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

If you asked the average person on the street to play a word association game focused on crypto, one of the first words that would come up would be ‘volatility.’ There’s a reason for this: cryptocurrency prices often rise and fall dramatically based on the slightest pretext, while fortunes are therefore made – and lost – more or less overnight.

One inevitable extension of this volatility is that the cryptocurrency sector has witnessed more than its fair share of collapses and bankruptcies over the course of its relatively short life. These stretch back almost a decade, and as much the industry has matured since the birth of Bitcoin in 2009, it’s likely that they’ll continue for some time to come (especially when we still see them in the legacy financial sector).

However, this article aims to provide cryptocurrency investors with a rough guide on avoiding the next big blow-up in the space, by examining three of the biggest crypto collapses to have happened to date. It unpacks just what happened in each particular case, and it also highlights the early warning signs that could have tipped investors off to a potential catastrophe.

Picture of defunct FTX arena

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.

Mt. Gox: Beware of Unregulated Exchanges

Back in 2013 and 2014, Mt. Gox was easily the biggest exchange in the early cryptocurrency market. However, this status didn’t last very long, with the platform’s collapse and bankruptcy highlighting the vital importance of cyber-security, as well as of basic administrative and financial controls (e.g. know-your-customer and reserves).

As early as 2013, Mt. Gox accounted for around 70% of all bitcoin trades worldwide. However, all was not right with the exchange, which was being subjected to regular hacks and attacks. One of these – which occurred in February 2014 – ended up being fatal, so fatal that around 750,000 BTC was stolen as a result of various bugs, which the attacker(s) had exploited over the course of several years.

Mt. Gox suddenly shuttered its platform and website in the immediate aftermath of the hack’s coming-to-light, with the exchange unable to meet customer withdrawal requests. It also filed for bankruptcy in Japan at the end of February, and then in the US in March, with CEO Mark Karpelès being arrested in Japan in 2015 on charges of tampering with data (related to the exchange’s finances).

Karpelès was found guilty in 2019, with the court finding that he mixed Mt. Gox’s reserves with his own personal accounts. And while it looks as though the exchange’s customers will end up receiving up to 90% of the BTC they’re owed, its downfall once again underlines the importance of self-custody, particularly if you’re sitting on a significant sum of crypto.

It also arguably underlines the importance of regulation, with Mt. Gox operating as an unregulated entity that didn’t have any know-your-customer measures in place, and that wasn’t required to keep reserves or maintain certain security standards. Fortunately, such laxity is now a thing of the past, with the industry increasingly becoming more regulated with every passing year, to the benefit of its customers.

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CryptoVantage Author Simon Chandler

About the Author

Simon Chandler

Simon Chandler is a journalist based in London. He writes about technology, markets and politics, and has bylines for Forbes, Digital Trends, CCN, Wired, TechCrunch, the Verge, the Sun, the New Internationalist, and TruthOut, among many others. His Twitter handle is @_simonchandler_

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