As FTX implodes, the crypto exchange model draws scrutiny


This week’s revelation that up to a million investors may be hurt by the collapse of cryptocurrency exchange FTX exposes what critics say is a fundamental flaw in the foundations of the $850 billion digital currency market.

As the Bahamas-based company implosion continued to spark turmoil in crypto markets on Wednesday, experts said the concern lies less with crypto itself than with the lightly regulated companies that serve crypto investors.

For investors, FTX was a gateway to the world of cryptocurrencies, an exciting marketplace where famous ambassadors like quarterback Tom Brady invited them to open accounts and trade digital currencies like bitcoin and ether. FTX, in turn, functioned in many ways like traditional banks and finance brokers, holding client accounts, trading currencies, and making loans and investments with client assets.

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But like other cryptocurrency exchanges, FTX operated outside of the traditional banking system, and this created huge risks. Although they act as banks and brokers, cryptocurrency exchanges are typically not subject to the same type of regulation, insurance, and disclosure rules that protect customers from traditional banks.

“On one level, the FTX crash is not a crypto story at all,” said Adam Levitin, a Georgetown University law professor and director of Gordian Crypto Advisors, a firm that provides advice on crypto bankruptcies. “People invested billions in an unregulated financial institution based on a Caribbean island. How could this end well?

What the large-scale FTX case shows is that companies holding cryptocurrency for clients can make investment decisions that end in disaster, and when they do, there is no clear guarantee clients will get their assets back.

According to Reuters, at least $1 billion in client funds have vanished from FTX, one of the industry’s largest exchanges, in circumstances under investigation by the Justice Department and the Securities and Exchange Commission. In bankruptcy filings, FTX revealed that it may owe money to more than a million people and organizations.

The crash drew attention because FTX is one of the largest cryptocurrency exchanges, and its founder, 30-year-old Sam Bankman-Fried, had been widely hailed as a cryptocurrency wunderkind and top Democratic donor. But over the past year, as the overall value of the crypto market has plummeted from a peak of over $3 trillion, other crypto companies have also struggled financially.

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Crypto Lenders Celsius Network Y digital traveler filed for bankruptcy earlier this year after they were unable to meet customer demands for withdrawals. Last week, another lender, BlockFi, announced that it was “unable to operate as usual” and was “halting customer withdrawals” in the wake of the FTX collapse. This week, the AAX cryptocurrency exchange announced that it had requested the cessation of withdrawals, citing technical issues with an external partner. And on Wednesday, cryptocurrency lender Genesis said that he will temporarily suspend repayments and new loan origination.

These issues have spooked investors, prompting executives at other big cryptocurrency exchanges, including Coinbase,, and Binance, to reassure clients that their balance sheets are strong. Some have portrayed the FTX collapse as an anomaly in an otherwise safe industry.

“This is the direct result of a rogue actor breaking all the basic rules of fiscal responsibility,” Patrick Hillmann, chief strategy officer at Binance, the largest of crypto exchanges, said in a statement to The Washington Post, referring to Bankman. -Fried. . “While the rest of the industry operates under an extreme measure of scrutiny, the cult of personality that envelops FTX allowed them a dangerous level of privilege that was not earned.”

But the lack of regulation creates risks for crypto investors, experts said. In the United States, the financial condition of a traditional bank is subject to official scrutiny and regulation. Had FTX been subjected to the same scrutiny, the weaknesses in its financial situation might have been revealed sooner. Additionally, customer deposits at traditional banks are insured up to $250,000 by the FDIC. None of those protections will help those who have lost money on FTX.

FTX is one of several large cryptocurrency exchanges that have played a pivotal role in popularizing cryptocurrencies, including paying for Super Bowl ads to reach large audiences. According to a survey by the Pew Research Center, 16 percent of American adults say they have at some point invested in or traded cryptocurrencies.

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Some “companies have been allowed to get very big despite their blatant disregard for the rules imposed on traditional financial institutions,” said Tyler Gellasch, president of the Healthy Markets Association, a group focused on increasing transparency and reducing costs. conflicts of interest in capital markets. .

“The banking and securities rules were put in place to ensure that if the bank or broker fails, you can still get your assets back,” Gellasch said. “Crypto exchanges don’t seem to comply with any of them.”

Since FTX filed for bankruptcy last week, several major exchanges have sought to become more transparent. Last week, Binance published a brief description of its cryptocurrency holdings, though not its responsibilities.

Binance chief Changpeng Zhao said the company would publish a more complete account of its financials in a few weeks, once an external auditor can complete its work. Zhao did not identify the auditor, but said the same firm had also worked for FTX.

“Nothing is risk free, right? Cryptocurrency exchanges are inherently quite risky businesses,” Zhao said Monday in a Twitter Spaces chat. “You have to handle them well. You have to do security well. You have to do several things well.”

Unlike FTX, Zhao said that Binance has no debt. “We are a very clean and very simple business,” he said. “We’re not trying to be a pawn shop or a hedge fund shop.”

At, CEO Kris Marszalek held a live video broadcast on Monday amid online rumors that the company had stopped processing withdrawals. Marszalek acknowledged that the number of withdrawals had temporarily increased after the company mishandled a transaction worth about $400 million that he claimed was inadvertently sent to the company’s account on a competitor’s exchange.

But he called the rumors of a pause “absolutely false”, adding: “We are operating as usual.”

In what Marszalek touted as an effort to restore depositor confidence, released a partial breakdown of its cryptocurrency holdings, revealing that as of Nov. 14, the company had at least $2.3 billion in cryptocurrency reserves. . But the company’s outstanding liabilities are not publicly known and were not included in the initial report the company released after FTX’s collapse.

Marszalek downplayed’s exposure to FTX on Monday, assuring investors that the company’s balance sheet is “tremendously strong.” He said a “third party audit” of the exchange’s client holdings would be published in the coming weeks.

Based in Singapore, has invested a fortune in flashy marketing campaigns, hiring actor Matt Damon as a brand ambassador and acquiring the naming rights to Los Angeles’ Staples Center in a deal valued at approximately $700 million. . This year, however, the price of its native token, chronos, has plummeted. Last week, Chronos lost more than 50 percent of its worth, fueling questions about the solvency of the stock market.

Marszalek said the upcoming audit will show that his position remains strong.

“We don’t run a hedge fund. We do not exchange client assets,” she said during the live stream. “In a couple of months, all these guys are going to look very, very bad for making accusations that have absolutely no substance.”

Coinbase, the largest of the publicly traded cryptocurrency exchanges, is based in the United States and is subject to more disclosure rules than most other large exchanges, a point its executives emphasize. The company said it has sought and obtained licenses in all jurisdictions where the company needs them to operate in the United States.

“We follow the laws and regulations in these jurisdictions, which include a variety of obligations such as capital requirements,” the company said in a statement.

Alesia Haas, the company’s chief financial officer, wrote in a blog post last week that the “public and audited financials of the company confirm that we do not have a liquidity problem.”

Still, regulators urge caution. in a speech Last month, Michael J. Hsu, the acting head of the Office of the Comptroller of the Currency, warned cryptocurrency exchanges about what he sees as their dangerous attempts to “disguise” themselves as banks.

“The crypto industry arose out of a desire to disrupt…the traditional financial system,” Hsu said. “However, crypto has imitated [traditional finance] concepts to market and grow… Using the familiar to introduce something new can minimize or mask the risks involved and set false expectations. Over time, people get hurt.”

The visionaries who laid the foundation for bitcoin and other digital currencies have also raised questions about the exchanges. Crypto was supposed to eliminate the need for banks, brokers, and other so-called “financial intermediaries,” and many early proponents criticized a financial system they viewed as predatory and opaque. The pivotal white paper that launched bitcoin called for eliminating banks because it “would allow online payments to be sent directly from one party to another without going through a financial institution.”

When centralized crypto exchanges emerged to take over the role of banks and brokers, critics say, they twisted the original ideals of crypto.

“It’s really hard to square centralized crypto exchanges with the core premises of cryptocurrency,” said Finn Brunton, professor of science and technology studies at the University of California at Davis and author of “Digital money: the unknown story of the anarchists, technologists and utopians who created cryptocurrencies.” Centralized crypto exchanges they essentially recreate the same risks and lack of transparency that have existed in other financial institutions, but with even less regulation and supervision.”

In their bankruptcy filings, Celsius and Voyager described their bankruptcies in a way that makes clear their similarity to traditional banks. Both explained how a surge of clients had demanded to withdraw their assets. Neither company had the resources to pay their customers back, forcing them to file for bankruptcy protection.

In court documents, both firms used the same phrase to describe their problems. They had been hit, the documents say, by “a bank run.”