FTX Crypto Exchange Bankruptcy: All The Facts you Need To Know

… A developing issue  (Updated)

The second largest crypto exchange FTX Group filed for bankruptcy hours after it assured customers that it had sufficient assets to cover its liabilities. This quick recap of one of the most eventful weeks in crypto history.

FTX Bankruptcy Timeline:

• On November 11, FTX Group, the former second-largest Cryptocurrency Exchange by trading volume founded by Sam Bankman-Fried, commenced voluntary proceedings under Chapter 11 of the United States Bankruptcy Code in the District of Delaware. 
  
• FTX has a native cryptocurrency token called FTT, which traders use to pay transaction fees.
  
• On November 2, 2022, CoinDesk reported on a leaked document showing that Alameda Research, a hedge fund founded by Mr. Bankman-Fried, held many FTT tokens.
  
• Binance CEO announced via Twitter on November 6 Binance would sell its held FTT tokens “due to recent revelations.” FTX then announced via Twitter that it suffered from a liquidity crunch from an unexpected bank run. Customers were making withdrawals at an incredible rate. FTT consequently dropped in value as withdrawals increased.
  
• On November 8, Binance said it had signed a non-binding agreement to bail out FTX by buying the company.
  
• On November 9, Binance announced it would no longer buy FTX, saying it had arrived at that decision “As a result of corporate due diligence, as well as the latest news reports regarding mishandled customer funds and alleged U.S. agency investigations.” 
  
• On November 10, FTX suspended the onboarding of new clients and withdrawals. A few hours later, FTX announced that it had agreed with Tron founder Justin Sun to establish a unique facility to allow holders of TRX, BTT, JST, SUN, and H.T. to swap assets from FTX 1:1 to external wallets.
  
• Crypto values have now fallen, with Bitcoin hitting a 2-year low value of about $16,000

FTX In Trouble: What Really Happened

The last 72 hours have been a roller coaster in the crypto industry. This is because FTX, one of the biggest crypto exchanges in the world, fell apart slowly in front of the public. Although this is still a developing situation, this is a quick rundown of what is known so far and how things might play out within the coming weeks.

Consequently, this article concerns Binance, FTX, and the crypto community. More importantly, It discusses how FTX went from ‘rescuer’ to ‘about to be rescued’ to ‘not rescued’ and then bankrupt.

Background.

Let’s start with some history. FTX.com is a Bahamian registered cryptocurrency exchange founded in 2019 by Sam Bankman-Fried (known as SBF within the crypto world), and by February 2022, the business had over one million users. Binance is one of the biggest cryptocurrency exchanges in the world in terms of how much cryptocurrency is traded there every day. SBF also owns Alameda Research, a quantitative trading firm specializing in cryptocurrencies. Its strategies include arbitrage, market making, yield farming, and trading volatility. 

A little more history. When FTX was founded in 2019, Binance initially invested in the company. However, as FTX grew in size, so did the rivalry between both companies, so in 2021  FTX bought back Binance’s stake in the company. Binance was given 2.1 billion in BUSD and FTT, FTX’s native token. 

Now, let’s talk about Alameda’s research. As was already said, Alameda Research is a quantitative trading firm that specializes in cryptocurrencies. It was started by SBF in 2017 and is focused on cryptocurrencies. But on November 2, 2022, CoinDesk published a balance sheet of Alameda’s research that had been leaked. The balance sheet showed that most of the company’s assets were held in its token, FTT, and that many of its coins couldn’t be traded easily.

According to a crypto expert, Dylan LeClair, “the total market cap of FTT is $3.35 billion, and the fully diluted market cap is $8.8 billion.” “You couldn’t sell $1 million of this thing without pushing the market significantly lower.” Dylan LeClair pointed out that Alameda’s FTT holding amount appears to be higher than the token’s entire market capitalization.

Furthermore, it showed that Alameda had about 14.6 billion dollars on its balance sheet as of June 30 this year. This means that most of the assets on Alameda Research’s balance sheet were FTX’s native token, FTT. But, from the leaked information, it would appear that FTX used its token, FTT, as collateral to take out loans in USD and other cryptos. Hence, the collapse of the price of FTT meant that Alameda would have to sell its assets. While the CEO of Alameda Research, Caroline Ellison, debunked the leaked balance sheet, publicly stating that the “balance sheet info that has been circulating recently” only showed a subset of Alameda’s corporate entities and that the firm has more than $10 billion in assets.

Amidst this,  Reuters reported that FTX had seen around $1.6 billion in withdrawals, and by the afternoon on November 8, 2022, that figure had jumped to $6 billion. On November 10, FTX suspended the onboarding of new clients and withdrawals. It would appear that FTX didn’t have the liquidity required to fulfill withdrawals.

To cover the liquidity crunch, FTX reached out to their rival, Binance. The two companies signed a non-binding Letter of Intent (LOI) with the goal of Binance buying FTX.com after it had done its due diligence and carefully looked at the situation. For context, a letter of intent (LOI) is not a concrete agreement to proceed with the deal. Where the due diligence (DD) exercise uncovers some unpleasant details about the company’s financial information, the company undertaking DD may withdraw, which was eventually the outcome. A day after this letter of intent was signed, Binance backed out of the deal, which sent shockwaves across the industry and created a contagion effect that plummeted the value of other cryptocurrencies.

In all of this, the puzzling question is how the value of FTTs significantly affected the FTX’s ability to liquidate. A standard theory is that FTX used FTT as collateral for loans.

Crypto expert Andrew Jikh provided a theory:

•  A company creates a hypothetical token called FTT.
• Give it artificial value by providing a use case and utility, then buy up most of its supply and burn the rest to increase its value.
• After the token gets value, they can send these tokens to their sister company, Alameda research, where they can show on their balance sheet actual profits.
• They can then leverage that balance sheet and borrow other assets against it.
• They can send all those crypto back to FTX.
• Rinse and repeat.

While this is just a theory since the parties haven’t confirmed it, the system, in theory, works fine until people have some reason to withdraw all their funds at once, and then it breaks.

The Impending Crypto Armageddon (Crypto Winter 2.0)

Liquidity is one significant risk crypto exchanges have to look out for. When people get scared by recent events and try to withdraw all their funds at once, the crypto exchange has to fulfill liquidity demands. This is because when people sell their crypto assets, they exchange them for fiat money, and if the crypto exchange platform does not have the cash to pay, it has to liquidate its assets to honor those withdrawals. The cryptocurrency industry has a long history of trying to win the trust of regulators, investors, and customers. The fall of exchange as large as FTX will spread fear, uncertainty, and doubt within the market. 

Potential Legal Issues

The Securities Commission of The Bahamas announced that it had taken action to freeze assets of FTX Digital Markets and related parties, as the crypto exchange is teetering on the verge of collapse due to liquidity fears. The Regulator said it had also suspended the registration and applied to the Supreme Court of The Bahamas for the appointment of a provisional liquidator of FTX Digital Markets Ltd. Department of Financial Protection and Innovation (DFPI) in the state of California announced on November 10 that it will open up an investigation as to the “apparent failure” of the cryptocurrency exchange FTX.

The U.S. SEC, DOJ, and other regulators are looking at the other regulated entities involved to determine how exposed they are. This event would make regulators look at crypto more closely and push the idea that it may not have real value. This has also led to the aggressive call on the regulators to enforce stricter transparency concerning custody and transparency of customer funds on the part of crypto exchanges.

FTX founder Indicted For Wire Fraud and Money Laundering

Samuel Bankman-Fried, aka SBF, the founder of cryptocurrency exchange FTX, has been charged with conspiracy to commit wire fraud, conspiracy to commit commodities fraud, conspiracy to commit securities fraud, conspiracy to commit money laundering, and conspiracy to defraud the Federal Election Commission and commit campaign finance violations.

He is accused of stealing billions of dollars in customer funds and deceiving FTX and Alameda Research, a cryptocurrency hedge fund founded by Bankman Fried. The charges carry a maximum prison sentence of 20 years for wire fraud and 5 years for the other charges.

The indictment is the result of an investigation by the US Department of Justice, FBI, and other law enforcement agencies, as well as the SEC and CFTC, both of which have initiated separate civil proceedings against Bankman-Fried.

Conclusion: The Future of Crypto

Following the success of Lunar, Celsius, Blockfi, and Voyager, some commentators have called for increased regulatory oversight of centralized exchanges, which can hold billions of dollars in customer assets. While others have said this event underscores the importance of decentralized exchanges, one runs entirely on smart contracts and gives root ownership to investors. 

 Disclaimer: This is a developing story, and we will update it as time progresses.