FTX Goes Belly Up: Time to Rethink Crypto Exposure?

Sam Bankman-Fried’s crypto empire filed for Chapter 11 bankruptcy in Delaware, capping a rapid downfall for the crypto wunderkind.

The FTX-Alameda nexus

Co-founded by Bankman-Fried in 2017, Alameda started off as a lucrative arbitrage trading firm and quickly grew into one of the largest market makers of digital tokens globally. Concerns over potential conflicts of interest, particularly its relationship with FTX and the lack of sufficient regulatory guardrails compared to traditional finance were swirling. Amid reports that client funds were used inappropriately to shore up liquidity, the prices for the exchange’s native crypto token, FTT, plummeted and users raced to withdraw their assets. FTX saw about $5 billion of withdrawals.

The failed bailout

Binance CEO Changpeng "CZ" Zhao and Bankman-Fried both took to Twitter to reveal that they’d reached a tentative deal for Binance to buy FTX. A day later, Zhao pulled out and Bankman-Fried dropped the bombshell to FTX.com investors that it faced a shortfall of up to $8 billion, pausing withdrawals.

CZ knew something we don't! That in itself is deeply concerning.

After filing for Chapter 11, Bankman-Fried resigned as chief executive officer, and John J. Ray III was appointed to replace him. “I f---ed up,” Bankman-Fried told investors on a call earlier in the week. He said he would be “incredibly, unbelievably grateful” if investors could help. However, the liquidity hole was too large to fill and there was no other option than to file for bankruptcy.

A Lehman moment?

The shuttering of Alameda could ripple through markets. The sudden collapse of the TerraUSD stablecoin project in early May set in motion a cascade of failures that reverberated through the sector for months. We don't know if this is a Lehman moment. But the fact that FTX has a global reach and has potentially signed financial contracts with large institutions (it had approximately 130 global creditors) does not rule out contagion risk. Case in point being BlockFi, a digital asset lender that halted withdrawals citing uncertainty over FTX.

BlockFi was in the process of moving its assets to FTX for custody and had also given over-collateralized loans to Alameda Research with liquid assets, including Robinhood shares. Furthermore, Bankman-Fried also owns about 7.6% of Robinhood shares.

Regulators will need to take a hard look at any systemic risk and the dreams of decentralized finance may not bear fruit, at least in the short-run.

What it means for you

If you own crypto assets, it might be worthwhile to understand what percentage of your investable assets that exposure is and which institution it is held at. You need to understand the financial condition of the exchange or the digital asset lender that is serving as your custodian. Remember, these assets are unregulated and therefore uninsured. If there is a run on the bank, you stand to lose all your money.

Even the likes of large institutions like Blackrock stand to lose millions.

At the end of the day, it is your comfort level and risk tolerance that should drive investment decisions. But let greed not be the driver. Taking small losses is almost always better than losing it all.

Stay cautious out there.