What Happened to FTX, and How Will This Crisis Affect the Future of the Crypto Industry?
Whilst the anguish over the FTX crisis is understandable, events leading up to the crisis and the following ramifications will provide the crypto industry with an important lesson, which will not only ensure that this never happens again, but may result in the market coming out of this for the better.
First and foremost, my deepest sympathy goes out to all the people who are suffering at this difficult time. Now is the time to stand in solidarity with one another, and to check up on friends and acquaintances who may have been affected by recent events.
At the end of the day, the crypto community is much more than a group of investors and builders, and is made up of people from all walks of life who have come together under the banner of decentralization to create a better financial future for themselves and others. For this reason, it is important to not only help one another during times like this, but to also avoid succumbing to FUD, which coming from a first-hand survivor of three bear markets, never leads to anything constructive.
Instead, as a long time writer and optimist, the best thing I can do right now is to educate people on what has happened (and is happening), and to provide an analysis of the mistakes that were made, and how the crypto market will be impacted in years to come; possibly for the better.
Now, to address the elephant in the room.
Early this week, FTX (formerly the world’s second largest crypto exchange) had undergone a significant crisis that has sent shockwaves throughout the market, and which saw the value of FTT (FTX’s native token) plummet from $26 to around $2, causing users to withdraw their funds in a bank-run fashion.
As I write, it has just been announced that FTX has filed for bankruptcy, confirming early rumors that a bailout was unlikely to happen.
This comes off the back of an array of significant events that happened earlier this week, and which resulted in FTX halting withdrawals following $6 billion being withdrawn over a three-day period.
Whilst the exchange did its best to maintain calm, the damage had already been done, with FTX’s overall balance of digital assets having fallen by 87% over the past five days, according to data from blockchain analytics platform, Arkham Intelligence.
It is important to note that this crisis was first triggered following a report by Coindesk, which showed that at least $5 billion of Alameda Research’s (a trading firm owned by FTX CEO, Sam Bankman-Fried) $14.6 billion balance sheet was in FTT, whilst a sizable amount of its additional net equity was also in illiquid altcoins.
This naturally raised concerns regarding insolvency due the trading firm’s $8 billion of liabilities ($2.2 billion of which was collateralized by FTT), and led to the world’s largest crypto exchange, Binance, to sell $500 million of their held FTT; which not only reinforced the aforementioned allegations, but is also what caused the FTT dump, and rush to remove funds from FTX.
There was however some optimism a few days later, when Binance agreed to step in and buy FTX. But this was cut short following a review of FTX’s finances, which led to Binance walking away from the acquisition.
As might be expected, these recent events have since had a damaging ripple effect on the overall crypto market and its connected entities, with Bitcoin having fallen below $16,000 for the first time since November 2020 (although crypto markets have since rebounded slightly), many people having had their crypto net worth eroded overnight, and powerhouse investors like Sequoia having had to mark their FTX investment down to zero.
Even publicly traded companies with crypto links have not been able to escape the adverse effects, and have also experienced dumps in their share price; as seen with Silvergate Capital losing 12% share value, and MicroStrategy 20% on theirs.
So where are we right now?
FTX have since filed for Chapter 11 bankruptcy in Delaware, which has included 134 of the exchange’s firms filing for bankruptcy, whilst Bloomberg has reported that the SEC are currently investigating Bankman-Fried for potential violations of securities rules.
With the full extent of financial implications still being unknown at this moment in time, I believe that taking a step back in order to learn how this all came to pass is an important first step in making sure that this never happens again.
At risk of sounding cliche, those who cannot remember the past are condemned to repeat it, and I believe it is now down to the wider crypto community to set differences aside in order to come together to find much-needed solutions moving forward.
A Timeline of FTX
In order to contextualize the scale and impact of the recent events, I think it will help to look at the early beginnings of FTX and Bankman-Fried, the operational structure of the various entities involved, and notable events that led up to the current crisis.
FTX first launched back in May 2019, and was founded by former Wall Street trader, Sam Bankman-Fried, and ex-Google employee Gary Wang. The cryptocurrency exchange set itself apart by targeting professional traders as opposed to retail investors, and offered an array of different trading products including derivatives, options, volatility products and leveraged tokens.
Because of the experience and acumen of the founding team (as well as the niche value-proposition that was on offer at the time), the exchange quickly caught the attention of Binance, which consequently decided to invest into FTX, and aside from owning equity, Binance also took a long-term position in FTT to help prop up the FTX ecosystem.
This is where things get interesting.
At the time of this investment, it was the aim of Binance to grow the crypto market alongside FTX according to CEO, Changpeng Zhao (CZ), and thus when the relationship soured within a timeframe of 18 months, the foundations were set for a course of events that would shape the current crypto market.
FTX had since grown rapidly in size, and it was reported by a former staff member that CZ now viewed the exchange as a genuine global competitor. So whilst Binance would still own a sizable portion of FTT, Bankman-Fried would go on to buy out Binance’s shares in FTX; reinforcing CZ’s earlier claims.
Both were now competitors vying to become the dominant force in crypto, and in order to ramp things up, FTX opened the company up to multiple funding rounds, including a $900 million raise at $18B valuation in July 2021, and $420 million at $25B valuation in October 2021. It is worth pointing out that FTX’s backers included some of the biggest venture capital firms in the world, with the likes of Sequoia, SoftBank, Temasek and Tiger Global all having participated in these rounds.
FTX now had the financial backing in which to make big moves, and a spree of strategic acquisitions and sponsorship deals ensued, with FTX acquiring the likes of Blockfolio for $150 million in 2020, followed by multi-year sponsorship deals with globally recognised sporting brands such as Mercedes in 2021, and a $135 million deal for the Miami Heats’ NBA arena in Miami to be renamed the FTX Arena until 2040.
But FTX’s strategic investment went beyond the realm of crypto and sport, and Bankman-Fried began to show interest in the political and regulatory world, which involved hosting lavish events such as Crypto Bahamas, where leading traditional finance and political figures were invited, well as donating to political causes; notably becoming one of the largest donors to the Democratic party.
So whilst it is not uncommon for wealthy businessmen to donate to political causes, the long standing tussle between regulators and the crypto industry made this especially noteworthy, and Bankman-Fried arguably became the face of pro-crypto regulation following his testimony to Congress back in December last year.
This naturally created an outcry amongst decentralization advocates within the wider crypto community, and these concerns were further amplified after notable crypto influencer, Ben Armstrong (otherwise known as Bitboy), accused Bankman-Fried of trying to create a federal BitLicence.
As a result, Bankman-Fried, once a beloved figurehead, was now under attack from the crypto community, and it was the continued suspicion regarding his intentions that was arguably the precursor for the events and FUD that have since followed.
Where Things Went Wrong
Whilst FTX was growing in scale and influence, Bankman-Fried was also managing Alameda Research (which he founded back in 2017), which besides conducting its own trading activities, also provided market making, and for those unaware, this is the service of providing liquidity and depth to clients in return for profits made on the difference in bid-ask spreads.
Traditionally, market makers are hired by exchanges, hedge funds or projects, and in a nutshell, ensures that the exchange maintains its competitiveness and is able to attract new traders. However, due to the highly volatile nature of crypto, it’s a risky operation that requires stringent risk management and treasury management procedures.
What is especially important about the dual relationship between FTX and Alameda, is that besides earlier claims of a conflict of interest, Bankman-Fried had actually gone on to refute these claims by maintaining that both were separate entities in a Tweet back in August.
However, a breakdown of FTX’s company structure by Forbes appears to negate these assertions, with FTX and Alameda not only having very interconnected structures, but also inter-company loans via subsidiary and overarching entities linked to both.
So when FTX loaned $10 billion to Alameda Research without any public notice, recent revelations are now showing that this was done on the basis that Alameda could not repay the loan due to over leveraged positions, and the trading firm’s sizable positions in illiquid assets.
Fast forward to today, and amidst all of the unquestionable revelations that have come to light, FTX is now bankrupt, and Bankman-Fried has now resigned.
Since then, there has been an understandable atmosphere of despair and anger within the crypto community, especially amongst those who had sizable positions on FTX.
But as already mentioned at the start of this blog post, FUD rarely does anything other than expending precious energy that could be better used, and as has always been the case with the crypto community, there’s no shortage of savvy and innovative minds to come up with creative solutions for overcoming obstacles.
For example, there are reports that people are now recouping their FTX funds by buying NTFs from Bahamian accounts in order to receive side payments in return for Bahamians withdrawing funds.
However, it is important to acknowledge that although this is indeed a great show of community ingenuity, many will sadly not be able to recoup their funds, and thus, a focus on long-term solutions is perhaps the best use of people’s time at this current moment in time.
The good news is that this already appears to be happening.
What Can Be Learned
There are many constructive lessons that can be learned from the collapse of FTX, and it appears that leading players are already taking note.
Some of the industry’s top crypto exchanges have already opened up conversations regarding the need to not only increase reserves, but to also implement new proof-of-reserve mechanisms that will allow for much more transparency moving forward.
This comes off the back of earlier efforts made by leading crypto exchanges, Kraken and Gate.io, who had both been championing the use using proof-of-reserve mechanisms to further instill confidence amongst their users.
This has since caught the attention of Binance, which recently announced that it would be starting to implement their own proof-of-reserves in a recent Tweet.
It is also important to note that transparency goes beyond just implementing solutions at the technical level, and recent events can also provide a valuable lesson on the importance of being consistently transparent with investors, partners and users.
I’m of the opinion that rather than doubling down, had Bankman-Fried been a little more transparent with regards to the situation, then there could have been some ‘potential’ maneuverability in which to get the required support FTX needed. Confidence, after all, is everything during uncertain times, and Bankman-Fried sadly failed to instill it in those that could have maybe helped.
There is then treasury management to consider.
As correctly stated by CZ, the lesson to be learned from the recent events is that using one’s own token as collateral, not only is a conflict of interest in the first place, but is nowhere near solid enough to cater for the types of liabilities that large exchanges may incur when trading.
This will undoubtedly put an end to the misplaced belief in capital efficiency as a credible approach for keeping company balance sheets afloat, and this will no doubt serve the crypto industry well moving forward.
This is where things get controversial.
The collapse of FTX comes off the back of other notable incidents, as seen with the demise of crypto-lending company Celsius, and the liquidation of crypto hedge fund, Three Arrows Capital. Following both incidents, there were discussions over the need to increase regulatory standards to protect both users and investors, and whilst there have been pertinent bills that have arisen, nothing tangible or constructive has since taken root so far.
However, I believe that this latest collapse will be the last straw for regulators, who will no doubt be ramping up preparations for a head-on clash with the crypto industry, which will then beg the question — can regulation ensue that will satisfy both parties?
I addressed the importance of harmonious regulation in an earlier article I wrote, and my point remains the same.
Most legitimate crypto companies are not against regulation in and of itself, but are more adverse to stringent regulation that will put a stranglehold on innovation and value maximization. Therefore, it is now the responsibility of crypto leaders to come together and engage with regulators in a respectful and open manner, so that both parties can come away with mutually beneficial solutions to ensure that events like this never happen again .
This of course will not be easy, especially since Bankman-Fried was the former posterboy for crypto-regulation, and has since left the credibility of the industry in tatters.
But if we can learn anything from the signing of Glass-Steagall legislation following the Great Depression, it is that when both parties are open to listening to the other, even polar opposites can make headway on certain issues.
What The Future Holds
Thank you for taking the time to read this blog post.
Again, there is no denying that times are tough for many, and that it may take a considerable amount of time for things to rebound. But please, hang in there, and try to remain optimistic. Brighter days are ahead of us, and I remain hopeful that things will not only get better, but the crypto industry will come out stronger because of the lessons learned from the events leading up to today .
Take care everyone.
Constantin.
