FTX breaks – and then gets hacked

FTX breaks – and then gets hacked

The second largest crypto exchange in the world, FTX, has filed for bankruptcy in the US. Although that alone would be enough to shake confidence in the crypto market – after all, if FTX can collapse, is any exchange safe? – the one speed with which FTX fell from prominence to ruin will be the real chilling factor for investors. The end came for FTX is a little more than a week, adding to the disbelief of everyone who saw it fall.

FTX CEO Sam Bankman-Fried, who had an estimated net worth of more than $15 billion last week and was sometimes known as the “Warren Buffett of cryptocurrency,” resigned when the company collapsed.

A run on the stock market

The company’s downfall was the result of a classic Great Depression-style “run” on the stock market. It began with rumors that both FTX and other companies owned by Bankman-Fried were financially unstable. The rumors grew into customer panic, and more and more exchange users tried to withdraw their money. That only put the stock market under further pressure, forcing Bankman-Fried to look for bailouts and financing to cover billions of dollars in withdrawals.

He failed to secure these bailouts, leaving FTX facing Chapter 11 bankruptcy, and many investors and stock market users high and dry, their money nothing more than a digital whisper on the crypto wind.

Chapter 11 bankruptcy will allow the company to stay alive while it restructures its debt obligations under the supervision of the court. What that means is that, to quote an FTX statement, it will “start an orderly process to assess and monetize assets for the benefit of all global stakeholders.”

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In its Chapter 11 filing, FTX claimed to have between $10 billion and $50 billion in assets and liabilities — but also that it had over 100,000 creditors.

The proceedings involve Alameda Research, a separate trading company (hedge fund) founded by Mr Bankman-Fried, and around 130 affiliated companies. Despite Bankman-Fried claiming that FTX’s US operations would be unaffected, it has now been confirmed that those operations are part of the filing.

Bankman-Fried will be succeeded as CEO by John J Ray III, an attorney with prior experience in venture capital and major bankruptcy cases.

His view of how FTX should move forward was “FTX Group has valuable assets that can only be effectively managed in an organized, collaborative process,” said new CEO John J Ray III, a lawyer who previously worked at a venture capital firm and has experience in high-profile bankruptcy cases.

Since FTX filed for Chapter 11 bankruptcy, other elements of questionable behavior have emerged, including $1 billion of missing funds said to have been transferred to Alamada Research.

Hacked

But more importantly, in a move that could be in the thesaurus under “kick a man when he’s down,” FTX has been hacked for an extraordinary amount of money. Originally it was reported in The Wall Street Journal that a hacker had extracted $370 million from FTX’s crypto wallet.

Since the first post-bankruptcy report, the amount has nearly doubled to more than $600 million, prompting an account administrator in the FTX Support Telegram chat to post the extraordinary advice to users that “FTX has been hacked. FTX apps are malware. Delete them. Chat is open. Do not go to FTX website as it may download trojans.”

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Right now, many users have $0 balances in their FTX accounts, and there is complete chaos and confusion as to whether these zero balances are due to the bankruptcy, the move of FTX to cold storage, or the mega-hack – or indeed to a mixture of all three.

Perhaps naturally, given the circumstances, it’s also the beginning of a conspiracy theory circulating among understandably offended users that the hack may have been the work of a corporate insider, either to make money before the money was needed to pay users their money, or potentially by some close to Mr Bankman-Fried as a way of salvaging assets from the ruins of the previously pristine stock exchange. It is important to note, however, that these conspiracy theories are still completely without any provable basis.

The long-lasting impact

Whether users will eventually get some or all of their assets back remains to be seen as FTX is able to restructure its debt burden, but the impact on the crypto market is unlikely to be forgotten for decades.

The basic point of crypto exchanges is that they should be distributed for security. But there are hacks on exchanges that happen more and more often, with losses in the hundreds of millions of dollars. These attacks have paved the way for a degree of caution with crypto exchanges. But the near-instant collapse of the world’s second-largest stock exchange will spook the market as much as the loss of any major company in the brick-and-mortar world. It will be felt particularly deeply, given that Mr Bankman-Fried had recently embarked on a publicity blitz specifically to convince people that the crypto market was a healthy, safe and valuable investment opportunity. Although the mechanics are not the same, this publicity blitz now looks like the PR perpetuating a Ponzi scheme – a worthless waste of words to cover up a scam.

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It’s a perception that has already shaken other crypto companies in the wake of the collapse of FTX. Bitcoin in particular fell 20% this week, while Binance CEO Changpeng Zhao warned that there were no winners in the crypto market as a result of FTX’s collapse. Ironically, Binance was one of the potential buyers that could have saved FTX when the rapid rot set in, but it ultimately chose not to proceed with the sale.

The relatively unregulated nature of crypto markets has left them vulnerable for some time, and regulators have warned that it would only be a matter of time before something like the FTX crash happened if such a situation continued.

The question now is how much longer the crypto market can dare to remain as unregulated as it is, if confidence in the entire system is to be retained and even increased to pre-FTX levels.

Confidence is nowhere near that level right now, as the full ramifications of the FTX bankruptcy have yet to play out. Watch this space, by all means, but there will be brave – or polite – investors backing crypto exchanges heavily right now.

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