Speaking at his criminal trial, looking visibly uncomfortable in an ill-fitting gray suit, Sam Bankman-Fried recounted a “screw-up” in which he was outwitted by a trader who had gotten around $800 million out of his company FTX. Mr. Bankman-Fried had Alameda Research, his ostensibly separate trading arm, take over the hugely negative account, thus — according to at least one witness — hiding the loss from FTX’s investors.

Prosecutors charged that the cover-up was just one example of the widespread fraud at the two companies, and a jury later agreed, finding Mr. Bankman-Fried guilty of seven wire fraud, conspiracy and money laundering charges. What prosecutors never focused on in the trial is the practice that had helped generate that enormous loss, which is similar to the practice that propped up FTX and Alameda.

What I’m referring to is the practice of pumping up the price of a token with no real value behind it and using that inflated valuation to lay the foundation of a business’s balance sheet or to borrow dollars. As a longtime industry watcher, I believe that same practice is still propping up vast swaths of the cryptocurrency industry today. Not only are crypto firms operating with massive undisclosed credit risk, they’ve also often managed to sidestep the kind of outside scrutiny that might have been invited by more traditional funding models. And when a business funded in this way collapses — or, as in FTX’s case, explodes because of fraud — it is the people who’ve given up their money for a whole bunch of nothing who suffer.

In the case of that $800 million exploit, the trader had accumulated illiquid cryptocurrency tokens with names like MobileCoin and BTMX, manipulated markets to jack up those tokens’ prices, and then used them as collateral to borrow hundreds of millions of dollars worth of other assets — far more than the tokens could ever actually fetch if sold on the market. The trader then cashed out the borrowed funds, leaving FTX and, later, Alameda with a pile of nearly worthless tokens for which there were few interested buyers. A similar scheme forms the basis of at least one other criminal case currently making its way through the Southern District of New York.

In early 2019, FTX’s token, FTT, was conjured out of thin air as Mr. Bankman-Fried launched FTX from the same Hong Kong office where he ran Alameda Research. Situated offshore and not serving U.S.-based customers at the time, FTX advertised the tokens to everyday investors as akin to stock in the company — a sales pitch that would be forbidden in the United States, owing to securities laws aimed at preventing unregistered companies from selling anything that looks like a share in the company to unaccredited investors.

The FTT token initially sold to the public for around $1, but as cryptocurrency boomed into 2021, the token skyrocketed to $10, doubled again to $20 within a month of that and eventually peaked above $75. Only a portion of the 350 million tokens created by FTX regularly traded on the open market. The bulk of them remained with FTX or Alameda Research. These were then used to collateralize loans of cash, Bitcoin and other more usable assets from many third parties who either didn’t know or didn’t care that FTX and Alameda Research were critically dependent on the price of the token remaining steady or continuing to go up.

A trader might have reasonably agreed to buy a small amount of FTT tokens for the market price listed on an exchange. A particularly deep-pocketed trader or a trading firm might have even agreed to buy tens or hundreds of thousands of them. But a financial statement leaked in November 2022 revealed that Alameda Research’s single biggest asset was a mountain of FTT: $3.66 billion worth, plus another $2.16 billion worth of FTT that was being used as collateral for loans (all valued based on the current market price of the tokens, rather than the substantially smaller amount they would realistically fetch if sold all at once).

That revelation helped to kick off the death spiral. As investors began questioning the value of FTT, the chief executive of Binance, FTX’s biggest competitor, worsened the panic when he threatened to dump millions of FTT onto the market. People rushed to sell their holdings until the token’s resulting price slump led people to question the stability and solvency of FTX and Alameda Research more seriously, especially now that they knew how dependent they were on the success of FTT. The drop in FTT valuation to under $2 also made it harder for FTX and Alameda Research to repay their customers and lenders who wanted their original assets back and would not be satisfied with receiving the still-devaluing FTT in its place.

The rapid snowball of the FTT collapse was catastrophic, both to FTX and to Alameda Research but also to the many customers, investors and lenders whose funds were in FTX. Most customers have been waiting for a year to recover their deposits, or some portion of them. Some investors have marked their investments down to $0. The cryptocurrency industry is small, and no one was truly insulated from FTX’s collapse. Everyone was lending everyone else money, and when one link in that chain failed, losses rippled throughout the industry. Other cryptocurrency firms that were overexposed to FTX or Alameda Research went bankrupt, in turn leaving their own customers and investors in the lurch.

Although some might try to dismiss the FTX collapse as a unique case, it is far from it: The funding model has become all too normal in the cryptocurrency world. Entrepreneurs thought they had found a free money machine in 2017 as initial coin offerings became popular, enabling cryptocurrency companies to bootstrap without needing to find venture investors — investors who might insist on a seat on the board or a view into the company’s operations. A crackdown on I.C.O.s in the United States shortly after failed to stop the practice, with companies either presenting the offerings in disguises designed to stymie if not entirely evade the Securities and Exchange Commission, or moving offshore in hopes of being beyond the reach of the long arms of the S.E.C.’s enforcers.

FTX is perhaps the best known catastrophe, but the same pattern has played out for customers of the Celsius cryptocurrency lender’s CEL token, the Voyager Digital broker’s VGX and the Terra/Luna ecosystem’s LUNA. Civil and criminal cases have revealed internal conversations among Celsius executives desperately trying to support the CEL token price to keep the floundering company afloat, to no avail, knowing what the token’s collapse would mean for the company. Binance, a still-operational exchange whose balance sheets are as opaque as those of the Bankman-Fried companies before their collapse, heavily promotes its BNB token. The extent to which the company relies on BNB to finance its operations is unclear, but history provides ominous warnings.

The collapse of the FTX exchange revealed the massive duplicity underlying many crypto exchanges, but its implosion should not be attributed to that alone. It, like so many companies in the cryptocurrency industry, had propped itself up on an imaginary foundation of tokens it had invented, and that foundation was bound to fail eventually. When the next company in its position falls, the only surprise should be that people expected any other outcome.

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