FTX Meltdown — Sam Bankman-Fried’s meteoric fall

An+illustration+of+the+logo+of+the+cryptocurrency+company+FTX%2C+or+Futures+Exchange.+Previously+the+third-largest+cryptocurrency+exchange+internationally+with+a+valuation+of+32+billion%2C+FTX+declared+bankruptcy+in+November+2022%2C+prompting+an+FBI+investigation+into+its+founder+Sam+Bankman-Fried+for+fraud.

Sally Zhu

An illustration of the logo of the cryptocurrency company FTX, or Futures Exchange. Previously the third-largest cryptocurrency exchange internationally with a valuation of 32 billion, FTX declared bankruptcy in November 2022, prompting an FBI investigation into its founder Sam Bankman-Fried for fraud.

By Jonathan Xue, The Harker Upper School

FTX, previously the third-largest cryptocurrency exchange internationally with a valuation of 32 billion, declared bankruptcy in November 2022, prompting an FBI investigation into its founder Sam Bankman-Fried for fraud.

After a run on deposits where clients rushed to withdraw their tokens because of speculation that FTX had misused customer funds, the company was unable to repay its lenders, leading to FTX’s collapse. Bankman-Fried also founded the trading firm Alameda Research, recently revealed to have borrowed over 10 billion in funds from FTX. 

The Justice Department and the U.S. Securities and Exchange Commission began examining the two companies’ relationship to determine whether Bankman-Fried illegally acquired the funds from FTX customers. So far, at least 1 billion dollars worth of consumer funds are known to be missing, with no financial records from FTX to show where they were allocated.

With the absence of this money, authorities have begun questioning whether Bankman-Fried artificially inflated the evaluations of FTX and Alameda Research. Junior Omkar Gavil-Nair, who trades cryptocurrencies, explains that due to the nature of these currencies, Bankman-Fried being able to manipulate the two companies’ estimated worth would not be surprising.

“The analogy is I can create a million tokens,” Omkar said. “If I sell one to you for a dollar, I can claim that I’m worth a million dollars, even though I won’t be able to sell all of the tokens at a dollar each. So on [FTX and Alameda Research’s] balance sheet, it looked like they had billions of dollars when it was illiquid.”

Federal authorities concluded their investigation of Bankman-Fried in December 2022, charging him with engaging in widespread fraud. They then arrested him the same day from his penthouse in the Bahamas. After paying 250 million in bail, Bankman-Fried is currently under house arrest at his parents’ home in Palo Alto.

The fall of FTX has resonated throughout the cryptocurrency industry, with other trading firms that had previously received funding from FTX announcing pauses in their operations. Bitcoin has also faced troubles, dropping over 20 percent in value since the collapse of FTX. Many investors have begun withdrawing their assets from cryptocurrency exchanges, leading to an overall decline in the industry’s reputation.

“I think this scandal shows that cryptocurrency was previously seen as this golden child,” Research Club officer Melody Yin (10) said. “People who had reservations about it will probably be more vocal about it now and there will probably be more people speaking up against it.”

As many cryptocurrency exchanges began to fall in early 2022, FTX used its tokens to bail them out of bankruptcy. FTX’s collapse has caused significant damage to trading firms BlockFi and Genesis which were previously exposed to FTX, and compromised at least eight other trading firms. Upper school economics teacher Samuel Lepler provides another perspective on the sudden fall of FTX and what it might mean for cryptocurrencies as a whole.

“As an economist, [I find] things tend to revert to their underlying value,” Lepler said. “So there was a famous Dutch tulip bubble where tulips [were initially] worth a dollar. And they went up to being worth several thousand dollars. But at the end of the day, it’s just a flower, so [the price] crashed back down to a dollar. Every single time that happens eventually, [the price] devalues back to its underlying value. So the question is, what is the true underlying value of Bitcoin or any cryptocurrency?”

After FTX’s collapse, the value of its token currency dropped over 75 percent in one day, with its price now having stabilized at around a dollar. Sam Bankman-Fried’s personal fortune has similarly dwindled, falling from 26 billion to $100,000. Having pleaded not guilty to criminal charges, he will face trial in October.

This story was originally published on Harker Aquila on January 18, 2023.