In the ever-changing world of crypto, fortunes can be made and lost in the blink of an eye. This was the case for FTX, a cryptocurrency exchange that began November 2022 with a valuation of more than $30 billion, only to end the month in bankruptcy proceedings. By November 2023, its founder, Sam Bankman-Fried, was found guilty of seven counts of money laundering and fraud.

D. Brian Blank and Brandy Hadley, professors who study finance, executives, firm governance and fintech, explain what happened, what effect it could have on traditional financial markets and why people should care.

What Happened?

In 2019, Bankman-Fried founded FTX, a crypto exchange where many investors traded and held their cryptocurrency. He also founded Alameda Research, a hedge fund that invested in cryptocurrencies and companies. In early November 2022, news outlets reported that a significant proportion of Alameda’s assets were a type of cryptocurrency released by FTX itself.

A few days later, it emerged that FTX had been loaning customer assets to Alameda without consent and issuing its own cryptocurrency (FTT) for Alameda to use as collateral. This caused criminal and regulatory investigations, leading to a bank run on FTX and the eventual bankruptcy of FTX, Alameda Research and 130 other companies founded by Bankman-Fried.

Bankman-Fried was arrested and charged with fraud and money laundering. He was found guilty of seven counts in November 2023 and is expected to appeal.

Did a Lack of Oversight Play a Role?

In traditional markets, corporations usually maintain liquidity and solvency, limiting the risk they expose themselves to. But the crypto world generally has less caution, and FTX was no exception. Most of the money FTX owed to its customers – about $11.3 billion – was backed by illiquid coins created by FTX. Nearly 40% of Alameda’s assets were in FTX’s own cryptocurrency.

When investors decided to sell their coins on the exchange, FTX didn’t have enough liquid assets to meet the demands, leading to a crash in the price of FTT. FTX owed more money to its customers than it was worth.

In regulated exchanges, investing with customer funds is illegal, and auditors validate financial statements. The crypto world lacks such guardrails.

Why is This a Big Deal in Crypto?

The fall of FTX and Alameda may lead more investors to think twice about putting money in crypto, especially as they were some of the most trusted figures in the space. It also demonstrates the potential risks of unregulated markets.

If I Don’t Own Crypto, Should I Care?

The impact on people who don’t own crypto will be minimal. Larger investment funds, like BlackRock and the Ontario Teachers Pension, held investments in FTX, but the estimated $95 million the Ontario Teachers Pension lost is just 0.05% of the entire fund’s investments.

The takeaway for most individuals is not to invest in unregulated markets without understanding the risks.

What Does the Trial Reveal about the Regulatory Environment for Crypto?

The trial of Bankman-Fried has highlighted the complex and ever-evolving nature of crypto regulation. It shows that the US is willing to assert broad jurisdiction over financial crimes targeting its citizens, and that there is a need for more robust regulatory measures.

The US still lags behind other nations in establishing comprehensive crypto regulations. This case shows the importance of understanding the risks when investing in unregulated markets.