Company / Analytics

Analytics, 17 November 2022

The fall of FTX: What really happened?

*FTX, at one point the third largest cryptocurrency by exchange, has filed for bankruptcy. The firm’s founder, Sam Bankman-Fried, popularly known as SBF, stepped down as CEO on Friday as his wealth plummeted about 94% to $991.5 million from his estimated $15.2 billion between Nov. 8-9. *

The company, which was at its peak valued at $32 billion, declined in value overnight as traders withdrew their deposits from the exchange. This was after Mr. Zhao, the CEO of Binance, tweeted on Sunday that Binance would sell its holdings of FTX’s digital token, known as FTT. FTT has lost almost 80% of its value this week.

Several revelations seem to point to FTX reportedly siphoning off customer assets as collateral for loans, and then covering it with a token it made up and printed at will, drip-feeding only a fraction of its supply into the open market. In this article, we look into the details of the FTX downfall.

The creation of FTX

FTX was founded by Sam Bankman-Fried (SBF) in May 2019. SBF came to be wealthy when in 2017 when trading crypto markets, he would sometimes see a 60% difference in the value of bitcoin between exchanges. His immediate instinct was to get in on the arbitrage trade — buying bitcoin on one exchange, selling it back on another exchange, and then earning a profit equivalent to the price spread. After one month of arbitrage trading, SBF had made enough money to launch his own trading house, Alameda Research to scale the opportunity and work on it full-time. According to an interview where SBF was hosted, the firm would make as much as a million dollars a day.

Fast forward to 2019, Alameda’s success birthed the crypto exchange FTX. FTX’s success begat a $2 billion venture fund that seeded other crypto firms. Bankman-Fried’s personal wealth grew to over $16 billion at its peak in March.

What went wrong?

As global financial markets tanked this year, cryptocurrencies were hit arguably harder in the wake of rampant inflation and rising interest rates. SBF continued to claim his enterprise was immune but in fact, the sector-wide wipeout hit his operation quite hard.

Alameda borrowed money to invest in failing digital asset firms this spring and summer to keep the industry afloat, then reportedly siphoned off FTX customers’ deposits to stave off margin calls and meet immediate debt obligations.

A Twitter fight with the CEO of rival exchange Binance pulled the mask off the scheme. Binance CEO Changpeng Zhao, commonly known as CZ, initially invested in FTX in 2019, but later sold his controlling stake in 2021. Zhao was paid about $2.1 billion worth of FTT, the native crypto token that gives users access to the FTX trading platform.

“Due to recent revelations that have come to light, we have decided to liquidate any remaining FTT on our books,” Mr. Zhao, said. This raised concerns about FTX’s financial health which reportedly caused $6bn (£5.2bn) of withdrawals in just three days by triggering fears among investors that FTX would be unable to pay its debts.

What does it mean for investors with holdings in FTX?

Holders of deposits in FTX exchange in the US are unaffected by the bankruptcy application according to SBF. By filing for Chapter 11 bankruptcy, the company can continue operating, while restructuring its debts under court supervision. FTX said the goal was to begin an orderly process to review and monetize assets for the benefit of all global stakeholders.

In the filing, FTX estimated that it had between $10bn and $50bn in assets and liabilities and more than 100,000 creditors. The proceeding involves FTX as well as Alameda Research and roughly 130 affiliates, according to the statement FTX shared on Twitter.

As per regulations, financial exchanges are expected to have insurance coverage for client protection. Like many other crypto exchanges, FTX’s insurance coverage only addresses certain criminal events such as theft or fraud. There is no insurance coverage just because the exchange fails. If there’s no bailout, some depositors in FTX could lose everything.

Crypto-market reaction

Bitcoin’s price hovered around $17,000 as of Nov. 11, down from above $20,000 on Nov. 8 before the onset of the FTX exchange drama. This also represented an over 60% decline in bitcoin from its peak price of around $68,000 in November 2021. The cryptocurrency currently trades at $16,562.70 and continues to struggle to recover from the recent fall.

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