Binance Takeover of FTX Is a Huge Red Flag for Crypto

The digital assets market had settled into relative quiet after the collapse of major industry players including TerraUSD, Celsius Network, and

Voyager Digital

over the summer. If any company looked strong after that crisis—crypto prices fell by about two-thirds from their November highs—it was Bahamas-based FTX, which is led by Sam Bankman-Fried and saved several crypto projects with big last-minute investments.

But in less than a week, FTX has gone from being dubbed crypto’s “white knight” to facing its own crisis of confidence and run on assets. The crisis peaked on Tuesday, when Bankman-Fried and Changpeng Zhao, CEO of competitor Binance, jointly said that Binance had signed a letter of intent to acquire the exchange.

The market apparently avoided another disaster, but crypto investors remain wary.

Bitcoin

prices spiked when the deal was announced but were down about 10.5% on Tuesday to $18,400.

But even if crypto has dodged a bullet in the near term, that the industry so quickly moved back to the edge of disaster should give pause to any investor considering jumping into digital tokens. The same is true for companies like Coinbase Global (ticker:

COIN)
,
whose fates are tied to crypto assets.

The first big takeaway from the whirlwind week is just how fragile the crypto ecosystem remains and how subject it is to runs.

FTX was long considered one of the stronger players in crypto. After this summer’s failures, Bankman-Fried’s huge investments in the industry led some to compare him to financier

J.P. Morgan

who helped orchestrate a bailout during the 1907 banking crisis.

However, that strength collapsed in the past week. A report last Wednesday from the news site CoinDesk said that the balance sheet of market maker Alameda Research, a sister firm also founded by Bankman-Fried, was largely comprised of FTT, a token that FTX issued. That such a large portion of Alameda could be tied up in a relatively illiquid token concerned some investors, who thought it could make the firm vulnerable to a liquidity crisis. 

Those concerns became self-fulfilling. Binance’s Zhao likely worsened the situation on Sunday, saying that Binance would unload its substantial holdings of FTT, citing “recent revelations that have came (sic) to light.”

Alameda CEO Caroline Ellison sought to reassure the market, saying that the balance sheet seen by CoinDesk showed only a portion of the firm’s assets. Similarly, Bankman-Fried said on Twitter that his company was being attacked by false rumors and that “FTX is fine. Assets are fine.”

But that wasn’t enough. FTT’s price dropped more than 30% through Tuesday morning. In the past two days, customers withdrew about $672 million in crypto assets from FTX, according to calculations by Needham and DuneAnalytics.

In his tweets announcing the acquisition, Zhao said FTX faced a “significant liquidity crunch” and had asked his company for help. He said Binance “has the discretion to pull out from the deal at any time.”

An FTX spokesperson declined to comment. A Binance spokesperson didn’t immediately have a comment.

That FTX could fall apart within days shows how vulnerable the industry is as a whole to customer runs, and that the number of potential “saviors” for companies in the industry keeps getting smaller, some industry critics say.

“A crypto death spiral can begin in an instant and seems extraordinarily imminent,” said John Reed Stark, a former enforcement attorney with the Securities and Exchange Commission.

FTX’s quick downfall is also sure to get attention in Washington, D.C., where Bankman-Fried has been one of the most prominent industry representatives. He has testified in Congress multiple times.

Bankman-Fried said in a tweet on Tuesday that FTX US, the U.S.-based affiliate of FTX, isn’t “currently impacted” by the Binance deal. But the debacle will still likely strengthen calls from lawmakers and agencies to more heavily regulate crypto firms, policy analysts say.

“Lawmakers and regulators will see this as validation of their belief that more transparency is needed,” as well as more investor protections, said Beacon Policy Advisors analyst Owen Tedford. Regulators could also require firewalls between related businesses like FTX and Alameda, he said.

Some stock analysts said FTX’s weakness could offer a short-term benefit for trading platforms like Coinbase, which might gain business if U.S. investors decide to leave FTX US. But the overall fragility of the industry brought into focus by FTX’s troubles will likely hurt more than that helps.

Retail investors “may look to pull assets into private wallets amid these ongoing centralized exchange issues” even if FTX’s problems give Coinbase new customers, said Needham analyst John Todaro, who most recently had a Buy rating on the stock.

Coinbase stock plummeted 13% to $49.58 as of midday Tuesday.

A Coinbase spokesperson referred a request for comment to a Tuesday blog post in which Coinbase Chief Financial Officer Alesia Haas said Coinbase customers “are not in any direct danger of liquidity or credit risk.” Hass wrote, “There can’t be a ‘run on the bank’” at Coinbase, saying that it held customer assets on a one-for-one basis.

There isn’t as much overlap between the customer bases of FTX and Coinbase as one might think, said Mizuho analyst Dan Dolev, who most recently had a Neutral rating on Coinbase. While FTX caters to “pro-sumer” investors who trade a lot and use advanced services, Coinbase’s core is regular retail clients.

“The long-term implication is very bad. It shows you how fragile these crypto exchanges are,” Dolev said. “One run on the bank just kills them.”

While J.P. Morgan was a hero in 1907, the long-term implication of that banking crisis was the creation of the Federal Reserve and a more robust government regime to protect against panics. Crypto regulation might be coming next year, but until then, investors shouldn’t count on private bailouts.

Even the white knights are dying.

Write to Joe Light at [email protected]