius, Voyager, and FTX, we still believe the industry itself will come out healthier, and the infrastructure will become more robust. As an asset management company, 3ARB will always treat clients’ asset safety as the No. 1 priority. Our strategies will never use excessive leverage, and the risk is carefully calculated. More importantly, we do not hold customers’ assets in custody so we would never “suspend withdrawal” in any case.

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