The Collapse of FTX: Crypto Industry in Deep Trouble?

Things have turned from bad to worse for the virtual digital assets industry, which comprises cryptocurrencies and NFTs. The second-largest crypto exchange in the world has collapsed, causing widespread sell-off and panic in the crypto markets. FTX has started bankruptcy proceedings in the US, and its CEO Sam Bankman-Fried has resigned. His net worth fell from nearly $16 billion to zero in three days! 

In this article, we dive into the reasons behind FTX’s collapse and recent developments surrounding the crypto firm.

The Rise of FTX

In 2017, former Wall Street trader Sam Bankman-Fried (SBF) wanted to dabble in crypto and established a proprietary trading firm called Alameda Research. The firm offered digital asset products and their derivatives (financial contracts). Two years later, he founded FTX along with ex-Google employee Gary Wang. With its headquarters in the Bahamas, the crypto exchange sought to promote liquidity and transactions of various crypto coins and tokens. FTX connects crypto buyers & sellers and collects a commission on all transactions.

Users can deposit fiat money (USD or other govt-issued currencies) into their FTX account and use the funds to buy & sell crypto. FTX provided leverage to those who were willing to bet big on certain trades. [Leverage is extra money offered by the exchange so that you can trade in larger quantities and potentially make more profit or loss.]

The Case of FTT Tokens:

FTX also introduced its own crypto token  called  FTT. The company promised all token holders priority access to their trading platform (lower fees, no-cost withdrawals), giving FTT some credibility. Moreover, FTX used to buy its token using a portion of its revenue, which meant its price moved up sharply.

With institutional investors like Sequoia and Softbank, FTX quickly became the second-largest exchange in the world. Its daily volumes even touched $2 billion during its peak. The company also brought in Binance (the world’s largest crypto exchange) as an investor in its initial stages. Meanwhile, SBF developed a sort of cult following, and his net worth touched $17 billion at a point. His relationship with the media and young investors contributed immensely to FTX’s sudden growth.

SBF gave credit facilities to crypto lenders like Voyager and BlockFi when they were struggling to survive. He even sponsored F1 teams and entered politics.

Once FTX became popular, Sam Bankman-Fried bought out Binance’s stake in his company in 2021. Reports indicated that SBF may have feared strict regulatory action against Binance and wanted to part ways with it. Binance was paid $2.1 billion for selling the stake in FTX— partly in cash and the rest in FTT tokens.

So What Went Wrong?

• Since Sam Bankman-Fried established FTX, he had convinced everyone that the firm had no links with Alameda Research. However, this doesn’t seem to be true. A report published by Coindesk on Nov. 2 claimed there was an unusually close relationship between the two entities.
• The report stated that Alameda held FTT tokens at low prices (worth billions). Thus, when FTT’s prices increased, the value of Alameda’s assets also surged. 
• Using these highly inflated tokens as collateral, Alameda reportedly started borrowing money from various “unknown” entities. It has also been alleged that FTX transferred tens of billions of customer funds as loans to Alameda.
• Thus, a fall in FTT’s value could severely hurt both firms due to their shared ownership.
• Many started raising concerns about FTX's financial health, risk management, and liquidity. 

FTX vs Binance

• Even though Binance supported FTX during its rise to the top, both firms have been bitter rivals. FTX has often threatened Binance's dominance as a crypto exchange. 
• Earlier, we mentioned that Binance held FTT tokens. The company’s CEO, Changpeng Zhao (CZ) had been waiting for a perfect time to get back at SBF for his hostile comments on Binance. And this is what he did on Nov 6:

• Binance’s position in FTT was around 5% of the total— worth around $580 million. Over the span of 2-3 days, $6 billion worth of FTT was withdrawn by investors, and the token crashed more than 90%! CZ was also vocal about the fact that FTX did not have enough cash reserves to process withdrawals. Eventually, FTX had to pause withdrawals on its platform due to a liquidity crunch (a lack of cash or easily convertible-to-cash assets).  

• If FTT’s price fell, Alameda Research's balance sheet would be emptied in an instant. It would severely harm the firm, and the effect would spread to FTX, especially if it had loaned customer deposits to Alameda.

Recent Developments

In an interesting turn of events, CZ came to the rescue of FTX (well, sort of). On Nov 8, Binance’s CEO announced that the company would acquire FTX amidst its liquidity crisis. They even signed a non-binding agreement, intending to fully acquire FTX.com. However, CZ immediately pulled out of the deal the next day as rumours grew about FTX’s damaged balance sheet. 

On November 11, FTX filed for Chapter 11 bankruptcy protection in the US., in a move that included its US platform and Alameda. Venture capital firm Sequoia marked down its $150 million investment in FTX to $0! Most investors were not aware of FTX’s related party dealings with Alameda. Softbank also had a $100 million exposure in the crypto exchange. A Reuters report has claimed that at least $1 billion of customer funds had vanished from FTX!  To make matters worse, FTX was reportedly hacked, with more than $600 million stolen from its crypto wallets.

The U.S. Securities & Exchange Commission (SEC) and the Justice Department are investigating the serious allegations against FTX. The company and its CEO are definitely in deep trouble.

FTX’s collapse has raised serious concerns about the future of the crypto industry. It continues to face an uphill battle to regain the trust of retail investors across the globe. We've already seen crypto firms like Celsius and Voyager collapsing amidst a brutal "crypto winter". Will FTX’s clients get their hard-earned money back? What are your thoughts on this entire issue? Let us know in the comments section of the marketfeed app!