FTX crash: Painful lessons learned

The recent demise of FTX has brought back painful memories of the Enron and Lehman Brothers scandal times much of the cryptocurrency community seems to be too young to remember. The outcomes appear to be very similar: billions of dollars in value lost and thousands of frustrated investors. As the situation with FTX and its founder and CEO, Samuel Bankman-Fried, continues developing, there are already lessons to be learned from the case.

When considering the current situation with FTX, the shocking part is the speed of its development. Just to reiterate:

• Binance, the largest cryptocurrency exchange at the moment, signed a letter of intent to acquire FTX on November 8, 2022.

• Aside from the financial incentive to Binance, it was planning to save FTX from the liquidity crunch the exchange was reportedly facing.

• As the markets were still in shock from the largest acquisition in the industry, the withdrawals from FTX reached $6.0 billion.

• Binance withdrew from its proposal on November 9, 2022.

• The situation kept developing at a head-spinning pace, and FTX filed for bankruptcy protection on November 11, 2022.

• The exchange froze all transactions on the same day. Just like that, over a period of fewer than 5 days, the second-largest crypto exchange ceased its existence.

As the regulators, including the U.S. Securities and Exchange Commission (SEC), launched their investigations, more details continue coming out about FTX. At the moment, it appears that the alleged loans of FTX to Alameda Research, a company also founded by Bankman-Fried, were a large contributor to the financial problems of FTX. The estimated debt of Alameda to FTX peaked at $10.0 billion at the moment of investigation. Alameda Research used the funds of FTX as a part of its own trading activities. In case the investigators confirm the allegations, there is a plethora of ethical and legal issues that would require addressing. A sheer conflict of interest and a lack of internal regulatory processes at FTX that should have triggered red flags are the most prominent ones.

What are the lessons to learn from the FTX case?

First and foremost, regulatory controls are crucial for the cryptocurrency sector, just as they are in the finance industry. Investors need to be very cautious about the approaches and procedures followed by cryptocurrency exchanges before investing with them.

Second, it is always important to remember that investments in cryptocurrency, just as any other financial asset, carry a significant level of risk. This acknowledgment calls for consistent due diligence on the entities providing financial services. Do they have a credible license? Do they pass inspections and regulatory reviews on the use of funds? These are the important questions that need answers before making investment decisions. Relying solely on the persona of the owner (after all, Samuel Bankman-Fried is an MIT graduate with a significant experience and reputation in the industry) is never enough to allocate funds.

The demise of FTX drops a shade on the entire cryptocurrency community. At last, if the second-largest exchange can go bankrupt within a matter of days, why isn’t it a possibility for the other large exchange ecosystems?

Bitcoin alone lost 25% over the news about FTX. Much of it came from the withdrawal of illiquid funds from FTX by Binance. However, I urge you not to rush with the conclusions. Similar to the banking system and all other industries, there are always bad players. Their unethical actions drop shade on the other participants, but it does not undermine their professionalism and value.

Malta, Estonia, Great Britain, and the Philippines are the significant jurisdictions to receive a regulated license. For example, the Estonian Financial Intelligence Unit (FIU) permission indicates economic substance for modern crypto platforms. A Class 4 Malta VFA License is a strong sign of security and reliability of an exchange. Reportedly, only a few crypto platforms like Kyrrex obtained it in 2021. This type of license allows companies to provide completely secure cryptocurrency services. Companies such as Kyrrex pass regular inspections and audits as regulated companies, which proves that it is not using assets for personal profits. In addition, Kyrrex does not rely on large companies, such as Binance, for its liquidity. The latest FTX reports partially prove that without proper exchanges regulation such an incident could repeat in the future.

It is now clear that the cryptocurrency markets will face another wave of regulatory scrutiny around the world, especially in the U.S. and the EU. These measures will require additional disclosures and independent controls over their finances. The steps, aimed at the improvements of transparency and accountability, are long-overdue for the crypto sector. It will most likely help to weed out dishonest participants and strengthen the industry overall. Furthermore, it will speed up the integration of crypto into the traditional banking system. Such a process can contribute to additional volatility and waves of funds withdrawals, as poorly-managed companies leave the market.

In the long run, it means a healthier environment for everyone seeking investments in crypto assets or the use of cryptocurrencies as a medium of exchange. It will take several months for the market to stabilize. Afterward, the growth trend will resume, as crypto remains amongst the most demanded payment solutions and assets globally.

Author Bio:

Viktor Kochetov is the founder of the global financial ecosystem Kyrrex.