A Traditional Exchange? FTX Was Anything But.
FTX’s terms of service made no mention of how, or where, client assets would be stored. Instead, there was a brief line saying that the legal title of any digital assets passed to FTX remained the property of the customer.
What is FTX? FTX is a now bankrupt company that was one of the world’s largest cryptocurrency exchanges. It enabled customers to trade digital currencies for other digital currencies or traditional money; it also had a native cryptocurrency known as FTT. The company, based in the Bahamas, built its business on risky trading options that are not legal in the United States.
Who is Sam Bankman-Fried? He is the 30-year-old founder of FTX and the former chief executive of FTX. Once a golden boy of the crypto industry, he was a major donor to the Democratic Party and known for his commitment to effective altruism, a charitable movement that urges adherents to give away their wealth in efficient and logical ways.
How did FTX’s troubles begin? Last year, Changpeng Zhao, the chief executive of Binance, the world’s largest crypto exchange, sold the stake he held in FTX back to Mr. Bankman-Fried, receiving a number of FTT tokens in exchange. In November, Mr. Zhao said he would sell the tokens and expressed concerns about FTX’s financial stability. The move, which drove down the price of FTT, spooked investors.
What led to FTX’s collapse? Mr. Zhao’s announcement drove down the price and spooked investors. Traders rushed to withdraw from FTX, causing the company to have a $8 billion shortfall. Binance, FTX’s main rival, offered a loan to save the company but later pulled out, forcing FTX to file for bankruptcy on Nov. 11.
“None of the Digital Assets in your Account are the property of, or shall or may be loaned to, FTX Trading; FTX Trading does not represent or treat Digital Assets in User’s Accounts as belonging to FTX Trading,” said the terms of service. There was no similar declaration for cash assets.
FTX’s alleged use of customer assets to fund its activities would be highly unlikely at U.S. stock exchanges, which don’t touch any customer money. Instead, stock market investors send their money to a broker who is a member of the exchange and can act on behalf of their clients. Larger institutional investors typically hold money with a custodian bank like State Street or BNY Mellon, sending trade details via their brokers to the exchange. Custodian banks are responsible for protecting investors’ assets, with strict rules on what they can do with them.
The exchange simply acts as a meeting place for buyers and sellers, collecting transaction and other fees for providing the service. Every trade conducted on an exchange contains instructions about what should happen next to ensure that money ends up in the correct accounts and that the ownership of whatever stock is being bought or sold transfers to the buyer.
Most banks are also brokers, catering mainly to professional and high net worth investors. Robinhood, Charles Schwab and other brokerages target retail investors. Exchanges are prohibited from owning brokerages, other than for sending trades to other exchanges if there is a better price for a stock elsewhere. And brokerages can own, at most, 20 percent of an exchange.
The rules are meant to prevent any conflicts of interest that can arise if a brokerage shares ownership with the exchange where the trades happen, and where the broker or its client stand to make and lose money on trades.
In contrast, Alameda Trading, one of the biggest trading firms on FTX that was at the center of its collapse, was also co-founded by Mr. Bankman-Fried. FTX has been accused of using customer money to prop up Alameda’s trading activity. Given the bankruptcy, it’s likely that FTX customers will never get all of their money back.
Article source: https://www.nytimes.com/2022/12/16/business/a-traditional-exchange-ftx-was-anything-but.html