What Happened to FTX?

In crypto, nothing is too big to fail. Three Arrows Capital, BlockFi, Terra Luna, Celsius, Voyager, and now FTX is filing for bankruptcy.

Chances are you’ve heard something about the rumblings of FTX, Alameda Research, or Sam Bankman-Fried in the last week. It’s the biggest story in crypto and likely the greater financial markets (even amid Elon’s Twitter acquisition and FAANG offloading loads of employees).

The entire crypto market is down roughly 20% in the last week, mostly because of FTX. So what’s happening with FTX, and why is it important?

A Brief Background of The Events

I want to preface first by saying every day more info is coming to light. Regulators still need to determine whether or not fraud is at play. And it’s obvious we don’t know the full story yet. But this is a brief synopsis of what happened up to this point.

If you’re unfamiliar, FTX is a crypto exchange founded by Sam Bankman-Fried (or SBF as he’s commonly known). Two years prior, SBF started Alameda Research which is a quantitative trading firm focused on digital assets.

FTX is huge. You’ve likely seen its logo on MLB umpire uniforms or all over the Miami Heat arena. Up until last week, they handled roughly 5-7% of all crypto transactions during 2022. They were once valued at $32B, counting investments from the likes of Sequoia, Softbank, Tiger Global, and Blackrock, among others.

The brief summary of the situation is that Binance founder, Changpeng “CZ” Zhao, raised concerns about the financial instability of FTX (due to the intermingling between FTX and Alameda), which triggered a wave of customer withdrawals in the billions of dollars. But FTX lacked sufficient funds to pay sellers and imposed a halt on withdrawals altogether. The estimated $8 billion shortfall led FTX to seek a bailout from Wall Street and Binance, which was unsuccessful. Now, FTX is filing for bankruptcy.

The longer summary involves a much more detailed relationship battle between CZ and SBF. That summary is as follows (edited from Vox’s timeline):

• Binance invested in FTX in 2019, acquiring a 20% stake in the company. Last year (2021), Binance exited this position, receiving a $2.1 billion payout in BUSD (Binance’s USD stablecoin) and FTT tokens (FTX’s token). Flash forward.
• On November 2, 2022, Ian Allison at CoinDesk published a leak revealing that much of Alameda’s $14.6 billion in assets were parked in the FTT digital token. (Effectively, FTX created this token and set the price, which Alameda then purchased a large amount of and used as collateral on other loans.
• The CoinDesk leak and revelations that Alameda had so much money in FTT prompted questions about Alameda’s financial health and concerns that a fall in the token’s value could cause real problems for both the trading firm and FTX.
• Days later, on November 6, Zhao said on Twitter that Binance would be liquidating its FTT holdings.
• Alameda’s CEO, Caroline Ellison, insisted Alameda was fine and offered to buy Binance’s FTT at $22 a token, around where it was at the time.
• Investors didn’t think everything was fine and began selling in swaths, driving the price of FTT down to $5. This created a chain reaction of people trying to liquidate their crypto on FTX and withdrawal their funds.
• By November 8, 2022, FTX was in a liquidity crunch, meaning it ran out of money. They halted all withdrawals.
• FTX sought $9.4 billion in rescue funds first from Wall Street and then from Binance.
• Binance signed a non-binding Letter of Intent to purchase FTX pending due diligence. Ultimately, they backed out of the deal on November 9, 2022.
• On November 11, 2022, FTX filed for bankruptcy.

At the moment, no one can confidently state the root of the problem.

This could be a story of FTX over-leveraging its assets. It could be a story of using FTX funds to prop up Alameda losses, as Reuters reported that SBF had transferred at least $4 billion in funds to Alameda, a portion of which were customer deposits. Or it could be a story of competing crypto billionaires (CZ vs. SBF), with Binance finding a weakness in a competitor and using it to squash them.

More than likely, it’s a combination of all three.

For further information, Vox has in-depth coverage of this story. Reuters spoke about how the relationship between Binance and FTX started and soured over time. And if you’re more of a video person, Coin Bureau is doing a great job covering this in real time.

My Take

First and foremost, this is just another reminder that self-custody is the only way to stay safe in crypto. “Not your keys, not your crypto.” But the problem is that self-custody is hard. I don’t even hold my crypto in cold storage because it’s so much easier to keep your crypto on an exchange.

Becoming completely in control of your crypto through cold storage options like Ledger wallets still comes with risks and liabilities. Not to mention, it can be quite complex to manage your keys properly.

“People park money with these different entities and then trust these entities with having control over the funds, and on the back end, these entities are doing frankly irresponsible things with customers’ deposits,” [Alex] Svanevik [CEO of blockchain analytics platform Nansen] said. – Vox

So much of crypto relies on collective confidence. It’s the belief that it can be a better financial instrument for the future. So when that belief wanes even just a little, the consequences are outsized.

Those who we are supposed to trust most aren’t taking that trust seriously.

The real tragedy is that Sam Bankman-Fried was a sort of crypto translator for policymakers in DC. He was working to advance the regulation without sacrificing the integrity of the blockchain.

“[FTX] was so intent on legitimizing themselves and getting in the DC policy orbit,” Carter said. “The bill that Sam was working on is dead in the water, crypto loses some of its luster among these politicians that FTX was cozying up to,” Carter said. “There’s a renewed sense that this industry is just totally unregulated and run by crooks and fraudsters.”

“SBF was just spending a lot of time in DC schmoozing with lawmakers and giving recommendations on possible crypto regulation, acting as the ‘adult in the room’ and the liaison from the crypto industry,” White said. “If I was those legislators, I would be questioning a lot of his suggestions.” – Vox

The losses here are more than financial. We may have squandered the little bit of trust policymakers had in crypto’s future. And the problem is that crypto is the conceptual umbrella for all blockchain innovation. I worry that this sets us more than a decade back on all fronts for blockchain decentralization efforts.

I don’t see any bright sunny days in crypto ahead. And that’s my honest take.