From Mt. Gox to FTX: What We Can Learn From the Biggest Crypto Collapses

FTX: Not Your Keys, Not Your Crypto

There are really two main lessons to be drawn from the FTX collapse, which unfolded in November 2022 and sent crypto even deeper into the bear market it had entered several months previously. The first is that you shouldn’t trust a crypto-exchange whose assets and financial reserves are primarily held in its own native token. And the second is that you also probably shouldn’t trust a trading platform that also trades itself.

Yes, because FTX’s parent company, Alameda Research, had put itself in a vulnerable position by investing in the cryptocurrency market. Its investments in a variety of tokens, including in yield-farming assets, began to lose money as the bull market of 2021 turned into the bear market of 2022, with Alameda reportedly needing to borrow around $10 billion from FTX.

This money came from customer deposits, putting FTX in a very risky position in the event of a wave of withdrawal requests. And such a risk was realized in November 2022, when a leaked report revealed that FTX and its parent company were effectively insolvent, given that 39% of its assets were in its native token, FTT.

Cue a massive run on FTX, which was unable to honor all of the withdrawal requests it received. As such, it had no choice but to file for Chapter 11 bankruptcy protection, a move which ultimately led to the arrest of founder Sam Bankman-Fried, on various counts of fraud, as well as on charges of money laundering.

And as we’ll see with another entry on this list (Mt. Gox, below), FTX’s collapse provided yet another stark reminder of possibly the golden rule in crypto: not your keys, not your crypto. The exchange owes some $8.9 billion to its customers, and while its administrators have recovered around $7 billion, this sum hasn’t yet been returned to its rightful owners.

Terra: Too Good to Be True

While FTX is arguably the biggest reason for the ongoing cryptocurrency bear market, the collapse of Terra in May 2022 is probably where it all began. And what this particular scandal teaches us is that investors shouldn’t trust platforms or cryptocurrencies that have Ponzi dynamics and that promise sustained above-average returns.

This is exactly what the Terra ecosystem did. While this ecosystem mainly consisted of a so-called algorithmic stablecoin (UST) and an associated cryptocurrency (LUNA), it also featured a staking/lending/borrowing platform, Anchor. As noted in a very instructive inquest by Delphi Digital, Anchor promised yields of 20% to users who deposited UST. This may have seemed relatively conservative in an ecosystem where triple-digit yields are sometimes offered, but it proved utterly sustainable for Terra, particularly when the pegged value of UST was dependent on the value of its associated cryptocurrency, LUNA.

Indeed, the whole edifice proved to be a house of cards, with the reduction in cryptocurrency prices leading to an increase in users depositing UST in order to earn their 20% yield. The thing is, in a context of declining prices, Anchor’s reserve – which it used to fund withdrawal requests – saw its value drop. This meant that the platform became increasingly unable to honor its commitments.

And things came to a head in May 2022, when two users withdrew more than $500 million from Anchor, which was left with only $300 million in its reserves. This led to a panicked bank run on Anchor, with the withdrawal of UST resulting in it being dumped onto the market. This caused a death spiral, with UST plunging as low as $0.00601921 in June 2022, down from $1 barely a few weeks earlier.