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Blockchain Technology and Polycentric Governance:

"FTX was a cryptocurrency exchange and trading platform headquartered in the Bahamas and founded by Sam Bankman-Fried in 2019, following the (seemingly) successful launch of his other major venture, Alameda Research, a quantitative cryptocurrency trading firm two years previously. The two ventures had always been closely intertwined, with Alameda incubating FTX at its early stages and using the exchange subsequently, thus providing the platform with liquidity and ensuring that FTX could fulfill its role as a market maker from its outset. After the incubation phase, the two companies were to be operated independently of each other, a legal requirement to hedge against insider trading and other collusion dynamics.

Both firms grew steadily, with FTX raising over $1.8 billion in capital, according to Crunchbase data, at a valuation of $32 billion before their demise in November 2022. The trouble started after CoinDesk, a cryptocurrency news outlet, published an article citing a leaked Alameda balance sheet, which showed that the company was heavily indebted to FTX and much of its collateral was held in FTT, the FTX native tokens issued by the exchange itself. Responding to the article, Changpeng “CZ” Zhao announced that he would sell the remainder of his substantial FTT holdings. CZ was the founder and (by then) the CEO of Binance, the world’s largest cryptocurrency exchange at the time of writing, and an early investor in FTX. The interactions following this Tweet led the price of the FTT token to drop by over 90%, from about USD26 at the beginning of November to around USD2 on 9 November. Despite repeated reassurances and attempts by both Bankman-Fried and Alameda CEO Ellison that they would be able to raise the capital required to cover the liquidity gap, Alameda filed for Chapter 11 bankruptcy on 10 November, followed by FTX on 11 November, which comprised 136 separate entities and including FTX US, which had until then been heralded as being fully solvent (Keoun 2022).

Subsequently, ongoing court proceedings revealed Alameda had borrowed significant customer funds from FTX against predominantly FTT-based collateral and used them to invest in the market, which rapidly turned down following the collapse of Terra/Luna, leaving Alameda unable to service its debt and FTX subsequently unable to payout customer funds (Koo et al. 2022). Beyond the plainly illegal and irresponsible management of customer funds, competitive market forces (Alston et al. 2021) ultimately contributed to the collapse of FTX.

From the perspective of polycentricity, observing how other autonomous units within the ecosystem began to rapidly adapt their practices in response to the FTX collapse to self-regulate the space through informal norms and standards is interesting. Actors in the blockchain space also started doubling down on “decentralization” as an overarching value guiding the ecosystem (Aligica & Tarko 2012). New norms and standards emerged, at least for a time, in the form of other centralized exchanges beginning to publish proof of reserves (Asmakov 2022) following the FTX debacle. The value of decentralization was tangibly re-emphasized by users withdrawing their holdings to self-custody wallets and moving to decentralized alternatives, causing a run on de facto crypto banks (Bambrough 2022). At the same time, the Ethereum community started accelerating efforts on Account Abstraction. This technical upgrade improves the user experience of using non-custodial wallets, making it more competitive to hold funds on centralized exchanges (Crypto.com 2023). Finally, the FTX case also illustrates the effects of the outsider’s governance forces overseeing the blockchain industry, as the ecosystem now faces increased regulatory scrutiny, with SEC activity increasing by almost 200% in the six months following the FTX collapse (Coghlan 2023)."