FTX Collapse: What Happened and Why? | Notum
Nov 28, 20226 min read
November 8 became a significant day. The native token of the largest FTX crypto exchange collapsed by 90%, followed by the king of the crypto market and all its courtiers. This article will analyze what caused the crash and its consequences for the market.
Sam Bankman-Fried (SBF). He is the founder and CEO of the FTX cryptocurrency exchange and the Alameda Research Foundation. Speaking of Sam’s influence, the Alameda Foundation has notable projects in its portfolio as 1inch, LIDO, Consensys, Anchor, and hundreds of others. In addition, Sam has a huge influence in the crypto community and even lobbies interests in Washington (more on this later). The FTX exchange quickly became one of the most popular trading platforms, leading to hostility between CZ (Changpeng Zhao, CEO of Binance) and SBF.
Exposition: Why Was the FTX Exchange Popular?
A few months before the collapse, FTX launched a series of very profitable products: a deposit product in US dollars with an interest rate of up to 8%, a deposit product in BTC with an interest rate of 5%, etc. Because of this, many users deposited tokens, and some even took bank loans to deposit.
The media estimated that 500,000 to 600,000 people in Taiwan suffered losses as a result of the collapse of FTX. People even took out loans from banks on FTX to get 8% APR.
Also, this situation has dramatically affected users from Singapore. For example, Singapore investors cannot use Binance, Bybit, and other well-known platforms, so they use FTX.
Moreover, the reputation of the FTX exchange was on par and somewhere even higher than that of Binance. SBF was the voice of the cryptocurrency community in the upper Washington offices and had a lot of weight in the eyes of the SEC and other US regulators. US Treasury Secretary Janet Yellen argued that FTX had great legitimacy in users’ eyes.
Rising Action: What Was the Catalyst for the Collapse?
On November 2, Coindesk published an investigation concerning two companies, FTX and Alameda Research, in which SBF was the prominent person since it is the owner of these companies. During this investigation, it was discovered that a large number of FTT tokens were found on the Alameda balance sheet.
According to the investigation, as of June 30, Alameda Research had $14.6 billion in assets: $3.66 billion were unlocked FTT tokens and $2.15 billion — FTT in collateral. Experts concluded that most of the net capital in the Alameda Research business is its own centrally controlled token. What does it mean? SBF created its own token, raised its price, and secured loans for its second company. And with the fall of the FTT token, loans, of course, became unsecured, which caused a liquidity crisis and formed a hole in the budget of more than $8 billion.
Conflict: SBF VS. CZ
Immediately after this investigation, Ben Zhou, CEO of Bybit, published that SBF violated the previously established agreement under which he was obliged to hold BIT tokens for three years. Ben Zhou stated that SBF sold his 100 million tokens and published a vote that obliges SBF to refute this information. Otherwise, the Bybit community has the right to dispose of FTT tokens stored on their balance as they please.
In addition, CZ published a series of tweets in which he wrote that they plan to sell their stake in FTT tokens for $600M within 1-2 months on the open market due to SBF's unethical actions. CZ planned to roll FTT and cause FTX and Alameda to have a liquidity crisis. In this case, Alameda loans will become unsecured, and creditors will withdraw their loans due to collateral depreciation.
Alameda Research CEO Carolyn Ellison publicly appealed to CZ to sell all FTT tokens for $22 to reduce the market impact on the FTT price, but CZ did not accept this offer.
CZ’s plan worked. Immediately after his statement, there was a massive outflow of funds from the FTX exchange. Collectively, in 24 hours, withdrawals amounted to more than $419M.
FTX, in turn, tried to fight and replenish the exchange through the USDC Circle. However, capital outflow continued, and FTX hot wallets continued to empty. By the evening of November 8, the FTT token had lost more than 70% of its value.
On the same evening, SBF approached CZ with a proposal for a strategic deal under which the FTX exchange was to be absorbed by Binance. CZ has published that after a thorough check, perhaps the deal will be carried out. Nevertheless, due to this check, it was decided to reject this offer.
Climax: Will the Funds Be Refunded?
As for the refund, this will not happen. FTX filed for bankruptcy under Chapter 11 of the US Federal Law, and Sam-Bankman Fried left the post of FTX CEO John J Ray III, a lawyer hired earlier by the Enron oil company during the scandalous bankruptcy and became the new head of the exchange.
In an interview with the New York Times, SBF repeatedly expressed regret for what happened and admitted that events could have developed more dramatically. Sam Bankman-Fried declined to give details of the crash, speculate on the topic of imprisonment and disclose his location, citing security concerns but agreed that he had expanded his business interests too quickly and missed signs of problems.
Resolution: What Faces SBF?
The U.S. Department of Justice has everything necessary to initiate criminal proceedings against the former FTX CEO Sam Bankman-Fried and other executives of the bankrupt exchange. In addition, the Bahamian authorities, the Manhattan District Attorney’s Office, and many other structures have already begun their investigations.
In a conversation with Fortune, a lawyer with many years of experience in the crypto industry referred to a federal law covering fraud using electronic means. The maximum prison sentence is 20 years.
Still, SBF has strong patrons, and rumors about this have been filling the info space for a long time, but will they stand up for him, or will they prefer to remain in the shadows, given the scale and scandalousness of the situation?
SBF spent millions on lobbying for his project and political donations. Moreover, he was the most prominent voice of the industry in Washington. The head of FTX took a proactive regulatory position, trying to significantly restrict the rights and freedoms of the developers of DeFi protocols, including by proposing to introduce licensing of front-ends of protocols so that users from the USA/other harbors with strict legislation could not use DeFi infrastructure. The winning side, of course, would be centralized exchanges, including FTX.
In addition to this bill, SBF financially supported the Democratic Party, which is why rumors appeared that the Coindesk investigation came out just before the elections for a reason. Therefore, the FTX bankruptcy deprived the US Democratic Party of a significant part of its funding. SBF was the second largest donor after George Soros.
The current showdowns of the owners of the largest crypto exchanges are amid a bear market and impending strict regulation by the United States. This is a severe blow to the crypto industry. People believed SBF. And, as it turned out, they believed in vain. Alameda Research and FTX invested very actively in all top blockchain projects. For example, FTX owns 10% of SOL tokens. And if FTX cannot pay its obligations, it will start selling off all its assets.
Someone will receive additional liquidity and be saved, and someone will be forced to declare bankruptcy simply. By the way, to reduce the further cascading negative impact of FTX, Binance is forming an industry recovery fund. They want to help projects that are strong in their fundamentals but are experiencing a liquidity crisis. But the volume of the fund is $100 million. Not enough to help all worthwhile startups.
The first contender for closure is a large cryptocurrency lender BlockFi. They are already preparing an application for potential Chapter 11 bankruptcy. This happened after the platform stopped withdrawing client funds and FTX declared bankruptcy.
Further, the Salt lending platform team declared it was suspending deposits and withdrawals because the FTX crash affected its business. They were also joined by the Australian crypto exchange Digital Surge.
Are There Any Victors?
The collapse of FTX will lead to significant structural changes in the markets and the crypto industry, namely, the rejection of centralization to decentralization. Decentralized exchanges (DEX), as well as non-custodial wallets, turned out to be the main beneficiaries of this crisis.
In confirmation of this, the token of the Trust Wallet TWT has grown by 84% in a week. Not without the help of the head of Binance, whose company owns this wallet.
Also, due to the collapse of FTX, Binance secured the title of the most reliable crypto exchange, which began to support projects affected by the fall of FTX and confirmed the assets available in its accounts.
The consequences of the FTX collapse will affect the crypto market for a long time. Many companies with a close relationship with FTX are forced to admit losses. Many market makers have lost substantial capital on FTX, which means there will be more market space for small-cap traders and more arbitrage opportunities between blockchains/exchanges.