A few days after the failure of the FTX crypto exchange, it is possible to begin a comprehensive and in-depth account of what happened.
FTX was by far one of the leading crypto exchanges in the world. It had grown very quickly, since it was only founded in 2019, and it had two different platforms.
The international version was on FTX.com, while FTX.US was the platform for the US market.
Indeed, it was a US exchange, founded by US citizens in Berkeley, California.
Its key figure was that of co-founder and CEO Sam Bankman-Fried (SBF), who himself had already co-founded in 2017 Alameda Research, also in Berkeley.
However, FTX’s headquarters had then been moved to Nassau, Bahamas, where the headquarters was also established from where to physically direct all operations. The company’s entire operating board, consisting of a dozen other millennials roughly SBF’s age (class of 1992), had moved to Nassau.
The underlying problem with the FTX crypto exchange: what happened?
Although FTX was highly regarded as a crypto exchange because of its technical features, and its operations, it had a very unsound financial foundation.
In fact, unfortunately, the board had decided to use the funds deposited by their clients to finance their company’s expenses and investments. This meant that they no longer had enough reserves in their cash to cover the full total value of the funds that their clients kept in the exchange’s wallets.
Moreover, among the expenses and investments financed in this way were several that were non-interest-bearing, or even loss-generating. For example, the trading and investment subsidiary Alameda Research had obtained a lot of funds from FTX, presumably drawn from customer deposits, and some of these had been lost in unsuccessful market transactions.
It should not be forgotten that during last year’s bull run it was not so difficult to make money from trading, yet in contrast this year it was rather easy to go into a loss.
The final collapse of the FTX crypto exchange: here’s what happened?
A couple of weeks ago news started circulating that there was a hole in Alameda Research’s balance sheet. Later it was also discovered that the company had been using FTT tokens created by FTX as collateral to obtain multi-million dollar loans.
The collapse started precisely from the problems related to the FTT token and its market value.
Until 5 November 2022, its price was about $25, but when Binance co-founder and CEO Changpeng CZ Zhao said they wanted to sell all the FTT they had on their balance sheet, the price started to fall.
At that point, the then-CEO of Alameda Research stepped in and said they were willing to buy them at $22.
In fact, until 7 November the price did not fall below this threshold.
However, on 8 November, rumors began to circulate about a possible temporary suspension of withdrawals from FTX.
In those days, withdrawal requests on the exchange had increased quite a bit, and we now know that the company did not have enough funds on hand to satisfy them all.
When it was discovered that no more withdrawal requests were being made, the situation imploded. The price of the FTT token on 8 November collapsed to $4, and the following day the company had to officially suspend withdrawals indefinitely.
Although Binance at first offered to take over the company to try to save the exchange, it was later forced to give up because of the huge budget hole that seemed impossible to fill.
At that point, bankruptcy was almost a foregone conclusion, so much so that a few days later the company filed for Chapter 11 under US bankruptcy law, after authorities in the Bahamas had effectively seized everything.
SBF resigned as CEO, and now the company is being run by a celebrated liquidator, John Ray III, well known for his handling of the colossal Enron bankruptcy.
The current situation
The situation at present is complex and in flux.
The exchange is down, and may even be closed forever. Much will depend on the eventual purchase of the assets by perhaps some competitor.
In the Bahamas, the process is underway to liquidate the assets of the FTX group, including those of Alameda Research, run by John Ray III.
In fact, another bankruptcy proceeding would also be underway in the US, such that the company itself hopes to be able to unwind from Bahamian authorities and operate under US regulations.
It must be said that FTX operated primarily just in the US, and the vast majority of creditors are US-based. There was only the headquarters in the Bahamas, but since there are also valuable assets there, especially real estate, it is unlikely that the Bahamian authorities would choose to let the US authorities do so.
Currently, it appears that the FTX group’s assets located in the Bahamas are under the control of the Bahamian authorities.
This situation greatly complicates the liquidation process, so much so that it seems possible that it will be a long and complicated process.
Users who had funds deposited with FTX can no longer withdraw them, and will have to wait for the liquidator to find some funds so that they can at least return some of them. It is not even clear yet how much they might receive, although it seems impossible that they could receive back 100% of what they had on deposit with the exchange.
The impact on the crypto ecosystem
For now, the impact of the FTX implosion on the crypto markets has been violent but not catastrophic.
As far as is known, other than the sharp drop in cryptocurrency prices, only a handful of other crypto companies went under as a result of this event.
Many claim that they expected Bitcoin’s price to drop to $13,000 or even $10,000 following such a major implosion, but it actually stopped at $15,500 and then rebounded to around $16,500.
A recent Kaiko analysis looked at the impact on DeFi, centralized exchanges, crypto market liquidity, and derivatives markets.
After analyzing these aspects, the Kaiko team concluded that once this scandal is behind us, the clear winner will be:
“a healthier foundation on which we can build upon, minus the excess leverage and fraudulent actors.”
Cold wallets and decentralized exchanges should emerge as big winners from this affair, but investors unfortunately tend to have short memories, and repeat the exact same mistakes over and over again over time.
“Hopefully this fiasco serves as a learning exercise for the entire ecosystem, an over-reliance on centralized entities is just recreating the traditional financial system and offers nothing unique.”
The lesson that should be learned therefore is that decentralization and regulation should be prioritized. They mention, for example, DeFi platforms such as Uniswap and Aave, which continued to function flawlessly even during the two major crypto market crises of 2022.
On the other hand, it has become quite clear that more regulation is needed with regard to centralized entities, not least because large centralized exchanges serve as gateways to crypto markets for the masses, thus being useful and necessary. However, this is precisely why the masses should be protected from crises like this, and only once these correctives are put in place can we really begin to think about creating a truly new financial system.