FTX Collapse and the Crypto Market Catastrophe Explained

Introduction: Crypto Exchanges and the Regulatory Gap

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 crypto exchanges, like Coinbase, take self-regulation seriously in the hopes of winning over and working with institutional investors — such as BlackRock, a partnership that is very much underway (Tejpaul and Tusar). Others, like FTX, projected an image of professionalism to clients while underneath operating as a shaky house of cards: over-leveraged and, allegedly, using client funds in a Ponzi-type scheme to support their own expansion, growth, and real estate acquisitions in the Bahamas (Qing).

Theoretically, that kind of practice is known as commingling of funds — that is, taking clients' deposited money held in portfolios on an exchange like FTX and mixing it with the exchange's own business funds. That is a serious violation, and FTX stands accused of having done exactly that.

It is worth noting, however, that the big banks engage in a similar practice — only they have a formal word for it: rehypothecation. Regulators, who maintain close relationships with major financial institutions, permit this practice for the supposed good of the broader financial system. The distinction between what FTX allegedly did and what large banks routinely do may be less about the behavior itself and more about accountability and regulatory cover.

Bitcoin's Rise, the Crypto Winter, and the Skeptic's Case

When it comes to asset classes, none is more controversial than crypto. From the start, cryptocurrency has been a head-scratcher for most people. No one really knows the original founder of Bitcoin — the original cryptocurrency. He is known as Satoshi Nakamoto, but that is widely understood to be a pseudonym. Nonetheless, Bitcoin rose from obscurity when early transactions were facilitated by gamers using GPUs who "mined" it and made the network possible. Today, some of the wealthiest companies in the world — like ExxonMobil — are mining Bitcoin, and certain countries have begun to adopt it as legal tender. Yet few people still fully understand how it works, why it has utility, or why it holds any value at all. Some continue to view it as a speculative mania — comparable to tulip-mania or the dot-com bubble — and believe it will ultimately go to zero.

One reason skeptics hold this view is the dramatic price action the crypto market has experienced in recent years. Bitcoin, for instance, fell from an all-time high of $69,000 in November 2021 to a low of approximately $15,460 just one year later. Such a spectacular collapse — in a market pumped up by an accommodative Federal Reserve and priced to perfection — seemed to many skeptics like confirmation of their suspicions. The resulting bear market, commonly called the "crypto winter," was widely regarded as the worst downturn in crypto history.

Much like the crypto winter that followed the 2017 price surge, the winter of 2022 may have more to run — or may be nearing its end. No one knows for certain. But skeptics have accumulated considerable ammunition for their "it's all a con" narrative, and perhaps no single episode has given them more material than the fall of FTX.

What Is a Crypto Exchange and Why Did People Trust FTX?

Before examining FTX specifically, it helps to understand what a crypto exchange is. In simple terms, it is a platform where people can buy, sell, or trade cryptocurrency. Like any exchange, users can open an account and hold funds on the platform — but they can also move their funds off the exchange and store them in a personal wallet, using the exchange only when they want to execute a transaction. Some users do both. More cautious participants keep their crypto in private wallets rather than on exchanges, precisely to avoid the risks that events like the FTX collapse made painfully clear.

FTX, however, had cultivated a powerful appearance of legitimacy. It sponsored the World Series, ran television commercials featuring celebrities such as Tom Brady, Steph Curry, and Larry David, and purchased the naming rights to an NBA arena. People trusted it. Sam Bankman-Fried — the young co-founder and public face of FTX — regularly appeared on stage at high-profile events alongside figures like former President Bill Clinton. Author Michael Lewis, best known for The Big Short, was reportedly in the process of writing a book about Bankman-Fried when everything suddenly fell apart.

Works Cited

Chafkin, Max. "The Winklevii Are the Latest Crypto Founders to Blame Everybody But Themselves." Bloomberg, 2023.

Nelson, Danny. "Ukraine Partners With FTX, Everstake to Launch New Crypto Donation Website." CoinDesk, 2022.

Qing, Koh Gui. "Bankman-Fried's FTX, Senior Staff, Parents Bought Bahamas Property Worth $300 Mln." Reuters, 2022.

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.

Tejpaul, Brett, and Greg Tusar. "TLDR: Coinbase and BlackRock to Create New Access Points for Institutional Crypto Adoption." Coinbase, 2022. https://www.coinbase.com