FTX (Futures Exchange), the world’s second-largest cryptocurrency exchange, filed for Chapter 11 bankruptcy protection in the American state of Delaware on 11 November 2022. Sam Bankman-Fried, a financial wunderkind, set up FTX in May 2019 as an offshoot of Alameda Research, which he had founded earlier in 2017. At the time of its collapse, Bankman-Fried’s financial empire included FTX and its three sister companies: FTX-US, a cryptocurrency exchange restricted to US customers; Alameda Research, a hedge fund and cryptocurrency trading platform; and FTX Ventures, a venture capital firm. Bankman-Fried stepped down as CEO after Binance, a competing cryptocurrency exchange and also an FTX investor, sold its holdings of $530 million of FTT, digital tokens issued by FTX to serve as collateral for loans on its balance sheet. This led to a run on FTX, leading it to close to withdrawals of crypto assets on 8 November. Binance subsequently announced plans to bailout FTX, which were abandoned after the discovery of an $8 billion blackhole in FTX’s finances.
FTX was run out of a $40 million penthouse in the Bahamas. At the time it declared bankruptcy, it had around a million individual and corporate investors on its books, who faced losses of billions of dollars. Apart from Binance, its corporate investor list included BlackRock, Sea Capital, Sequoia Capital, Softbank, Temasek, and Tiger Global, among others. FTX was only the latest among a series of high-profile collapses in the cryptocurrency industry over the spring and summer of 2022, including Celsius Network, Terra-Luna, Three Arrows Capital, and Voyager Digital.
As a cryptocurrency exchange, FTX held and managed crypto assets on behalf of its clients, using Alameda Research’s trading arm to generate returns for investors. During its early years, FTX became popular among investors and by early 2022 it was valued at $32 billion. Bankman-Fried, the son of Stanford Law School professors and an MIT physics cultivated the image of an eccentric billionaire genius, who often dressed down in public. It is now being alleged that his newly acquired wealth funded a “lavish life-style” and helped him acquire a portfolio of luxury properties in the Bahamas.
The prototype cryptocurrency, Bitcoin (BTC), was developed by a pseudonymous computer programmer (s), using the name Satoshi Nakamoto, who announced a “new electronic cash system that’s fully peer-to-peer, with no trusted third party” in an email to the Cypherpunks cryptographic mailing list on 31 October 2008, in which he publicised his earlier nine-page “white paper”-entitled “Bitcoin: A Peer-to-Peer Electronic Cash System”. His system was based entirely on “cryptographic proof” rather than the trust which underpinned conventional financial transactions. In preparation, the domain name bitcoin.org had been registered on 18 August 2008. The first BTC to be created, or “mined”, on 3 January 2009, had no commercial value, but within a decade each BTC was worth thousands of dollars. The initial ‘genesis block’ delivered 50 BTC. BTC was first used to buy goods on 22 May 2010, when two pizzas were purchased for 10,000 BTC (equivalent to $41 at the time, but later worth hundreds of millions of dollars),making them the most expensive pizzas of all time. The first BTC ATM opened in Vancouver in October 2013. The supply of BTC was strictly limited to 21 million by Nakamoto, in the belief that this would make it a “store of value” and provide a hedge against inflation.
BTC is an encrypted digital, intangible, asset whose ownership can be transferred from account to account, or address to address, using cryptographically-coded communication. A BTC address consists of a string of letters and numbers and can be likened to a bank account number, which can only be accessed by a matching key, which is the equivalent of the PIN to a bank account. Keys are kept in a virtual “digital wallet”, which can be stored on a computer or a smartphone. BTCs are lost for ever if the key is lost or if the hardware on which the keys are stored is damaged. All transactions are irreversible and are recorded on blockchains, which serve as public ledgers of transactions. These transactions are grouped into blocks. Each new block of data is time stamped and is validated by a cryptographic “hash” or signature link from the previous block. The first transaction in a block, a coinbase transaction, is created by a process known as mining, in which miners use competitive computation, open-source software, and dedicated computer hardware to solve complex algorithmic puzzles that protect blocks and are rewarded with new BTC for their success. Cryptomining is, however, a highly energy-intensive method. It should be obvious that unlike other forms of money, users of cryptocurrency do require some technical knowledge to benefit from their holdings.
Since the introduction of Bitcoin, several other cryptocurrencies, such as Ether (ETH), Tether, and USD Coin, have emerged, with different ways of verifying and securing transactions, thereby muddying the playing field. Stablecoins are a special type of cryptocurrency, designed to maintain a stable value by linking their value to a national currency, and are thus less liable to price volatility.
Cryptocurrencies share some of the properties of money, but are accepted as either legal tender or as a currency in only ten countries, with El Salvador having led the way in 2017 by first recognising BTC as legal tender. They can be used to transfer value, in the purchase of goods, to send money to people or organisations, or to extend credit. A cryptocurrency can be bought, sold, lent, or exchanged for other cryptocurrencies or conventional fiat currencies within cryptocurrency exchanges, which serve as marketplaces where buyers and sellers deal in mutually agreed prices. Exchange rates vary with supply, which is controlled by an algorithm, and demand within these markets. Price volatility, which is the result of inelasticity in supply, means it cryptocurrencies cannot be considered a reliable long-term store of value.
Coinbase, founded in San Francisco in 2012, became the first major cryptocurrency firm to be publicly traded, on the Nasdaq Global Select Market on 14 April 2021, being valued at $85.8 billion at the end of the first day’s trading.
Cryptocurrency appeals to various disparate groups of people. Libertarians welcome the prospect of decentralised and borderless money that is not controlled by either the government or a central clearing house, believing that inflation is the result of central banks’ increasing money supply, through such measures as quantitative easing. The anonymity of blockchain transactions, the lack of centralized regulation, and exemptions from tax have proved attractive to corrupt high-net-worth individuals, organised criminals and authoritarian rulers, as a means of tax evasion, money laundering, financing terrorism, or reaping the profits of human trafficking. The prospect of making large sums of quick and easy money draws in speculative investors seeking to make their fortunes. On the other hand, some optimists see cryptocurrency as the “global reserve currency of the future” and as means of reaching out to the unbanked millions.
Despite its turbulent history, characterised by multiple speculative asset bubbles and its susceptibility to hacks, scams, and Ponzi schemes, it might be premature to proclaim the demise of cryptocurrency, given the extent and continued interest in this latest form of money. But the collapse of FTX’s “house of cards” is an indication that the days of cryptocurrency may be numbered, and that it may end up as yet another chapter in the world’s financial history. Blockchain technology, on the other hand, has considerable potential to ensure secure data sharing and financial transactions, to establish supply-chain provenance, and even help confirm the fairness of elections. Meanwhile, Bankman-Fried’s engagement with corporate governance will be scrutinised by the US Department of Justice, the Securities and Exchange Commission, and the Commodity Futures Trading Commission. Lessons from the past will undoubtedly be relearned, only to be forgotten soon after.
Ashis Banerjee