The Collapse of FTX: What Went Wrong With the Crypto Exchange?

The swift demise of cryptocurrency exchange FTX in 2022 had damaging domino effects on the cryptocurrency industry, stoking widespread mistrust among the public and toppling cryptocurrency services that did business with it. At the time, FTX was the third-largest crypto exchange, widely regarded as one of the prime players in the space. Its sudden collapse not only shocked the market but also shook the very foundation of the crypto industry, revealing major vulnerabilities in what investors perceived as a promising and robust ecosystem.

Learn more about what led to FTX’s downfall, including the role and trial outcome of its founder and former CEO, Sam Bankman-Fried.

What Happened to FTX?

FTX was a leading cryptocurrency exchange that went bankrupt in November 2022 amid allegations that its owners had embezzled and misused customer funds. Sam Bankman-Fried, the CEO of the exchange, was sentenced to 25 years in prison and ordered to repay $11 billion.

The catalyst was a Nov. 2 scoop by crypto news site CoinDesk, revealing that the majority of assets held by Alameda Research, a quantitative trading firm and sister company also run by Bankman-Fried, consisted of FTT and other tokens invented and controlled by FTX and its insiders, rather than fiat currency or cryptocurrency with market-driven, time-tested value.

Scores of investors and customers pulled their funds from FTX, forcing the exchange to become insolvent and declare bankruptcy. The revelations raised concern across the cryptocurrency industry that FTX was overly leveraged with Alameda Research, relied on precarious financial accounting metrics, and faced associated financial management risks.

The End of FTX: A Sequence of Events

The following is a play-by-play recap of FTX's implosion and bankruptcy, law enforcement's civil and criminal prosecution of Sam Bankman-Fried, and the outcomes of the company's redistribution proposals to creditors, customers, and shareholders.

Binance Sells All Its FTT Tokens

Binance, the world’s largest crypto exchange, announced on Nov. 6 that it would sell its entire position in FTT tokens—roughly 23 million FTT tokens valued at the time at approximately $529 million. Binance CEO Changpeng “CZ” Zhao said the decision to liquidate the exchange’s FTT position was driven by risk management concerns following the collapse of the Terra (LUNA) stablecoin earlier in 2022.

FTX Liquidity Crisis and Binance Deal

By the next day, Nov. 7, 2022, FTX was experiencing a liquidity crisis. Bankman-Fried attempted to reassure FTX investors that its assets were stable, but customers demanded withdrawals worth $6 billion following the CoinDesk report. Bankman-Fried sought additional money from venture capitalists before turning to Binance, its competitor. The value of FTT plummeted by over 80% in two days.

On Nov. 8, Binance announced it had reached a non-binding agreement to buy the non-U.S. business of FTX for an undisclosed sum, potentially bailing out its close rival.

Binance Cancels FTX Bail Out

The promise of a rescue was short-lived. Just one day later, on Nov. 8, Binance backed out of the deal. On Nov. 9, 2022, the exchange said it would cancel the transaction after corporate due diligence revealed concerns about FTX's mishandling of customer funds, among other issues.

FTX Assets Frozen

On Nov. 10, 2022, The Bahamas’ securities regulator froze the assets of FTX Digital Markets, FTX’s Bahamian subsidiary, following news that Bankman-Fried was seeking up to $8 billion in capital to bail out the exchange. On the same day, the California Department of Financial Protection and Innovation announced it had initiated an investigation into FTX.

Bankman-Fried apologized for the liquidity crisis and admitted on Twitter (now known as X) that FTX’s non-U.S. exchange had insufficient funds in reserve to meet customer demands. Bankman-Fried said “poor internal labeling” caused FTX to miscalculate leverage and liquidity and announced that Alameda would shut down its trading operations.

Bankman-Fried Steps Down and FTX Files for Bankruptcy

Bankman-Fried stepped down on Nov. 11 as CEO of FTX and a court appointed as his successor John J. Ray III, an American executive who led energy trading firm Enron through bankruptcy proceedings after an accounting scandal fabricating corporate earnings was discovered.

That same day, FTX, along with a vast network of roughly 130 other affiliated companies, filed for Chapter 11 bankruptcy protection. The bankruptcy filings indicated FTX had assets and liabilities each in the range of $10 billion to $50 billion.

Suspected FTX Hack

Within hours of filing for bankruptcy, FTX said it was the victim of “unauthorized transactions” and announced plans to move its digital assets to cold storage for security purposes. Outside analysts estimated about $477 million was stolen from FTX in the purported hack.

Lawsuit Filed Against FTX and Celebrity Promoters

On Nov. 16, a class-action lawsuit was filed in a Florida federal court, alleging FTX was a fraudulent cryptocurrency scheme designed to take advantage of unsophisticated investors across the U.S. High-profile celebrities and professional athletes such as Stephen Curry, Shaquille O’Neal, Shohei Ohtani, Naomi Osaka, Larry David, and Kevin O’Leary were liable for promoting FTX, the lawsuit further claimed.

The Bahamas Takes Control of FTX Digital Assets

On Nov. 18, the Securities Commission of The Bahamas (SCB) seized cryptocurrency assets held by FTX. The SCB said it instructed Bankman-Fried to move crypto assets into the regulator’s possession to protect creditors from suspected cyberattacks.

Bankman-Fried Arrested and Charged

Bahamian authorities arrested and jailed Bankman-Fried on Dec. 12, 2022, at the request of the U.S. government. He was then extradited to the U.S. on Dec. 21.

On Dec. 13, the U.S. Department of Justice (DOJ) unsealed an indictment charging Bankman-Fried with eight criminal counts, including wire and securities fraud, money laundering, and unlawful campaign finance contributions. The U.S. Securities Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) also brought enforcement actions pursuing civil claims of securities and commodities fraud.

According to the agencies, Bankman-Fried and top executives lied about FTX's financial health to investors, customers, and lenders and hid a billion-dollar hole in its balance sheet with fake financial statements, inflated valuations of speculative tokens like FTX's FTT, and cryptocurrencies borrowed from lenders.

Exchange reserves were depleted, exacerbating the risk of insolvency, after FTX management allegedly misappropriated at least $8 billion in customer deposits to foot heavy Alameda losses, luxury real estate and yacht purchases, business investments, and charitable and political donations.

In a bankruptcy court filing on Nov. 17, new FTX CEO Ray stated: "Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here." Ray went on to testify before the U.S. Congress on Dec. 13, describing FTX practices as "no bookkeeping" and "old-fashioned embezzlement."

Bankman-Fried Released on Bail

Following a court hearing on Dec. 22, a federal judge ordered Bankman-Fried's release from custody after his attorneys and federal prosecutors agreed to a $250 million bond, the largest bail amount on record in the U.S.

Under the terms of his bail, the 30-year-old former crypto executive was allowed to live under house arrest with his Stanford law professor parents in Palo Alto, California, while wearing an electronic monitoring bracelet. Bankman-Fried pled not guilty to all criminal charges on Jan. 3, 2023.

Bankman-Fried Charged Again

The DOJ filed an additional four criminal charges related to unlicensed money transmission and other categories of fraud against Bankman-Fried on Feb. 23, 2023, and a foreign bribery charge on March 28, 2023.

The superseding indictment alleged Bankman-Fried violated the Foreign Corrupt Practices Act (FCPA) by authorizing a $40 million bribe to one or more Chinese government officials to restore Alameda Research cryptocurrency holdings previously frozen by Chinese law enforcement. Bankman-Fried pled not guilty to these charges on March 30, 2023.

Bankman-Fried Moved Back to Prison

On July 20, 2023, prosecutors accused Bankman-Fried of attempted witness tampering toward his ex-girlfriend Caroline Ellison by leaking the contents of her diary to the New York Times. Ellison succeeded him as CEO of Alameda when he launched FTX.

One week later, on July 26, a federal judge placed Bankman-Fried under a gag order, prohibiting him from communicating with the public and the media. Bankman-Fried then had his bail revoked on Aug. 11 and was remanded on Aug. 14, 2023, to the Metropolitan Detention Center, a notorious prison in Brooklyn.

Ellison and other FTX and Alameda Research executives, including Gary Wang, Nishad Singh, and Ryan Salame, had been criminally charged on similar counts and agreed to testify for the government as part of their guilty pleas.

Bankman-Fried Convicted on First Set of Charges

Bankman-Fried's trial for seven of the eight pre-extradition criminal charges began Oct. 2, 2023, and ended Nov. 1. The jury returned guilty verdicts on all seven charges on Nov. 2.

Throughout the trial, executives, customers, and investors testified that Bankman-Fried directed employees or acted in his personal capacity to spend customer deposits for non-business purposes and to make material misstatements about FTX's solvency and relationship with Alameda Research.

The DOJ had dropped an eighth charge, a campaign finance charge, on Jul. 26, 2023, to comply with procedural rules of the U.S.'s extradition treaty with The Bahamas.

Damian Williams, the U.S. District Attorney leading the criminal prosecution, said when announcing the charges and convictions that Bankman-Fried "perpetrated one of the biggest financial frauds in American history."

Bankman-Fried Sentenced

On March 28, 2024, Sam Bankman-Fried was sentenced to 25 years in prison and ordered to pay $11 billion.

Future of FTX and Consequences of Collapse

As the largest collapse of an exchange in the short history of cryptocurrencies, the events at FTX have deterred cautious investors from remaining in the market, and business partners owed money have been forced to shut down.

Crypto Contagion

Cryptocurrency exchanges like Crypto.com downsized due to a surge of customer withdrawals following FTX's collapse. Cryptocurrency lenders and banks BlockFi, Genesis Global, Celsius, and Voyager Digital underwent bankruptcy liquidations and legal proceedings for authorizing severely undercollateralized loans to FTX and Alameda Research and overlooking the risk profile on repayments. One lender, Genesis, and its parent company, Digital Currency Group, were sued by the Winklevoss-founded crypto exchange Gemini for defaulting on lending agreements with Gemini's Earn product.

BlockFi began shutting down its services in November 2022 and declared bankruptcy. Its web platform was deactivated on May 31, 2024.

Regulatory Crackdown

Regulators have called for greater government oversight of cryptocurrencies. Law enforcement has tightened scrutiny of cryptocurrencies, both domestically and internationally, and has sought to limit exposure to traditional markets. Members of Congress have said they are more inclined to legislate new protections governing digital tokens and exchanges.

Reimbursements

On May 7, 2024, Kroll Restructuring filed a disclosure statement outlining a plan to repay creditors and customers. According to the plan, customers would receive 100% of their holdings back at the bankruptcy petition date rate but with interest. The plan anticipated a repayment rate of between 127% and 142% for website and U.S. customers, who have been given priority over several other claimants. These customers were to receive between zero and 118% depending on the claim class they belong to. As of Oct. 10, 2024, the creditor and customer payback plan was in its third edition with many dissatisfied parties.

The Bottom Line

FTX is a prime example of how not to run a business, especially in an industry as young as cryptocurrency. In addition to being poorly managed, its owners diverted investor funds for personal use and to finance bad business decisions.

The stunning collapse of what was widely considered one of the best crypto exchanges, and the following shock waves that razed other businesses have only raised awareness of the fragile foundation the industry is built on. For years to come, FTX will be used as a case study for examining modern financial crimes and corporate compliance and governance failures.

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