(Image via www.businessinsider.com)
Staff Writer: Julian Cassady
This article is not financial advice
On November 9th, users of the popular cryptocurrency exchange, FTX, lost a collective $6 billion.
An exchange is a place where you can use money to buy equities like stocks, bonds, and as of recently, cryptocurrencies. Buyers are paired with sellers on the exchange, making equities incredibly easy to trade.
On FTX, users can buy and sell various cryptocurrencies, including some directly backed by the company. Users can purchase crypto with cash deposited in their account or with other cryptocurrencies that they already own on the exchange.
FTX makes a small profit for each trade done on its exchange, known as a transaction fee. This transaction fee is only a few cents; however, the millions of trades made each day ensure that the company still makes a hefty profit.
The business of these exchanges works when each dollar in every user’s account is backed by a dollar in the exchange’s corporate account. This prevents issues when there is mass panic, and many users want to withdraw their funds at once. Users can take comfort in knowing they can withdraw all their funds, even during a collapse.
FTX didn’t operate this way.
Rumors started floating around the crypto social media that FTX was attempting to get bought by another large crypto exchange, Binance.
Binance conducted a large-scale business analysis on FTX, which is normal when a company is looking at a prospective acquisition target.
What they found was alarming.
The company being acquired usually puts itself on the market because it isn’t performing well and is hoping for a turnaround.
This assumption rang true for FTX. Binance’s research into FTX’s financials revealed $6 billion in assets unaccounted for.
Binance and Wall St. investors now know that FTX was “cooking the books,” meaning that it was using shady accounting practices to misrepresent its financial performance.
Retail investors are starting to connect the dots and are speculating that FTX was investing in cryptocurrencies with money from its users’ account balances. By doing this, FTX did not maintain the 1:1 ratio of its user account balance total to its corporate account balance total, guaranteeing tremendous risk to its customers.
Because of the recent recession and inflationary fears, crypto sales skyrocketed. This drove the price of most cryptos down and caused a loss that required FTX to sell all of its assets to break even.
The total of all user account balances became significantly greater than FTX’s cash on hand. FTX had to file for bankruptcy so it could fully pay back the losses of the risky investment to all its users.
Cryptocurrencies like Bitcoin have been in freefall for about a year. This is Bitcoin’s (BTC) performance since November 2014:
It’s plain to see how risky investing in cryptos can be right now.
This needless risk is why investors and users are furious at Sam Bankman-Fried, the CEO of FTX. He’s a 30-year-old (former) billionaire that has referred to cryptocurrency as a Ponzi scheme numerous times during various interviews.
FTX sponsored many content creators and organizations, including the eSports team TSM, and Magic: the Gathering content creators like the Limited Resources Podcast.
Many of these creators and organizations are releasing statements telling the public that they weren’t aware of FTX’s instability. These people were convinced that the company was as safe as it claimed to be.
So what comes out of this controversy? Politicians may see this as a signal to buckle down on cryptocurrency regulation.
FTX’s bankruptcy also weakens the trust investors have in cryptos. Investors tend to sell during times of uncertainty which creates a negative feedback loop to the price of cryptos.
This controversy serves as a cautionary tale that, sometimes, things may not be as they seem.