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| FTX Logo (17) |
Abstract:
It’s a quiet morning in 1945, George Bailey opens Bailey Brother’s Bank and Loan for the day ahead. All is well until the unexpected happened. Swarms of customers come running into the bank demanding their money to be withdrawn from the bank. George is stunned, he doesn’t have enough money in the bank to pay out to everyone. What’s happened is a classic bank run, something everyone in the industry dreads. Although, these events are entirely fictional taking place in Christmas classic “It’s a Wonderful Life”, the threat of a bank run is very real. On November 6th, 2022, the unexpected happened and crypto exchange giant FTX’s coin “FTT” lost 80% of its value causing a six-billion-dollar bank run on the firm, crippling it in the process. This paper will delve into if FTX operated in an ethical manner, using four different principles: Individualism, Utilitarianism, Kantianism, and Virtue Theory.
Background of FTX:
FTX’s
journey from a small exchange within a separate finance company, Alameda
Research to the fastest growing crypto exchange in the world to a smoking wreck
is rocky one. Founded in 2019 by Sam Bankman-Fried, FTX began its slow climb as
a subsidiary of Alameda Research, an investment firm. Sam, the founder, and CEO
got to work, raising capital for his fledgling company through venture
capitalists. By July of 2020 FTX was valued at eighteen billion dollars, fast
forward two years, thirty-two billion dollars. One important early investor in
the company was Binance CEO, Changpeng Zhao. He bought a twenty percent stake
in the company. From its founding to August of 2022, FTX grew exponentially. In
March of 2021, FTX bought the naming rights to the Miami Heat’s stadium. By
2022 it was the second biggest crypto currency exchange in the world, only
surpasses by Changpeng Zhao’s company, Binance. Importantly, FTX bought back
the share’s Zhao purchased using a crypto currency they created, FTT. FTT is
used by FTX to fulfill customer’s exchanges of currency on their platform. As
an exchange FTX’s business model is to serve as a middleman between one form of
currency and another. Simply put, “A cryptocurrency exchange is simply where
buyers and sellers can trade crypto. If you want to trade crypto, you need to
do it via a crypto exchange” (10). This leads to the events that took place in November
2022.
The controversy:
In
the early hours of November 2nd, 2022, CoinDesk a popular website that covers
the cryptocurrency market released an article on Alameda Research the company
from which FTX was founded. Within the article it was revealed that Alameda
Research held nearly fifteen billion dollars’ worth of assets. Of that fifteen
billion about eight billion dollars was in FTX’s coin FTT. As another crypto
currency CEO and expert Cory Klippsten puts it, “It’s fascinating to see that
the majority of the net equity in the
Alameda business is actually FTX’s own centrally controlled and
printed-out-of-thin-air token)(2). What is important about this revelation is
that according to FTX themselves, there is only five billion dollars’ worth of
FTT coin in circulation, yet on Alameda’s books they had eight billion dollars’
worth of the coin. Zhao who was previously paid FTT for his twenty percent of
FTX announced his was selling all FTT in his company’s possession not long
after the article came out. The combination of the imbalances on the sheets and
Zhao’s announcement caused the value of FTT to plummet, losing nearly eighty
percent of its value in the following days of the article being released. On
top of that, Sam Bankman- Fried’s FTX had more to worry about, a classic bank
run. The New York times described the event as a, “ sudden cataclysm [that]
prompted comparisons to the collapse of Lehman Brothers, the investment bank
whose implosion helped set off the 2008 financial crisis.”(12). Much like
the big banks going under in 2008 crisis, the crypto giant looked for a
bailout. This bailout tentatively came from Changpeng Zhao and Binance. Zhao,
Binance’s CEO went to twitter to say, “This afternoon, FTX asked for our help.
There is a significant liquidity crunch. To protect users, we signed a
non-binding LOI, intending to fully acquire http://FTX.com” (14). He also added that the company
would be doing its due diligence into FTX before finalizing any deal. It was a
good thing that Zhao did so, as what was uncovered was that FTX had been
mishandling funds associated with customers. According to Fox Business an FTX
lawyer was quoted to saying, “Bankman-Fried used the firm as his "personal fiefdom". (13). Unsurprisingly,
the deal between FTX and Binance fell through, and on November 11th
FTX, along with Alameda Research filed for bankruptcy. Bankman-Fried went to
twitter to say,” I'm sorry.
That's the biggest thing. I f**ked up and should have done better.” (3). Following
this announcement Sam stepped down from CEO of FTX and
John J. Ray
III who handled Enron’s bankruptcy in 2001 stepped up to helm the company. John
after looking at the company financials 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” (Fox) As of the writing of this paper, FTX owes,
“its creditors at least $3.1 billion, according
to court documents filed by the bankrupt cryptocurrency exchange” (5).
Stakeholders:
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| Timeline of Events |
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| Sam Bankman Fried (15) |
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Changpeng Zhao (16) |
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| Timeline Part II |
Sequoia Capital
and other investment firms: Invested funds in FTX, with the bankruptcy are
likely to get pennies on the dollar of their investments.
Alameda
Research: Sister Company to FTX. Very closely related, is also tied up in
bankruptcy process
Individuals:
Everyday users of the platform. Likely to have lost their funds they had with
FTX if they did not withdraw in time. All users of the platform are due to be compensated
if funds can be found.
Individualism:
An
individualistic perspective on how FTX operated would show that they failed.
Individualism argues for the business and its owners to maximize its own
profits and gains. With a net worth of over fifteen billion dollars before the
collapse of FTX, Sam Bankman-Fried was one of wealthiest crypto investors in
the world, not to mention straight up one of the wealthiest people in the
world. After FTX went under due to the negligence of the company he, is
currently valued at just over one billion dollars (11). The management of the
firm was not in line with their own gain as it resulted in the company going
belly up.
FTX was poorly operated. The company routinely
inflated FTT’s value, thereby raising its own value, as they operated the coin
and had control of the flow of it. While this tactic worked in the short term,
once the Coinbase article came out the value of FTT sank, bankrupting FTX. Essentially
FTX shot themselves in the foot and was short sighted in their business strategy,
the opposite of serving themselves. The market that FTX was in is essentially
unregulated. Crypto currency is an extremely new concept, and governments have
not caught up to the times. This left FTX with essentially unlimited avenues to
succeed. Unfortunately, they built as Fox Business described them, “A house of Cards”
(7). FTX couldn’t even save itself, let alone their customers failing to follow
individualism.
Utilitarianism:
Under the guise of Utilitarianism, FTX’s actions are not
acceptable. Utilitarianism demands that the majority is “happy” under all
circumstances. The classic movie trope of the protagonist exclaiming “It’s for
the greater good!” is a perfect example of Utilitarianism in action. In the
case of FTX, they failed everyone. Due to their negligence over two billion
dollars of assets are unaccounted for, and three billion is owed to customers
and investors. Everyone the company effected was hurt by it in some way. No one
wants to lose money on an investment, and through the companies’ misguided hand
many people have. Others will get their money back, however, must go through the
company’s bankruptcy process to do so. This not only is a headache for these
investors but also could be costing them even more money due to legal fees and court
procedures. Utilitarian thought is fundamentally upside down with the state the
company is in. Employees are affected negatively without a job, investors and
investment firms are hurt as they have not lost a portion of their portfolio. Not
to mention, FTX has affected other investors and business with their recent
collapse.
FTX was the second largest crypto currency exchange in the world when they declared bankruptcy in November. This large of an exchange causes ripples in the crypto currency market. In financial terms, it will and did cause a downturn in the market in general. In fact, the crypto currency market has taken a hit in the last few weeks. Bitcoin the most popular crypto currency has dropped in price due to FTX’s bankruptcy. Time Investing reports, “Prior to FTX’s unraveling, bitcoin’s price was holding steady for most of October. Prices remained low at around $19,000 [per coin]” (8) Compare this with the price of Bitcoin as of December 1st, 2022, which is listed at just under seventeen thousand dollars per coin (10).
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| Bitcoin's Price Dec.2 2022 (1) |
That is an eleven percent drop in value in just under a
month sense FTX has collapsed. Admittedly this is circumstantial evidence,
however a similar event occurred when the investment bank goliath Lehman
Brothers collapsed in the 2008 financial crisis. From the BBC, “The consequences for the world economy were extreme. Lehmans'
fall contributed to a loss of confidence in other banks, a worldwide financial
crisis and a deep recession in many countries” (4). FTX’s collapse has caused
mistrust in the market. This as a result creates a downturn in the market. This
downturn has affected an untold number of investors as small as individuals to
as large as firms. The majority has been affected more in a negative way than
the minority has. The rules of Utilitarianism have therefore been violated.
Kantianism:
Kantianism
argues that the means of actions are more important that the result of an
action. Not only this but the meaning behind the action is also equally
important. Kant described the meaning behind the action as “Good Will”. For a
business’s actions to be ethical permissible the actions the business takes
must be first good, and second their intention must also be good, or at least
neutral. In the case of FTX, the company’s bankruptcy isn’t the center of the
controversy, being merely a consequence of the company’s actions. FTX’s
management was poor. They took risks that were not necessary. Sam Bankman-Fried
was even quoted to saying, “I wasn't spending any
time or effort trying to manage risk on FTX” (6). Of course, this boils down to
downright negligent management of a multibillion-dollar corporation. Without
FTX releasing a statement as to why they took the actions they that inevitably
bankrupted them, it can only be left to speculation. One theory would show that
FTX violated Kantianism ethical procedure for pure greed of the company. FTX
was shown to purposely inflate the market value of FTT by selling a small
portion of the coin at a certain favorable price, then using that value to calculate
their net worth (7). An analogy by Ben McMillan shows the flaw in this method, “imagine someone owns every house in a 100-home neighborhood
and forces the sale of one home for $1 million, then uses that sale to show
they have $100 million in "equity." But then, the owner is forced to
sell all the remaining 99 homes, and the houses only sell for $100,000 each –
meaning $90 million of their so-called equity disappears” (7). By inflating
their net worth FTX could theoretically get more capital through loans, thereby
giving the company more cash. Ethically through the guise of Kant, this isn’t
permissible. It is misleading, FTX doesn’t have nearly the amount of equity as
they claim, instead they misled customers and investors by having the inflated
numbers on the books. This tactic is shady and impermissible by Kantian thought
as the means that the company used to get larger is misleading, automatically
violating Kant’s philosophy.
Virtue
Theory:
Virtue theory is an ethical theory that takes one’s character traits into account, to determine if one’s actions are ethical or not. Traits that help one flourish and grow as a person are good, or “virtues”. Whilst traits that hinder people’s growth and happiness are “vices”. Putting FTX under the microscope, they displayed both virtues and vices. Looking at Sam Bankman-Fried’s twitter shows the man at least at the public level is remorseful for what has occurred, and how it affected his customers; tweeting, “My goal—my one goal—is to do right by customers… after that investors. But first, customers” (3).
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| Tweet from Sam Bankman-Freid (3) |
While this
is after the fact, he as the de facto head of the company does show willingness
to fix what he self admittedly blundered. Being virtuous after the fact, however,
does not make up for greed the company heads had before bankruptcy. As
previously stated, FTX had no risk management, it routinely pumped FTT’s value
increasing FTX’s on paper equity, and it also gave out messy loans to sister
firm, Alameda Research. The New York Times claims that FTX could have loaned as
much as 10 billion dollars to Alameda Research, much of that being customer
funds (9). Of course, investment bankers loan out money all the time, it is
their way of making money. However, the big difference here is that FTX’s ties
to Alameda Research made it so FTX heads made money too when Alameda Research
made money. FTX was greedy, it pushed risky investments and inflated their own
revenues to the point where when hardship hit in the form of FTT tanking in
price, the whole system collapsed around it. By falling to the vice, FTX doomed
itself, and its unethical practices tarnished the company. Even before the
collapse, other companies pulled out of loans with Alameda Research, which in
extension is FTX. For instance, the New York Times reported, “Blockchain.com, a leading seller of Bitcoin and other
cryptocurrencies, closed out a loan it had made to Alameda, concerned about
“too many illiquid-related assets” (9). At the end of the day companies exist
to make money, so it shows the risk that FTX and Alameda Research were taking
for one to pull out. The risk taken was backed only by the greed of the firm’s
leaders.
Justified
Ethics Evaluation:
FTX during its operation seemed too
good to be true, and as the adage goes, if it seems too good to be true it is. Being
the fastest growing exchange for crypto currency in the world is lucrative and
enticing. Figures like Sam Bank
man-Fried took the world by the reins, capitalized
on a budging market to make as much money as possible. The company clearly was
a personal piggy bank for Sam and his cronies. The company was run with a loose
cannon at the wheel, it is no wonder why it collapsed. Playing fast and loose
with billions of customers dollars shows no regard to one’s customers. As a
result, FTX is unable to pay back their customers and investors, loosing three
billion dollars’ worth of assets. Sam’s actions as CEO were downright negligent.
He ran FTX into the ground through his risky investments with Alameda and the
self-inflation of FTX’s main asset, FTT. It doesn’t take a genius in economics
to realize artificially pumping up the value of FTT would cause a market
correction eventually. This tactic was used by Jorden too Belfort, better known
as The Wolf of Wall Street with his investment firm, Stratton Oakmont. He
pushed his customers to buy cheap stock on mass, inflating the price of it. It's
out of pure greed to capitalize and make as much money as possible. Both firms
ended in the same fate, bankrupt. If FTX were to go back and redo their past,
they could easily be in business today if they didn’t do a measure of actions.
One; FTX needed to cease their grey area relations with Alameda Research. This
relationship in a non-crypto related market would’ve been under lots of
scrutiny from investors and regulatory agencies. Second, FTX needed to practice
ethical business practices, such as being honest about actual revenue, not
inflating their net worth through shady means. The mix of negligence and FTX’s
more dubious business practices marked their downfall. The company was
mismanaged to the point that they had no idea of the amount of liquidity they
had to pay debts owed. When FTX’s house of cards toppled, their customers paid
the price.
Conclusion:
FTX’s
bankruptcy comes as no surprise in hindsight. Under the scrutiny of four
different ethical theories, the company failed to show any sort of
ethical actions. It didn’t serve itself by making poor decisions that ended the
company, failing Individualism. The company did not serve the greater good
either, instead plunging the market into distress and hurting the wallets of
potentially millions of people. This breaks the rules of Utilitarianism. The company’s
actions were not out of the good will either, they mislead customers and
investors about the net worth of the company and thereby it’s security,
breaking the rules of Kant. FTX was also not virtuous, operating out of pure
greed, again pumping up its net worth and investing funds in risky bets. Truly,
the fall of FTX is a shame, not because the company itself was anything
particularly special, but the fall of FTX marks a new struggle in the crypto market
and may delay its adoption into the mainstream. The concept of crypto is
heavily intertwined in what experts are calling the “Internet 3.0” and this
fall may falter a new renaissance in the development of the internet and
humanity as whole.
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<a
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