FTX's Collapse: What It Exposed About Venture Due Diligence

In January 2022, crypto exchange FTX raised money at a valuation of about $32 billion. Its backers included some of the best-known names in investing: Sequoia Capital, SoftBank, Temasek, Ontario Teachers' Pension Plan and Tiger Global. Ten months later, FTX filed for bankruptcy after it emerged that customer funds had been used by its affiliated trading firm, Alameda Research.

Founder Sam Bankman-Fried was convicted of fraud in 2023 and sentenced to 25 years in prison. The collapse raised uncomfortable questions for venture investors: how did so many sophisticated firms miss such basic failures? This post-mortem focuses on what FTX exposed about venture due diligence.

1. How It Unravelled

• Early November 2022: a news report revealed that Alameda Research's balance sheet was heavily reliant on FTT, a token created by FTX itself.
• Loss of confidence: a rival exchange announced it would sell its FTT holdings, triggering a rush of customer withdrawals.
• A rescue that failed: a proposed acquisition by that rival was abandoned within days.
• 11 November 2022: FTX filed for bankruptcy.

2. What Went Wrong Inside

• Misuse of customer funds by the affiliated trading firm.
• No real board of independent directors to oversee management.
• Weak financial controls, with poor record-keeping and limited accounting oversight. The executive appointed to run FTX in bankruptcy described an unprecedented failure of corporate controls.
• Related-party conflicts between the exchange and the trading firm controlled by the same founder.
• Concentrated control in a small group of insiders.

3. What Investors Missed

• Governance. Investors accepted a company handling billions of dollars in customer assets without a functioning independent board. See startup boards and governance.
• Related-party risk. The relationship between FTX and Alameda was known, but its risks were not adequately examined.
• Custody and controls. Few investors verified how customer funds were held and segregated.
• Founder mythology. A charismatic founder and rapid growth encouraged investors to move quickly.
• Competitive pressure. In a hot market, some investors reportedly did limited diligence to secure allocations.
• Reliance on others. Each investor could assume that the other prominent investors had done the work.

4. The Aftermath for Investors

• Major backers wrote their investments down to zero.
• Several firms publicly acknowledged diligence shortcomings and revised their processes.
• LPs questioned how their fund managers had diligenced crypto and high-growth deals.
• Through the bankruptcy process, many customers were later expected to recover their claims, but equity investors were largely wiped out.

5. Lessons for Venture Due Diligence

• Governance is not optional, especially for companies holding customer assets.
• Map and scrutinise related parties.
• Verify custody and financial controls directly. See operational due diligence.
• Do not rely on other investors' reputations as a substitute for your own work.
• Resist FOMO. Speed and allocation pressure are exactly when diligence matters most.
• Run thorough references and background checks. See founder reference checks.

For similar lessons, see Theranos and Wirecard.

Frequently Asked Questions

How much was FTX worth before its collapse?

It was valued at about $32 billion in a funding round in January 2022.

Who invested in FTX?

Backers included Sequoia Capital, SoftBank, Temasek, Ontario Teachers' Pension Plan and Tiger Global, among others.

What happened to Sam Bankman-Fried?

He was convicted of fraud and conspiracy in November 2023 and sentenced to 25 years in prison in 2024.

What is the main lesson for venture investors?

That governance, controls and related-party risks deserve rigorous scrutiny, regardless of a company's growth, reputation or investor line-up.

The Bottom Line

FTX showed that even the most prominent investors can skip basic diligence in a hot market. Its collapse is a reminder that governance, controls and verification are not bureaucracy; they are how investors protect themselves and the customers of the companies they back.

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This article is general information, not investment or legal advice.