Looking Ahead: Bankruptcies in Crypto
The Rise and Decline of FTX, BlockFi
June 2022 was the first time I ever heard of Sam Bankman-Fried. It was a cold, late summer night in San Francisco as I had wrapped up the first day of my banking internship. Walking out of my building and onto Market Street, there was a plump, curly-haired figure on numerous billboards, newsstands and public benches. Ads for his company, FTX, seemed like they stood on every corner. I thought hard, who is this guy and why is his face everywhere?
Long before cryptocurrency made Sam Bankman-Fried the youngest billionaire ever seen, he had his sights set on more traditional career routes. After studying Physics and Mathematics at MIT, he took a prestigious job at hedge-fund Jane Street Capital to pursue a career in finance. After quickly moving up the ranks, he moved back home to the Bay Area to found Alameda Research, a quantitative trading firm (remember that name). It was here that he fell in love with crypto, and his life changed forever — for better or for worse. The month of January 2018, SBF executed an arbitrage trade. He moved up to $25M of bitcoin per day in order to capitalize on the relatively higher price of bitcoin in Japan. Fast forward four years, and SBF had founded the third-largest crypto exchange, FTX, with an enterprise value of $32B. What a life! Now based in the Bahamas, SBF was living a tropical life of wealth, fame and power. His entrepreneurship and innovation were looked up to by countless young kids starting their careers in finance, including myself. What caused the firm to go bankrupt just a mere eleven months later? Who is to be held accountable, and will the crypto industry ever be the same?
It all happened so quickly. Life was but a dream for SBF and his executive team in the Bahamas. Life became a little bit less of a dream in November 2022 when CoinDesk released an article, stating that Alameda Research held a significant holding in the FTX Token, FTT. Days later, prior investor of FTX, Binance, announced it would completely sell its holdings in FTT. The market price of FTT crashed. Panicked holders of FTT rushed to withdraw their holdings — only to find that their accounts were frozen. FTX had become insolvent in a matter of days, filing for bankruptcy. Binance initially signed an offer to acquire the distressed firm, only to withdraw after reports of mishandled customer funds. It turns out that FTX had lent $10B of customers’ accounts to fund Alameda Research, and $1–2B is completely unaccounted for (1). It was found that SBF had indulged in hyper-luxurious spending for him and executives, including a $300M splurge on beachfront real estate (2). Following the unfortunate news, the crypto economy took a hit. Since the event, the price of ETH is down 25%, while Bitcoin is down 22%.
The downfall of FTX is acting as a contagion within the crypto landscape. On November 28th, leading crypto lending platform, BlockFi, became the second firm to file for bankruptcy after it announced its client, Alameda Research, defaulted on $680M (3). The filing made it clear that the top ten creditors alone are still owed $1.2B, and that the collapse of FTX has made it harder to stay solvent. Fortunately for BlockFi, it has at least $250M cash on hand which can be used to support operations throughout the restructuring process. Yet, it is no guarantee that the distressed firm will outlive this bankruptcy. BlockFi may just be the second domino to fall, with the top 100 digital currencies dropping more than 65% YTD (4).
Looking Ahead
There is good and bad news stemming from these bankruptcies. I’ll briefly start with the good news. The crypto-market is one of the most closed-loop markets in the global economy. Crypto firms sell to crypto-users, who invest in crypto firms, and this exchange goes on and on. These bankruptcies had minimal effect on indicators like the Russell 3000, income growth/decline, and GDP growth. If you are the typical global investor, who has yet to invest money into this market, you can sit back, watch, and learn.
On the flip side, these bankruptcies have five main long-term effects on the crypto economy: a prolonged bear market, slowed adoption, decreased VC funding, layoffs, and regulation. First off, there will be a prolonged crypto winter. Crypto exchange outflows have been among the highest ever seen, with outflows for crypto investment products totaling $23M in the past three weeks. In this same time, there were also $9.2M of inflows into short Bitcoin funds (5). This highly bearish sentiment indicated investors are holding their coins for the long-run or making a run on the exchange before it’s too late. The adoption of crypto will also be slowed. The events described above came before wounds of crypto investors had fully healed from the Terra-Luna crash earlier this year. FTX was considered one of the safest, most trustworthy crypto exchanges. Witnessing the implosion of the firm has further put a dent in investor sentiment, with more bankruptcies emerging. Currently, most crypto tokens are trading 60–70% below all-time highs (4). As the crypto economy has added more risk this year, an increasing number of risk averse investors are turning a blind-eye from the hype of digital assets.
Venture capital surrounding crypto also looks to take a long-run hit. Crypto funding from VCs had taken a 37% YoY decline in 3Q22FY (6), even before the FTX meltdown. The meltdown caused prominent VCs like Sequoia Capital to take a 100% paper loss on their FTX investment, and some firms taking their largest losses in a decade (7). My first point about the long-term crypto bear economy ties into further decreased investment from VCs. It is also important to note that additional layoffs are expected in the crypto industry. There have been 4,695 employees in the industry that have been laid off YTD, with exchanges like DeFi and dApps leading the charge (8). These numbers were reported before the FTX and BlockFi bankruptcies. These layoffs are likely to remain a trend in the long run while firms are forced to cut back on costs with the largest sudden decrease in liquidity seen to date.
The last long-term effect is ironic. A main thesis point supporting crypto’s value proposition to society is that it is unregulated by the government. It is likely that November’s events act as a node that put both governments and the crypto economy in a tough spot — to decide whether to increase federal regulation. Many believe the answer is clear — in order to relieve the previously made points regarding the negative long term effects of the bankruptcies (slower crypto adoption, chronic bear market, VC funding hit) the brightest outlook is in a world with increased regulation. US Treasury Secretary Janet Yellen believes the industry is in dire need of increased regulation, with the FTX bankruptcy showing “weaknesses of this entire sector” (9). Increased regulation could ensure the safety of investor funds. It is reasonable to assume many of the thousands of investors who lost lots of money in the FTX bankruptcy would vote to regulate crypto.
The crypto industry is in a dark place. All crypto stakeholders have been impacted. It seems apparent that there are major long-term effects of November’s bankruptcies, which may only compound in a bearish trend. This is unfortunate given Web 3.0’s value-add to all people of society. The question now is, what can reverse the tide? Given all the publicly available information, the sentiment assumes that in order for crypto to become adopted by the early to late majority, it needs to be regulated to some extent. Hopefully, in the near term, we see a new crypto martyr on billboards across the streets of San Francisco.
Works Cited
(1) Images, Kevin Dietsch/Getty. “Opinion | an SEC Rule May Cost FTX Crypto Customers Billions.” The Wall Street Journal, Dow Jones & Company, 15 Nov. 2022, https://www.wsj.com/articles/an-sec-rule-may-cost-ftx-customers-billions-trading-exchange-crypto-assets-broker-dealers-investors-markets-11668455906.
(2) Barrabi, Thomas. “Sam Bankman-Fried Ran FTX like ‘Personal Fiefdom’ as Firm Spent $300m on Luxury Real Estate.” New York Post, New York Post, 22 Nov. 2022, https://nypost.com/2022/11/22/sam-bankman-fried-ran-ftx-like-personal-fiefdom-as-firm-spent-300m-on-luxury-real-estate/.
(3) Gladstone, Alexander. “Crypto Lender BlockFi Follows FTX into Bankruptcy.” The Wall Street Journal, Dow Jones & Company, 28 Nov. 2022, https://www.wsj.com/articles/blockfi-files-for-bankruptcy-as-latest-crypto-casualty-11669649545?mod=tech_lead_pos6.
(4) “Live Cryptocurrency Prices, Charts & Portfolio: Live Coin Watch.” LiveCoinWatch, https://www.livecoinwatch.com/.
(5) “Biggest Outflows in 12 Weeks as Investors Cash out Following FTX Fall.” Yahoo! News, Yahoo!, https://news.yahoo.com/biggest-outflows-12-weeks-investors-212232650.html.
(6) Blackwell, Evelyn. “Pitchbook: Venture Capital Investment in Crypto Startups Declined 37% Yoy in Q3 2022 to $4.44B, the Industry’s Lowest Level in More than a Year (Hannah Miller/Bloomberg).” WorldNewsEra, 11 Oct. 2022, https://worldnewsera.com/news/tech-tips/pitchbook-venture-capital-investment-in-crypto-startups-declined-37-yoy-in-q3-2022-to-4-44b-the-industrys-lowest-level-in-more-than-a-year-hannah-miller-bloomberg/.
(7) Jin, Berber. “WSJ News Exclusive | Sequoia Capital Apologizes to Its Fund Investors for FTX Loss.” The Wall Street Journal, Dow Jones & Company, 22 Nov. 2022, https://www.wsj.com/articles/sequoia-capital-apologizes-to-limited-partners-for-ftx-investment-11669144914?tpl=pe.
(8) “Technology Startup Layoffs, by Sector.” CoinGecko, https://www.coingecko.com/research/publications/tech-layoffs-by-sectors.
(9) Kennedy, Dana. “Treasury Secretary Janet Yellen Says Crypto Must Be Regulated after FTX Collapse.” New York Post, New York Post, 14 Nov. 2022, https://nypost.com/2022/11/12/janet-yellen-says-crypto-must-be-regulated-after-ftx-fiasco/.
