The collapse and bankruptcy of digital asset exchange FTX offers stark lessons into why rules that apply to traditional investments—overseen by government regulation—ought to apply to digital investments as well.

As recently as Nov. 6, FTX, founded in 2019 by Sam Bankman-Fried, was one of the world’s largest digital asset exchanges, with $16 billion in assets under its control. By Nov. 11, the company filed for bankruptcy following a week in which investors and customers demanded to cash out their investments and sell their FTX tokens (FTT), all at once.

Even for the cryptocurrency industry, which has become accustomed to wild swings in value, the speed of FTX’s fall was stunning. What happened?

On Nov. 2, digital asset news outlet CoinDesk reported the private balance sheet of Alameda Research, a trading firm, was intertwined with FTX’s. Both Alameda Research and FTX, each separate companies, were owned by Bankman-Fried.

Alameda’s balance sheet showed a significant portion of the firm’s $15.8 billion valuation was tied to FTT, the digital coin FTX invented, according to the report. The story confirmed what was long suspected in the cryptocurrency industry: The financial relationship between Alameda and FTX was unusually close.

Traditional investment vehicles, all heavily regulated entities, are required by law to disclose apparent conflicts of interest. But since cryptocurrencies and other digital investments operate outside of rules and regulations that apply to other kinds of investments, neither Bankman-Fried, FTX, nor Alameda were compelled to disclose how closely the two businesses were intertwined.

Several days later, investors and customers attempted to drain their FTX accounts and sell their FTT, leading to a huge run on the exchange.

The CoinDesk story provided the first in a series of revelations about the finances of FTX and Alameda, the former of which is being investigated by the Securities and Exchange Commission (SEC) and Department of Justice following its collapse, according to the Wall Street Journal.

The WSJ also reported FTX lent as much as $10 billion in customer funds to Alameda, which might have contributed to the downfall of both.

“If you’re an investor in Alameda, you expect that the fund managers are looking out for ‘your’ interests, not using your money to prop up the value of a token that will help a totally different business,” tweeted Renato Mariotti, a former federal prosecutor and partner at Bryan Cave Leighton Paisner. “When you’re told your money will be used for one purpose and instead the person uses it for another purpose, that’s fraud.” 

These lending practices were something FTX promised in its terms of service it would not do.

“FTX’s terms of service stated that title to customers’ assets would at all times remain with the customer and shall not be transferred or loaned. In direct contravention to these commitments, it now appears billions of dollars in customer assets were transferred to fill a huge hole in Alameda’s balance sheet,” said Philip Moustakis, counsel at Seward & Kissel and a former senior counsel in the SEC’s Enforcement Division. “If that is true, we’re talking about fraud with a capital F, meaning there may be serious criminal and regulatory exposure. The only question is who is responsible.”

As FTX customers were demanding their money back and FTT’s value was plummeting, approximately $662 million worth of tokens up and disappeared, either lost or stolen. It’s still unclear.

Another force potentially buffeting FTX was the exchange’s numerous attempts to buy other failing or bankrupt crypto ventures, including Voyager Digital, which it won at auction in September, and BlockFi, which it signed an option to buy in July. An entity that would collapse in the span of a week is clearly not one that should be bailing out other failing enterprises.

Regulators like the SEC and Commodity Futures Trading Commission (CFTC) have been calling for the cryptocurrency industry to be more closely regulated. SEC Chair Gary Gensler has previously said most cryptocurrency tokens are likely securities and should be regulated as such, as should the platforms that trade them. For now, the SEC has been content to regulate cryptocurrencies and crypto trading platforms through enforcement while several lawsuits—like one involving Ripple Labs—work their way through the courts.

Meanwhile, the CFTC had insight into FTX’s finances but never sounded the alarm. FTX Derivatives US, a derivatives clearing organization, was licensed and registered by the agency as a derivatives clearing organization. On Monday, the CFTC issued a press release stating FTX had withdrawn a request to offer products that were not fully collateralized. The application, submitted in December 2021, had not yet been approved.

The CFTC has been criticized for failing to properly oversee FTX Derivatives.

“The CFTC appears to have failed miserably … and missed what now appears to be multiple failures at FTX to meet fundamental corporate governance standards,” said Dennis Kelleher, president and chief executive officer of Better Markets, a nonprofit that promotes the public interest in financial markets.

One of the ironies of this situation is Bankman-Fried has been a strong proponent of cryptocurrency regulation. He appeared before Congress and spent millions of dollars lobbying lawmakers to pass legislation creating a U.S. regulatory framework for cryptocurrencies. His support of regulation earned him scorn in some corners of the crypto industry.

The cause of many of FTX’s problems could be traced to poor corporate governance, poor internal controls, and a concentration of material decision-making within a small group of executives led by Bankman-Fried. Ultimately, FTX was unaccountable to investors and regulators.

It’s a fundamental problem with all digital investments. And that must change.