What Happened to FTX?

Hot on the heels of one of the largest cryptocurrency seizures in history, the second-largest crypto exchange platform in the world, FTX, almost collapsed entirely after a report from Coindesk caused a fire sale that tanked the platform’s value.

But how did FTX go from dominant to destitute in a just a matter of days?

THE HISTORY OF FTX

FTX was originally founded in 2019 by Gary Wang and Sam Bankman-Fried, the founders of cryptocurrency trading firm Alameda Research. As a cryptocurrency exchange platform, FTX provided a central place for crypto sellers to connect with potential buyers, as well as loaning out funds for customers wishing to make larger trades.

By charging interest on these loans and taking a cut of each and every transaction conducted on their platform for themselves, FTX was able to raise more than $1.3 Billion in seed funding in just three short years. This level of success gave the company an enormous valuation of more than $32 Billion; making them one of the largest cryptocurrency exchanges in the world, second only to one of their former investors, Binance.

When the FTX exchange was launched, they also introduced their own cryptocurrency token to their market, known as FTT. To encourage their customers to buy this new coin, anyone who held a balance in FTT was given premium access to the platform as an incentive, allowing them to take advantage of much lower transaction fees and no-cost withdrawals.

As the coin began to pick up traction, FTX made the unusual decision to inflate demand by buying up large amounts of their own coin in a process known as burning - causing the value of FTT to skyrocket to a dramatic high.

Unbeknownst to many, Bankman-Fried’s previous company Alameda Research held a large amount of these tokens. Since Alameda had initially bought these tokens at a very low price, when FTX began burning the coin to inflate it’s worth, the value of their assets rose sharply. Thanks to the wonders of asset-based lending, Alameda was now able to borrow significantly more money from lenders by offering the high-value tokens as collateral.

Currently, the identity of these lenders is still unknown, though many have been speculating that FTX may have provided the loans themselves from their own coffers, from borrowed money or even from customer funds! Wherever this borrowed money may have come from, until last week, only this mysterious lender and Alameda knew how exactly may FTT tokens were backing up these loans.

COINDESK CAUSES CHAOS

On the 2nd of November, the crypto-focused news site CoinDesk reported that these tokens made up the majority of Alameda’s asset portfolio: “Bankman-Fried’s trading giant Alameda rests on a foundation largely made up of a coin that a sister company invented, not an independent asset like a fiat currency or another crypto.”

“As of June 30, the company’s assets amounted to $14.6 billion. Its single biggest asset: $3.66 billion of “unlocked FTT.” The third-largest entry on the assets side of the accounting ledger? A $2.16 billion pile of “FTT collateral. There are more FTX tokens among its $8 billion of liabilities: $292 million of “locked FTT.” (The liabilities are dominated by $7.4 billion of loans.)

The Coindesk article announced to the world that Alameda owed their evasive lenders more than $8 billion despite the lion’s share of their assets being held in an extremely volatile token that was owned and operated exclusively by FTX, their sister company.

As more people realised that both companies were tied up in the same precarious financial situation, the ensuing panic prompted a large number of FTX customers to begin withdrawing all of their funds from the exchange en masse. Though FTX had set aside several billion dollars to support any ongoing withdrawals, it wasn’t enough and the exchange was forced to stop all withdrawals as a result.

HOW DOES BINANCE FIT IN?

When the FTX exchange was launched in 2019, a significant portion of the initial investment came from Chanpeng Zhao, the CEO of Binance. Despite being direct competitors, the two companies worked closely together until 2021 when Bankman-Fried offered to buy Zhao’s stake in FTX. The details of why the two companies parted ways have never been revealed publicly, though it was speculated at the time that Bankman-Fried’s decision was prompted by pending regulatory action on Binance. Zhao was given $2.1 billion for his shares in FTX, with the money being paid in the form of FTT and BUSD (Binance's stablecoin).

Unfortunately, relations between the two CEO’s soured in the year that followed, with both trading insults back and forth via social media. This war of words escalated when Alameda’s risky balance sheet was revealed by Coindesk and Zhao published a statement on twitter confirming Binance’s intention to liquidate any of the FTT holding they had left.

While the exact amount of FTT that Binance planned to sell wasn’t known, after Alameda’s CEO Caroline Ellison offered to purchase the entire quantity, other investors were worried that selling such a large amount at once would collapse the token’s market entirely. The resulting fire sale caused the price of FTT to drop from £25 to less than £3.50 per token, leading to an incredible run on the exchange that saw more than $6 billion withdrawn in less than 72 hours.

When it seemed almost inevitable that FTX would collapse, they were forced to reach out to their former investor for help. On the 8th of November, Zhao confirmed on Twitter that Binance had “signed a non-binding [Letter Of Intent], intending to fully acquire FTX.com and help cover the liquidity crunch” pending due diligence. The deal would have seen Binance fully acquire FTX for providing the necessary funds required to resolve their liquidity crisis.

Though many of the raptured observers hoped this offer would stem the bleeding, it was not to be. Less than 24 hours later, on Wednesday the 9th of November, Binance confirmed on Twitter they were backing out of the deal and would not be acquiring FTX:

"As a result of corporate due diligence, as well as the latest news reports regarding mishandled customer funds and alleged US agency investigations, we have decided that we will not pursue the potential acquisition of FTX. In the beginning, our hope was to be able to support FTX’s customers to provide liquidity, but the issues are beyond our control or ability to help."

As expected, this statement has spooked the small amount of FTT investors that were left. In a note to it’s partners, the venture capital firm Sequoia announced it had written down its $150m FTX investment to nothing:

“In recent days, a liquidity crunch has created a solvency risk for FTX. The full nature and extent of this risk is not known at this time. Based on our current understanding, we are marking our investment down to $0.”

The exchange’s other high profile investors will also lose the majority of their investments. The Ontario Teachers’ Pension Plan is set to lose the $400m they invested into the platform, while NFL Legend Tom Brady and his ex-wife supermodel Giselle Bündchen will have their collective fortune caught in the crossfire thanks to the equity stake in the company they purchased last year before filing for divorce. While details of the investment were not disclosed to the public, the deal saw both Brady and Bündchen given high-profile ambassador roles within the company.

THE REACTION

Like much of the industry, our co-founder and CEO Aidan Larkin has been glued to the astonishing and tragic story that has been unfolding over the last few days:

“As a startup founder and someone who’s going through the process of capital raising myself, I’m still perplexed at how this could’ve happened, at this scale, in such a short period of time.”

“Some of world's largest and most respected venture capitalist funds (with incredibly talented teams) who normally perform weeks of enhanced due diligence, invested hundreds of millions of dollars in FTX. One even put an article out last month proclaiming we should share in the founder’s “Saviour complex”.

"I’ve met so many amazing startup founders with incredible ideas who struggle to get a VC to write a £100k cheque (quoting their internal DD processes) yet FTX got almost a billion dollars of investment in the last 2 years. Everyone affected will be understandably asking “how the hell did this happen?”

“We deal with victims of fraud and those that have lost digital assets and they themselves are tragedies - but to see potentially billions wiped out, that affects entire sectors, costs jobs and loses peoples investment, in something that should’ve and could’ve been picked up just seems cruel.”

“No doubt the open-air autopsy will continue for some time as more facts emerge and, fingers crossed, the ripple effect is contained.”

He went on to discuss the complexities involved when large crypto companies like FTX choose to register themselves in foreign countries in order to avoid local laws:

“CeFi Companies can choose to register overseas to avoid regulation but look, act and feel like they are ‘local’ through their celebrity endorsements, sports and events sponsorships and talking at local conferences, participating in local politics etc. But when things don’t fit with their ethos, their business model or is insisted upon by local laws and regulation they can simply sidestep and swerve citing ‘we’re not a [insert local jurisdiction] company.’ Do you think the average US crypto investor knew FTX was based in the Bahamas?”

“I can only imagine being a creditor (or potential litigant) now in this mess trying to figure out what asset recovery remedies I have available and how I start an action against an overseas company. Spoiler alert, potentially prohibitively expensive and drawn out. Basically, you’re not getting anything back in most cases.”

“The game is not fair for users. Not just FTX - all the exchanges that have their cake and eat it - they know who they are. You wouldn’t be allowed to open an international restaurant, rake in large profits but then not comply with local food safety laws or pay minimum wage to staff in that country because you’re “not from there”. You’d be shut down.”

It seems hypocritical that many companies in this space present as safe and centralised when it suits but turn into Satoshi and proclaim “decentralisation’ when it’s convenient. This is just my opinion, but if you make profits in a country, you should adhere to the local standards in terms of basic user protections, business conduct and customer services.”

Update:

On the 10th of November, after FTX announced they had unfrozen withdrawals for funds based in the Bahamas, rumours began flying that this restriction only allowed employees to cash out their funds. Soon after, all of FTX's assets were frozen by the Securities Commission of The Bahamas. They appointed a provisional liquidator and suspended the powers of the director's board, preventing any assets from being removed from the company without the prior approval of the liquidator.

On the 11th of November, a press release issued by FTX on Twitter confirmed that Alameda Research, FTX International, its American subsidiary FTX US and approximately 130 additional companies affiliated with the FTX Group have voluntarily filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code in the District of Delaware.

The statement also confirmed that CEO Sam Bankman-Fried resigned from his position effective immediately. He will be replaced by John J Ray III, the lawyer famous for overseeing the liquidation of energy giant Enron after its collapse in 2001.

New reports from the CoinTelegraph imply that Bankman-Fried is planning to flee the country with Alameda Research CEO Caroline Ellison and two of FTX's other executives, Gary Wang and Nishad Singh. The article's source claimed the group was planning to head to Dubai due to its lack of extradition with the United States.

As the fallout from this collapse begins to settle, knock-on effects are being seen across the industry. Cryptocurrency lender BlockFi is one of several crypto companies that had previously accepted financial aid from FTX. They were forced to halt withdrawals and limit activity on their own site amidst the confusion and are now preparing for a round of lay-offs and a potential bankruptcy filing themselves.

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