FTX was the third-largest crypto exchange in the world, with reportedly over a million users.
In November 2022, the company collapsed, wiping billions off the cryptocurrency market and eventually leading to the arrest of FTX’s founder, Sam Bankman-Fried.
While FTX grew and Bankman-Fried earned praise from across the crypto sector, the company seems to have hidden grievous mismanagement and misappropriation of funds.
At its core, the FTX scandal is a story of non-transparency. And yet it comes at a time when people, businesses and regulators increasingly recognise the importance of openness in business.
The Fall of FTX
The FTX scandal first unfolded with revelations about the firm’s close ties with its sister company, trading firm Alameda Research.
In early November, CoinDesk reported that some of Alameda’s most significant assets consisted of FTT, a token created and controlled by FTX.
The article sparked a public dispute between Bankman-Fried and Binance CEO Changpeng Zhao, leading to a plummet in FTT’s value and contributing to the collapse of FTX.
After FTX failed to find a competitor willing to buy it out, the company filed for bankruptcy. Then the true extent of FTX’s financial and managerial failings came to light.
In the following weeks, investigations and lawsuits were launched into FTX’s conduct. Bankman-Fried himself was arrested in the Bahamas and faces charges including wire fraud, money laundering and campaign finance fraud.
A ‘Complete Absence’ of Trustworthy Information
In a Vox interview given a month before his arrest in mid-December, Bankman-Fried expressed his disdain for regulatory oversight of crypto—and suggested that regulation was failing to protect consumers in other sectors, such as traditional finance and “big tech”.
Since Bankman-Fried stepped down, the company’s new CEO, John Ray, stated that he had never seen “such a complete failure of corporate controls” and “such a complete absence of trustworthy financial information” as occurred at FTX.
Ray’s assessment is particularly remarkable, given that he also oversaw the unwinding of Enron—the energy firm at the centre of what was arguably the most notorious financial scandal of all time.
Misleading financial statements, poor management of private information and misuse of corporate funds were among FTX’s many failings, according to a court submission by Ray in the aftermath of the company’s bankruptcy filing.
Like with so many corporate scandals in crypto and beyond, a lack of transparency underpins FTX’s demise.
Could Audits Be the Answer?
There can be little doubt that, had the company been held accountable via proper transparency obligations, FTX would have either avoided its calamitous demise or failed to grow to its over-inflated peak size.
Some commentators suggest that audits could solve crypto’s transparency problem.
But audits must be independent, rigorous and meaningful. Audits in themselves don’t improve transparency or prevent crypto scandals.
Indeed, FTX was among the few crypto companies that have commissioned a broad third-party audit, which covered the 2021 fiscal year. While this process reportedly reassured some investors, the auditors, the law firm Prager Metis, allegedly missed numerous red flags.
Prager Metis stands by its audit, but FTX’s new CEO has commented that he has “substantial concerns” about the audit reports (let alone the company’s numerous unaudited financial statements).
Audits of non-crypto-oriented financial firms have come under scrutiny, too, including the notorious EY audits of German payment processor Wirecard.
EY initially investigated allegations of accounting manipulation at Wirecard in 2007 and repeatedly provided audits over a period of more than a decade despite suspicions of malpractice.
In 2020, Wirecard filed for insolvency and revealed a €2 billion hole in its accounts. EY has come under criticism for its failure to reveal Wirecard’s mismanagement—and reportedly lost €42 million in auditing business as clients moved away following the scandal.
A New Era of Transparency?
The FT reported in late November that many auditors are re-examining their crypto clients following the FTX debacle. But one problem with crypto audits as a transparency solution is a lack of recognised standards or legal requirements.
In early November, nine well-known crypto exchanges announced that they would be publishing independent proof of their reserves to help reassure investors.
However, a senior staff member at the US Securities and Exchange Commission (SEC) subsequently told the Wall Street Journal such an audit is “not enough information for an investor to assess whether the company has sufficient assets to cover its liabilities”.
In the meantime, legislators and regulators are gradually closing in on crypto.
The EU published a new draft directive in December that would increase transparency obligations on crypto service providers. In the US, the Biden Administration’s March executive order is a step towards greater transparency in cryptocurrency markets.
And regulators are also demanding greater transparency beyond crypto and other finance areas.
Transparency failings are among the most common reasons for enforcement under the EU’s General Data Protection Regulation (GDPR). A lack of transparency contributed to fines against companies like WhatsApp, Instagram, and many other smaller companies.
The FTX scandal is further evidence that companies tend to fail if they do not operate in an open and transparent way.
Few firms crash as spectacularly as FTX. But it’s increasingly clear that customers, employees and regulators expect openness and integrity. Organisations that integrate these values from day one are plotting a path to sustainable growth and long-term success.