FTX’s stunning collapse: what really happened

The scenario of what transpired in this case seems somewhat of a classic: one rival, Binance, saw a chance to try to eliminate another, FTX, and took it. One definitely won and one clearly lost in this economic battle between the two founders of cryptocurrency exchanges.

In reality, however the story is much more convoluted. It turns out that the main reason why Binance was able to do that were the big mistakes FTX did and the ponzi-style gambles it did with investors’ money.

Binance was established in 2017 and has since grown to become the largest cryptocurrency exchange in the world by Changpeng Zhao, a Canadian citizen of Chinese descent. In 2017, Bankman-Fried established the quantitative trading company Alameda Research, which specialized in digital assets. In 2019, he established the FTX exchange. Bankman-Fried stopped overseeing Alameda’s daily operations, although the two organizations remained closely linked.

The narrative up until very recently was that FTX and Alameda were in reasonable condition. FTX was valued at $32 billion, its FTX US business, which is smaller and compliant with US laws and regulations, was valued at $8 billion, and Alameda had earned $1 billion in profits in a single year. Since then, everything have rapidly fallen apart.

FTX’s FTT digital coin was used to store a significant portion of Alameda’s $14.6 billion in assets, according to a leak published by Ian Allison at CoinDesk on November 2.  FTT token owners receive a discount on FTX trading fees in addition to other benefits. The tokens, however, were somewhat fictitious and their worth was generated from the belief that there was value, similar to many other crypto tokens. Nic Carter, partner at startup funding firm Castle Island Ventures, said that “they created this token out of thin air, gave it some value, and then Alameda utilized it as collateral.”

Tracy Alloway of Bloomberg gave the example of a Beanie Baby, which you might purchase for $5 and then sell for $20 after creating a price guide indicating his market value. In this instance, FTX was producing the Beanie Baby itself by giving away the FTT token and then purchasing a portion of the tokens for whatever price was desired. It was then able to claim that the token was worth that sum and do business with it, for as by utilizing it as loan collateral.

Questions regarding Alameda’s financial stability and worries that a decline in the token’s value could result in serious issues for the trading firm and FTX were raised in response to the CoinDesk breach and the news that it had such a large amount of money in FTT.

Zhao said on Twitter a few days later, on November 6, that Binance will be selling its FTT assets, which it acquired after selling its position in FTX last year. (Binance invested in FTX, with Zhao reportedly purchasing a 20% share in the exchange not long after it opened.) He said that at the time, Binance received $2 billion in tokens, some of which were the FTX token, but that they were now dumping the FTT because of “recent discoveries that have come to light.”

As part of Binance’s exit from FTX equity last year, Binance received roughly $2.1 billion USD equivalent in cash (BUSD and FTT). Due to recent revelations that have came to light, we have decided to liquidate any remaining FTT on our books. 1/4

— CZ 🔶 Binance (@cz_binance) November 6, 2022

From there, everything sort of went in circles. Caroline Ellison, CEO of Alameda, said Alameda was fine and offered to purchase FTT from Binance for $22 per token, or around where it was at the time. FTX’s assets, according to Bankman-Fried, were fine. Investors did not have faith in them.

Due to frantic selling by holders and clients wanting to withdraw their money from FTX completely, the value of FTT fell to below $5. The exchange experienced a liquidity problem, which caused it to run out of funds. By Tuesday, November 8, it was obvious that this was all just some sort of “this is fine” meme, but the building and everyone within had already been destroyed by fire. FTX and Binance have agreed to a “strategic deal,” according to Bankman-Fried (he claims FTX US is still fine). Zhao stated that subject to due diligence, Binance had signed a non-binding letter of intent to purchase FTX. The non-binding clause turned out to be crucial because there were soon rumors that Binance might withdraw, which it subsequently did.

Change of mind

In a series of tweets, Binance announced that it would not pursue the possible acquisition of FTX.com. “As a consequence of corporate due diligence, as well as the newest news allegations about mishandled client cash and suspected US agency investigations”, the company said. “At first, we hoped to be able to assist FTX’s clients in providing liquidity, however the problems are beyond our control or capacity to assist.”

In a letter to investors on Tuesday, including SoftBank, Tiger Global, and the Ontario Teachers’ Pension Plan, Bankman-Fried apologized for being difficult to reach during the drama and stated that the “details” of the Binance deal were still being worked out. He also noted that the Binance deal was non-binding and would ultimately soon become obsolete. The protection of customers and the industry has always been our first focus, he stated. An inquiry from Vox for comment received no response from Bankman-Fried.

Before Bankman-Fried appealed for assistance on November 9, Zhao tweeted a note he’d written to the Binance team, stating that he “did not master plan this or anything similar to it” and that he had “very little understanding of the internal status of things at FTX.” (Sure, he had a suspicion otherwise from his tweet earlier in the week.) On November 8, Semafor claimed that FTX had attempted to secure a bailout from Wall Street and Silicon Valley investors before turning to Binance; several of FTX’s investors apparently claim they were taken by surprise by the arrangement.

“Binance noticed something at FTX, they knew there was a weakness, we don’t know what it was yet, and they knew they could take them out, which they did. It was a truly brilliant strategic maneuver”, according to Carter. It is undoubtedly a difficult pill to chew for Sam to sell to his actual largest rival, so obviously something went horribly wrong.

Zhao and Bankman-Fried had been at odds for some time; the former didn’t like the latter’s policy outreach in the US, but this was the first time it had erupted in such a public fashion. Although the prospective agreement suggested a detente, it currently seems that hostilities continue. Bankman-Fried tweeted on Thursday, “At some point I might have more to say on a certain sparring buddy, so to speak,” in an apparent reference to Zhao. “However, there are glass houses. All I’ll say for the time being is, ‘Well played; you won.’ “

There is much more to discover about why FTX and Alameda were so vulnerable during the ensuing days, weeks, and months. Bankman-Fried informed investors on a call with investors on Wednesday that he needed $8 billion to meet all of the demands clients were making to withdraw their money. This information was originally published by the Wall Street Journal. Sequoia Capital has reduced its investment in FTX to zero dollars, indicating that it believes it to be worthless.

There has been a lot of speculation about what transpired since things started to go apart in early November. Observers had concerns that FTX wasn’t fully solvent, wasn’t appropriately supporting client deposits, or was trading with customer deposits, which they had brought up in contact with me. According to Reuters, Bankman-Fried moved at least $4 billion in money, including some customer accounts, to Alameda to support the company when it suffered losses. He reportedly didn’t inform other FTX executives about it because he was concerned it might leak.

The long and short of it is that when you give your money to a crypto exchange, you are supposed to be able to retrieve it back when you want to. Accordingly, “a client fund needs to be segregated, whether that’s cash or that’s crypto,” according to Douglas Borthwick, chief business officer at INX, a crypto trading platform.

Additionally, if the exchange lends or trades client cash rather than keeping onto them (as Matt Levine of Bloomberg notes, banks, for instance, lend customer deposits), it runs the danger of not having the funds to return to clients, especially if they request the funds all at once. Bankman-Fried asserted in a tweet on Thursday that FTX had “total market value of assets/collateral larger than client deposits,” but it is not the same as liquidity; he is stating that FTX still has that customer money, they can just not pull it out of the things it is in.

Damage to the entire crypto sector

In reference to other projects in the space around areas like decentralized finance and public works, Scott Moore, the co-founder of Gitcoin, a project for building and funding Web3 open source infrastructure, said: “In a very real way, SBF did this to himself, and its impacts will be felt across the ecosystem even by those trying to make a real difference.”

Despite admitting that he is still “fleshing out every aspect” of what transpired, Bankman-Fried provided some explanations on Thursday. He also stated that he believes he “fucked up twice,” including “bad internal categorization of bank-related accounts.” Numerous people also questioned the source of the initial leak to CoinDesk.

Whatever the situation, it’s obvious that FTX wasn’t being as open about what it was doing with assets and deposits as it ought to have been, according to Alex Svanevik, CEO of blockchain analytics platform Nansen. “At some point, because of the situation with the FTT price [falling] and the information that Alameda had these positions that were collateralized with the FTT token and all of these things, it translated to a bank run on FTX,” Svanevik said, using the slang term for when a sizable number of clients withdraw their funds from a financial institution out of solvency concerns. “The great irony is that of course SBF was the guy in Washington attempting to interact with regulators, and it appears like he didn’t have his own house in order,” says the author.

What occurred is not all that unlike from what occurred when cryptocurrency lender Celsius filed for bankruptcy earlier this year, as well as when cryptocurrency broker Voyager or another cryptocurrency lender, BlockFi, went out of business.

Svanevik claimed that although clients trust these many organizations to manage their money, they actually act in a reckless manner with their deposits. Cryptocurrency is problematic because of how quickly prices may change, making it riskier than more conventional assets.

The fact that Bankman-Fried offered to intervene to attempt to salvage some of the crypto firms that collapsed earlier this year only serves to complicate matters further. Now that he is in need of assistance, it is unclear what will happen to the deals he struck to assist others when things at FTX were allegedly still going well. Carter opined that it was actually conceivable for none of the deals to be completed. Concerns of a type of crypto contagion, where one failure leads to another leads to another, have been raised in response to FTX’s failure.

According to Georgetown University finance professor Reena Aggarwal, “FTX was coming out as the rescuer of the sector and attempting to help others” over the past few months. Could there possibly be a second white knight to aid FTX? No one knows. According to Bankman-Fried, he is still looking for ways to provide his clients with liquidity.

All of FTX’s legal and compliance professionals have resigned, according to a report from Semafor on Wednesday. Ironically, Bankman-Fried was one of the company’s first investors. The website for Alameda Research has since been made private, and on Thursday, Bankman-Fried stated that the fund was ceasing trading. Bloomberg reports that US officials are investigating into FTX’s handling of customer assets and the connections between FTX, FTX US, and Alameda.

“FTX could have been squeaky clean for all we know, but when the largest player in the space turns and says, ‘I don’t like this company and I’m dumping everything I own in it,’ then the whole market starts to get worried and says, ‘It doesn’t matter if everything’s great there, I’m getting my money out,’” Borthwick, whose own exchange fully complies with US securities regulations, stated. “The Fed would have intervened if it were a regulated bank, but it isn’t.”

It doesn’t really matter whether this was a Bear Stearns scenario, a Bernie Madoff scenario, or something altogether else for clients holding money on the exchange if they don’t get that money back, which it’s uncertain they will. Not to mention the fact that the investors who supported FTX will almost certainly not see a return on their investment and will likely lose most or all of their money.

If you can’t get your money out, it doesn’t matter what the back-end scheme was, according to Svanevik. They used weak risk management practices and put clients’ savings at jeopardy, which is wrong.

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