FTX Collapse: In an unregulated environment, good governance and due diligence by all stakeholders remain critical!

In a very short time, less than 10 days, FTX, a major actor in crypto trading sunk causing tens of billions of USD losses for clients, counterparts, and investors. The main defendant, the CEO is now pleading not guilty to all charges. So, what went fundamentally wrong? And what can be done to prevent re-occurrence?

The Crypto industry is a very specific business, one that mixes blockchain transparency with virtual records to create a false sense of security through hidden weaknesses. It is an exciting, new, and unfamiliar space that very few people truly master but attracts the usual crowd of speculators. Very few people master the business model and understand how value is created. This implies a predominant speculative mindset and an overriding objective to make easy money. 

Almost everybody has forgotten investment basic rules: 1) high yields always mean high risks and 2) avoid investing in a business you don’t understand. The fear of missing out on the bonanza has led many investors to lose common sense. History is full of such patterns. 

Consequently, this collapse is not crypto-specific. This is simply a result of investors’ hubris. 

What can we conclude after this debacle? The same causes are always present:

• Unmanaged conflict of interests: FTX trading combined with Alameda bets created a highly inflammable mix turbocharged by the links between the trading platform and the so-called « research company » without proper segregation of accounts and duties.
• Lack of good governance and professional skepticism: Nobody seems to have performed the appropriate due diligence during the raisings of debt and equity or the necessary investigations after the « Terra-Luna crash » generated huge losses last summer. What had been the reaction of board members and other key stakeholders to that crash and its possible consequences for FTX financial and economic conditions?

The bad news is that the innovation that decentralized finance could bring to global finance has spoiled, at least for a while. This is the ironic wink of traditional finance to the so-called smart disrupters. 

One obvious winner is FTX’s main competitor, Binance. The Chinese venture correctly identified its risks, protected its position. Foe the time being, the knight in shining armor, Sam Backman-Fried, has been recasted as the disgraced villain after a splendid and traditional bank run that John Law would have applauded. 

Fabrice CHAFFOIS, Certified Fraud Examiner and Senior financial advisor 

Francis HOUNNONGANDJI, Certified Fraud Examiner, Chartered Financial Analyst charterholder, CEO of Institut Français de Prévention de la Fraude (IFPF)