Four things that went wrong at FTX (and why self-custody matters)

The collapse of FTX led to the darkest bear market in crypto’s history. But how did it happen, and how can it be prevented from happening again in the future?

‍The shock collapse of FTX was much more than a bankruptcy, it was an implosion. Other crypto firms went bust as shockwaves reverberated through the industry, top politicians faced pressure to return seven-figure donations from Sam Bankman-Fried, and millions of innocent consumers were left locked out of their savings.

It’s been almost a year since SBF’s house of cards collapsed — and as we speak, the exchange’s new management is still trying to recover billions of dollars. Users remain out of pocket too, and it could be years before they see any of their funds back. Three members of Bankman-Fried’s inner circle have also pleaded guilty to their role in the saga, testifying against the one-time Crypto King during an ongoing fraud trial in New York.

Here, we’re going to delve into the four things that went wrong at FTX — and why self-custody matters. Almost a decade on from a devastating hack at Mt. Gox that led to 850,000 BTC being stolen, too many people have forgotten the old saying of “not your keys, not your coins.” With a worrying number of custodians going under since 2022, limiting your exposure to centralized platforms has never been more important.

1. Risky bets

FTX had billed itself as a safe, secure place where customers could buy and store their crypto — but the reality couldn’t have been any more different.

Much of the exchange’s downfall can be linked to Alameda Research. The trading firm had launched back in 2017 — a full two years before FTX — and at the time of its collapse, it was run by SBF’s on-and-off girlfriend Caroline Ellison.

At first, Alameda had focused its efforts on arbitrage — profiting from the difference in crypto prices between different markets. But in later years, as the market became increasingly congested and opportunities dwindled, its focus changed.

The doomed trading firm was making a number of high-risk bets — investing aggressively in up-and-coming crypto projects.

A crucial part of the puzzle was FTT, a native token that FTX had launched so the exchange’s customers would benefit from slashed trading fees. But according to Ellison, SBF had other motives in bringing this cryptocurrency to market.

During the trial, she alleged that Alameda Research had been tasked with manipulating the token’s price — and using FTT as collateral when seeking loans from external providers. Here’s the problem: the altcoin proved to be hugely illiquid, as evidenced when customers started rushing for the exits — hot on the heels of a damning CoinDesk report that delved into its balance sheet.

This wasn’t the only source of funding that the hedge fund had access to.

Behind the scenes, a secret backdoor had been established that allowed Alameda to borrow funds that belonged to FTX customers. In the aftermath of the bankruptcy, the U.S. Securities and Exchange Commission described this as a “virtually unlimited line of credit” that ultimately helped create a multibillion-dollar black hole.

Alameda was over-leveraged — and while this can boost profits during the dizzying days of a bull market, it dramatically amplifies losses once things turn south. When the embattled hedge fund started to face margin calls from lenders, collateral couldn’t be sold off without dramatic falls in its value.

Why self-custody matters: It’s sobering to remember that FTX was the world’s second-largest exchange before the company’s fortunes changed — practically overnight. Many customers mistakenly believed that their funds would have been ring-fenced from any casino-like activity undertaken by Alameda Research, just like in the banking sector. Storing cryptocurrencies on any centralized exchange is incredibly dangerous — as evidenced by the eye-watering number of platforms that abruptly halted withdrawals with little warning. Keeping assets under your control at all times is the only way of eliminating the risk of losses. No CEX is too big to fail.

2. Poor management

As FTX hit the buffers, Sam Bankman-Fried’s net worth fell by a staggering 94% in just 24 hours — the biggest wealth collapse in percentage terms that a billionaire had ever suffered. He subsequently resigned as CEO, unaware that he would later be arrested on multiple fraud charges — and jailed for repeatedly violating bail conditions.

A new management team was rapidly brought in to clean up the mess — spearheaded by John Ray, a shrewd lawyer with vast experience in recovering lost funds, famously steering Enron through its bankruptcy. And after spending just a few months attempting to sift through thousands upon thousands of documents, his verdict of how FTX had been managed was damning.

In court filings, Ray warned he had “never seen such a complete failure of corporate controls” during his illustrious career — and said the exchange went under because it was “in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals.”

The daunting task he’s facing has been compounded by seriously shoddy business practices. He described how SBF regularly set his messages to auto-delete — meaning there was no record of past decisions — and other employees had been directed to follow his lead. Invoices were approved with emojis on Slack. And according to Ray, the multibillion-dollar company had been using QuickBooks (QuickBooks!!!) for its accounting.

For Ray, who is being paid $1,300 an hour, the staggering levels of mismanagement have inevitably made the recovery operation much harder, but progress is being made. Estimates in September suggested about $7 billion in liquid assets had been recovered — roughly 80% of the funds that customers are owed. Out of this, about 90% is set to be distributed to creditors, a painful illustration of how costly the restructuring process has been.

Why self-custody matters: Linen is designed to protect your Ethereum wealth with three keys. Even if one of them ends up lost or stolen, your assets will remain safe and accessible. And crucially, your wallet can be accessed through third-party interfaces — meaning it’ll always be available whether Linen exists or not. When things go wrong, you shouldn’t have to settle for a fraction of a fraction of the digital assets that were rightly yours — years after they were frozen. You deserve 100% of your crypto, on demand.

3. A media charade

The rise and fall of FTX was a perfect storm in many ways — and for all the shady trades and poor corporate governance going on behind closed doors, the scenes playing out publicly in the months before the bankruptcy were equally problematic.

Sam Bankman-Fried was depicted as the man who could do no wrong — the white knight who was swooping in to save rival crypto firms in deep distress. Business journalists breathlessly described his deals with BlockFi and Voyager Digital after both firms teetered on the edge of bankruptcy — with the then 30-year-old casually boasting that FTX still had $1 billion to deploy.

Just two months before the game was up, SBF had told CNBC: “It’s not going to be good for anyone long term if we have real pain and real blowouts — it’s not fair to customers and it’s not going to be good for regulation.”

Few could have anticipated back then that his collapsing empire would end up being the biggest, most painful blowout of them all. Worse still, the tousle-haired entrepreneur had appeared before the U.S. Congress to offer his insights on regulation — rules that FTX would have found impossible to follow. The exchange’s name was plastered on Miami Heat’s arena in a 19-year, $135 million deal that hastily had to be scrapped.

And then there was SBF’s PR offensive, designed to depict himself as a philanthropist who had no desire to hold on to his billions — a man who wasn’t interested in the trappings of wealth. The young businessman had long been described as an “effective altruist” who planned to pass on his fortune to good causes. While countless articles and YouTube videos fawned over his selflessness, others were more skeptical. Forbes noted that Bankman-Fried was worth $22.5 billion in 2021 but had given away just $25 million to charity — calculating that this was the equivalent of a typical American donating $15 to the Salvation Army.

All of it was much too good to be true — nothing more than a media charade.

Why self-custody matters: There’s an old motto in crypto — “don’t trust, verify.” The dramatic ascent of Sam Bankman-Fried, followed by the sudden and devastating downfall, serves as a painful reminder that everything in this industry needs to be taken with a huge pinch of salt. And while it’s often all too easy to think of crypto as Monopoly money, every sat and gwei has real value. The only person you should ever entrust your savings with is yourself.

4. Celebrity involvement

As the value of cryptocurrencies raced to astronomical new highs in 2021 — with Bitcoin nearing $69,000 and Ether approaching $5,000 — exchanges including FTX embarked on aggressive advertising campaigns in an attempt to woo new customers, with a slew of star-studded partnerships.

NFL star Tom Brady was paid a whopping $30 million in FTX stock to become an ambassador, and appeared in several TV spots. So too did NBA player Steph Curry, and in one ill-fated commercial, holding up the FTX app to the camera, he said: “I’m not an expert, and I don’t need to be.”

One-time Tennis №1 Naomi Osaka was transformed into a comic book character in yet another advert — and in early 2022, when the mania surrounding crypto reached a fever pitch, FTX dug deep to enlist Curb Your Enthusiasm star Larry David for a primetime spot during the Super Bowl. In it, the comedian was seen traveling through the ages dismissing inventions including the wheel, the fork and the toilet, dismissively declaring they’d never take off. The film then fast forwards to the present day, where David is told that FTX is a safe and easy way to get into crypto. His response was eerily accurate: “Ehhhh… I don’t think so. And I’m never wrong about this stuff. Never.”

That ad ended with the slogan “Don’t Miss Out On Crypto.” The many millions who relied on FTX around the world will no doubt be wishing they had.

A whole host of A-listers involved in plugging the doomed exchange have since been slapped with lawsuits for their endorsements — with a class action claiming they were “responsible for the many billions of dollars in damages they caused.” Even Taylor Swift had agreed to a $100 million sponsorship deal, but luckily for her, FTX backed out of the partnership.

It’s worth noting that the SEC has taken action against celebrities who have endorsed crypto before. Lindsay Lohan was fined after promoting the Tron and BitTorrent tokens on social media, without disclosing she had been paid to do so. And Kim Kardashian — who plugged Ethereum Max on Instagram — reached a settlement where she agreed not to endorse crypto products for three years. Just weeks after she shared a post about EMAX to 250 million followers, the value of that token had cratered by 98%.

Why self-custody matters: Given what’s happened over the past couple of years, it’s fair to say that — if you see a celebrity endorsing a crypto product — you should run as far as you can in the other direction. There’s no guarantee that the star lending their name to an exchange, NFT or dApp even uses it, or knows how it works. Always do your own research, and remember: a slick marketing campaign doesn’t make a business trustworthy.

Protect yourself

The crypto world is beginning to dust itself off after the most punishing, brutal bear market in its history — with Bitcoin heading back into the $30,000s after falling 75% from all-time highs.

Inevitably, momentum in the digital assets space will return — and as we told you recently, the rise of exchange-traded funds could fuel institutional interest in the industry.

Now, it’s crucial that history doesn’t repeat itself — that a major platform like Mt. Gox or FTX doesn’t win the trust of millions, only to leave them badly burned and out of pocket. Self-custody is the only answer. That’s why Linen offers a secure, complexity-free, decentralized way of keeping crypto safe, and in your control at all times.