EconExtra: Will the FTX Failure Drag Other Financial Markets Down?
Will the FTX failure drag financial markets down? The short answer to this question is “no.” The total market capitalization of cryptocurrencies is $890 billion, compared to a $41 trillion market capitalization for US equities. This crypto market is relatively small and “siloed.”
EconExtra is a series of posts that go beyond the textbook, helping you incorporate current events into your classroom. This week: market structure, corporate structure and regulation.
An excellent place to start for some background understanding of what happened with FTX and the potential impact to the crypto world is this 6-minute MarketPlace segment. It also includes a good explanation of the regulatory framework that keeps other financial markets from failing. If you have 25 minutes, this Planet Money episode gives more context to the evolution of FTX/Alameda Research itself by examining the rise (and fall) of Sam Bankman-Fried and his empire. He was not interviewed for this episode, but it includes clips of interviews with him describing aspects of his company. (Warning, one swear word is uttered)
The Issues Coming to Light
There will be fallout beyond FTX, for sure. The venture capital funds and pension funds who have invested in FTX and will lose money. And of course, the customers using FTX assuming they could access their balances someday will likely come up empty. According to a CNN article, there could be over one million creditors lining up in this bankruptcy.
Collateral damage may also include the long list of celebrities who were paid to endorse FTX who are now being sued. (Quartz) (Remember the Larry David Super Bowl Ad?) It isn’t likely that the $11 billion class action suit will have much traction, as they would have to prove that the celebrity endorsers knew FTX was a scam and/or the Sam Bankman-Fried (SBF) was a felon, but celebrities have been successfully sued in similar cases (Kim Kardashian for EthereumMax endorsement.)
Within the crypto and crypto adjacent industries, firms that act as the lending arms for crypto firms are under pressure. (CNBC) Genesis Global Capital, the lending arm of crypto firm Genesis Global Trading, has stopped any new loans or redemptions, and crypto lending firm BlockFi is rumored to be considering filing for bankruptcy.
So SBF stepped down from his company, FTX filed for bankruptcy, and the man put in place to sort out the mess has plenty of experience in this field. His name is John J. Ray III and he was the same person who was called in to sort out Enron when it failed. (The Verge-warning, some may find language inappropriate for younger readers.) He has been quick to point out how he found the situation at FTX to be worse than anything he has encountered. This paragraph has been quoted in several articles:
"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. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented."
For a deeper dive into the subject, students can listen to the Planet Money episode on SBF and read The Verge article describing the chaos he left in his wake. (Note language warnings on both.) Students might find these to be entertaining, and you can then discuss how this can happen.
- In listening to SBF describe what he does in Planet Money , do you get any indication from those early interviews that he might end up getting into this kind of trouble down the road? How, in fact, did SBF amass his initial fortune?
- How did SBF try to make both crypto and himself more “respectable?”
- What events led to the collapse of the FTX “house of cards?”
- Do you think this could have happened, (or happened so easily) if there were more regulations in place covering crypto markets?
- Do you think he intentionally ignored common corporate control structures and safeguards? Do you think he was ignorant of them, ill-advised, or did he just think he was too smart?
- Can you think of other example of epic corporate failures where the employees may not have realized what was going on around them? Why do you think companies that engage in complex financial transactions fail?
- Does any of this change your view of investing in cryptocurrency? Why or why not? If yes, how so?
- What role will confidence play in the future of cryptocurrency? What about transparency?