FTX Meltdown, Explained
By: Michael Flannelly · November 16, 2022 · Reading Time: 7 minutes
FTX, one of the world’s largest cryptocurrency exchanges, filed for Chapter 11 bankruptcy protection on Friday, and CEO Sam Bankman-Fried resigned. The exchange crashed amid a liquidity crunch and allegations of misused funds, followed by a large volume of customer withdrawals. A bailout by Binance was possible, but the deal fell through because of FTX’s troubled finances.
The rapid downfall of FTX has shocked the financial industry, as the company was a leading player in crypto. FTX’s crash could have wide-reaching implications throughout the crypto market because cryptocurrencies and exchanges with exposure to FTX could face financial troubles in the weeks and months ahead. The details of the fall of FTX are still being revealed, but here is a brief overview of the FTX collapse.
What Is FTX?
FTX is a cryptocurrency exchange, meaning that it allows customers to store and trade cryptocurrencies with their fiat currency or to trade different cryptocurrencies for one another on its platform. Sam Bankman-Fried, popularly known as SBF, founded FTX in 2019 and operated the company in the Bahamas. Notably, Bankman-Fried also founded and operated a crypto trading firm called Alameda Research.
Before filing for bankruptcy protection, FTX was one of the world’s most prominent crypto exchanges, along with Binance, Coinbase, Kraken, KuCoin, and Bitfinex.
Though it offered spot market trading of cryptocurrencies, FTX specialized in crypto derivatives and leverage products, such as options, futures, and leverage tokens.
Since its founding, FTX has also been one of the most visible crypto companies. It is known for its Super Bowl ads featuring NFL star Tom Brady and comedian Larry David, for purchasing the naming rights for the Miami Heat’s basketball arena in Miami-Dade County, and its partnership with Major League Baseball to place the FTX logo on the uniforms of umpires.
FTX’s fall from a significant player in the crypto industry to bankruptcy seemed to occur quickly. The heart of the matter surrounds the relationship between FTX and Alameda Research. FTX and Alameda were supposed to be separate businesses, but they reportedly had close financial ties that raised alarms.
According to a November 2 report by CoinDesk, FTX’s partner firm Alameda Research had a troubled balance sheet, including holding a significant portion of its assets in FTX’s native token, FTT. This report caused some investors to question the relationship between FTX and Alameda and whether the money held in FTX was safe.
A few days later, on November 6, Changpeng Zhao, CEO of the world’s largest crypto exchange Binance, tweeted that the firm planned to sell its holdings of FTT supposedly because of the blurred relationship between FTX and Alameda.
This announcement spurred a wave of selling of FTT, causing the price of FTT to crash. Additionally, FTX customers withdrew approximately $6 billion from the exchange over three days, suspecting that the company didn’t have the liquidity to stay afloat. In response, FTX halted customer withdrawals.
On November 8, Zhao announced Binance had entered into a non-binding agreement to purchase FTX, a move to bail out the troubled crypto exchange facing a liquidity crisis. However, Zhao backed out of the deal after Binance looked at FTX’s finances. Zhao cited “mishandled customer funds and US agency investigations” as reasons to back out of the agreement.
The sudden collapse of the deal essentially forced FTX and Alameda Research to file for bankruptcy. The company had an $8 billion shortfall without an investor to bail the company out.
Who Is Affected?
FTX has many creditors; according to one report, the company owes money to more than one million individuals and organizations. During bankruptcy proceedings, the creditors would be the first to receive whatever assets a bankruptcy judge says is appropriate to distribute.
FTX investors, which include several venture capital firms and institutional investors, would be next in line to recoup funds during bankruptcy proceedings. Several institutional investors are set to lose their investments in FTX, notably Sequoia Capital, which wrote down its equity in FTX from $210 million to $0.
For customers who use FTX and need access to their holdings, it could be years until they can get anything back from FTX. And even if customers are lucky enough to recover some funds, it is unclear how much they would get back.
To make matters worse, at least $1 billion of client funds are missing at FTX, and a hack drained more than $600 million from wallets after the company declared bankruptcy.
The failure of FTX has also caused issues with other companies in the crypto industry. BlockFi, a crypto lender with ties to FTX, paused customer withdrawals last week and will likely file for bankruptcy.
Additionally, the lending arm of Genesis Global Trading, a crypto investment bank, announced that it was suspending redemptions and new loan originations because of the crypto market volatility in the wake of the FTX bankruptcy. The turmoil at Genesis spilled out to other crypto firms, including crypto exchange Gemini Trust Company, which paused withdrawals on its lending platform because of a liquidity crunch.
What Happens Next?
Bankman-Fried and FTX are under investigation by the Department of Justice and the Securities and Exchange Commission. The investigations likely center on the reports that FTX may have used customers’ deposits to fund bets at Alameda Research.
The blow up of a company that was once valued at $32 billion is also likely to cause lawmakers to look closer at regulating the industry.
Bankman-Fried has been a vocal advocate for increased government regulation of the crypto industry, lobbying on behalf of the Digital Commodities Consumer Protection Act (DCCPA) . It’s unclear whether lawmakers will move forward with the bill as written or if they’ll reevaluate the legislation in the wake of the FTX blowup.
For many crypto enthusiasts, government regulation is contrary to the original idea of cryptocurrency and Bitcoin, which was proposed as a decentralized way of running a financial system. Additionally, the fall of a significant centralized exchange like FTX highlights the differences between centralized and decentralized exchanges. Opponents of centralized crypto exchanges point to the fall of FTX to show how the security of decentralized exchanges is the only way to move forward with crypto.
Additionally, the issues facing investors who stored their holdings with FTX reinforce the idea that investors need to hold their crypto in their own crypto wallets if they want to make sure they always have access to their money.
The details of FTX’s bankruptcy are still coming out, so it’s unclear what the true fallout will be. FTX’s collapse is just another dark moment in the crypto market during 2022.
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