The biggest news in the financial world in the past two weeks has been the collapse of the previously renowned cryptocurrency exchange FTX. Founded by Sam Bankman-Fried in 2019, the exchange shot up in value after venture capitalists poured billions of dollars into the business. At one point, Bankman-Fried was valued at $16 billion, making him one of the wealthiest people in the world on paper. Now, Bankman-Fried is estimated to have a net worth of zero after FTX collapsed amid allegations that he may have transferred billions in customer funds to cover losses at his hedge fund Alameda Research. Customers who deposited funds at FTX may never get their money back.
Here's why the cryptocurrency exchange FTX imploded and what it means for both FTX customers and crypto investors.
What happened with FTX?
This story is still unfolding and extremely complicated, so here are the nuts and bolts. Bankman-Fried founded and owns two companies: FTX and Alameda Research. FTX is an offshore cryptocurrency exchange based in the Bahamas where people could buy and sell crypto tokens like Bitcoin or Ethereum. Alameda Research is a market-making hedge fund for cryptocurrencies.
According to The Wall Street Journal and other news outlets, FTX may have shifted as much as $10 billion in customer funds to Alameda Research to plug losses that occurred when the crypto markets started to crumble this spring. This move left FTX in a vulnerable position. Understanding this, Changpeng Zhao -- head of rival cryptocurrency exchange Binance, which also had an investment in FTX -- said he would be selling FTX's FTT cryptocurrency coins. This triggered a wave of customers trying to pull money out of FTX. Zhao then went to Bankman-Fried with a proposed buyout for FTX, most likely at a bargain price, but pulled out after looking at FTX's books.
FTX soon filed for bankruptcy with customers clamoring for withdrawals, which is not a surprising development after the reports of transfers of customer funds to Alameda Research. Because FTX is based in the Bahamas, where there's no insurance fund as there is in the U.S. for banks or stock brokerages, the thousands of people who deposited money at FTX will likely never get their funds back.
This is a sad day for investors who put large sums into cryptocurrencies via FTX. But there are safer ways to invest in cryptocurrencies that don't involve depositing money in offshore exchanges.
How to stay safe with crypto
The surest way to avoid a cryptocurrency implosion, of course, is to not put any money into these tokens in the first place. Cryptocurrencies -- unlike stocks -- are not ownership stakes in businesses that generate a profit. This means they are much riskier to buy even when compared to speculative stocks, never mind blue-chip companies like Apple or Microsoft.
However, if you really want to dabble in crypto, I'd recommend avoiding offshore exchanges like FTX. Stick to publicly traded and audited exchanges like Coinbase Global or Robinhood Markets, which are under more stringent regulations because they are incorporated in the U.S. and have stocks themselves that are monitored by the Securities and Exchange Commission. Does wrongdoing in public and regulated markets take place in the U.S.? History has shown that it does and it will surely happen again. But the likelihood of this occurring is much lower at Coinbase, compared to an exchange in a location where there's no oversight.
Of course, just because an exchange is running on the up and up does not mean you will make money buying its listed securities. Still, cryptocurrencies are much riskier than stocks because they lack the financial fundamentals that give shares intrinsic value. Plus, there's no government backstop. That's something to keep in mind no matter where you decide to invest your savings.